Columbia Banking System Inc (COLB) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking System's third quarter 2012 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. (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. Please go ahead.

Thank you, Martina. Good afternoon, everyone, and thank you for joining us on today's call to discuss our third quarter results. I hope you've all had a chance to review our earnings press release, which we issued this morning and which is also available on our website at columbiabank.com. With me on the call today are Clint Stein, our Chief Financial Officer; and Andy McDonald, our Chief Credit Officer.

As we outlined in our press release, our third quarter results showed the continued improvement in our credit quality, the relative stability of our operating net interest margin, a rise in fee income, and the announcement of our merger with West Coast Bancorp.

Clint will begin our call by providing details of our earnings performance for the quarter, including the financial benefits of our FDIC-assisted transactions, our capital position, and net interest margin. Andy McDonald will review our credit quality information, including trends in our loan mix, allowance for loan losses, and our charge-offs. I will conclude by giving you our thoughts on the economy here in the Pacific Northwest, an update on our merger with West Coast Bank and a brief outline of our strategies as we move forward. We will then be happy to answer your questions.

As I always need to remind you, we will be making some forward-looking statements today which are subject to economic and other factors. And for a full discussion of the risks and uncertainties associated with the forward-looking statements, please refer to our security filings and in particular, our Form 10-K filed with the SEC for the year 2011.

And now, I would like to turn the call over to Clint to talk about our financial performance.

Thank you, Melanie. Earlier today, we announced third quarter earnings of $11.9 million, $0.30 per diluted common share. This compares to $18.9 million for the same quarter of 2011 or $0.48 per diluted common share. Our reported earnings decreased considerably over the same quarter last year due to the substantial positive impact acquisition accounting entries had on our third quarter 2011 earnings.

On a linked-quarter basis, our reported results for the third quarter are consistent with our second-quarter performance. However, there are some subtle differences, so I would like to review a few of the items that made an impact to the results of the third quarter as compared to the second quarter of this year.

We've provided a table in our earnings release illustrating the impact of certain accounting entries associated with our acquired loan portfolios. The net effect of our acquired loan accounting resulted in additional pre-tax income of $2.6 million for the current quarter. This is a reduction of $800,000 when compared to additional pre-tax income from acquired loans of $3.4 million for the second quarter of 2012 and a reduction of $2.5 million from the first quarter of this year.

As expected, the accretion in interest income of the discount on the other acquired loans portfolio, also known as the Bank of Whitman portfolio continues to decline and is becoming less significant to the results of our acquired loan accounting. The discount accretion recorded in the third quarter was $613,000, a $524,000 decrease from the $1.1 million in the second quarter of 2012. But more significantly has declined $2.5 million from the first quarter. If the accretion income from the discounted loan portfolio is removed from the total, the net change in the third quarter pre-tax income resulting from the acquired loan accounting entries was a decrease of $261,000 when compared to the second quarter of this year.

This is notable because the individual components of our acquired loan accounting entries can change significantly by millions of dollars in some cases, but the change and the impact to earnings is relatively inconsequential. While the GAAP accounting entries for our covered loan portfolios create some geographic noise within the components of the income statement, the volatility they have on earnings has moderated in recent quarters.

Our tax-equivalent net interest margin for the third quarter was 5.52%, down from 6.53% for the same quarter last year and 5.88% for the second quarter of 2012. The margin was positively impacted by 112 basis points as a result of the additional accretion of income related to our acquired loan portfolios as compared to 144 basis points in the second quarter. The change in our reported net interest margin is an example of why it is important to understand the geographic interplay of the acquired loan accounting I previously mentioned. The net interest margin excluding the additional accretion income was 4.4% for the third quarter compared to 4.44% and 4.49% respectively for the second and first quarter of 2012.

As you can see, our operating net interest margin is declining each quarter. Historically, our operating net interest margin has been consistently in the 4.25% to 4.50% range regardless of the rate environment. We continue to maintain our disciplined approach to deposit pricing. Our average cost of interest-bearing deposits for the quarter was 20 basis points, down from 23 basis points in the prior quarter.

Our cost of total deposits for the quarter was just 14 basis points, down from 16 basis points in the second quarter. We still have some limited ability to lower our deposit costs and have $105 million of our $113 million in Federal Home Loan Bank advances maturing during the fourth quarter of 2012 and first quarter of 2013. Unfortunately, our anticipated lower funding costs will not be enough to slow the velocity of margin compression resulting from the anticipated length of this low rate environment we are currently experiencing.

On a linked-quarter basis, average interest-earning asset yields decreased 39 basis points to 5.72% in the current quarter, down from 6.11% in the second quarter. The decrease in yield is due in large part to the reduced accretion income on our acquired loan portfolios, but lower loan origination interest rates and investment yields are a factor as well.

We originated roughly $130 million in loans during the third quarter and have originated in excess of $400 million year-to-date. New loans were originated during the third quarter at rates that are about 55 basis points lower than the existing portfolio.

The yield on our non-covered loan portfolio declined 10 basis points from the second quarter to roughly 5.07%. The yield on the investment portfolio declined 21 basis points to 3.24% during the third quarter as compared to 3.45% in second quarter of 2012. With a portfolio duration of 2.77 and current CPR rates for our mortgage-backed securities averaging in the mid-20s, we expect there will be significant cash flows reinvested at lower market rates during the coming quarters, putting additional downward pressure on the yield of the investment portfolio.

Total non-interest income was a loss of $911,000 for the third quarter, a decrease of $12.7 million from the second quarter. The decline was due entirely to the $13 million change in the FDIC loss-sharing asset recorded as a reduction in non-interest income during the current quarter, compared to a $168,000 reduction during the second quarter. At the risk of being redundant, this is another example of the previously mentioned geographic noise that occurs as a result of the GAAP accounting entries stemming from our FDIC-assisted acquisitions.

If we compare non-interest income before the change in FDIC loss-sharing asset, the third quarter experienced an increase of $44,000 over the second quarter of this year and nearly $800,000 or 7% from the first quarter's run rate. The increase from the first quarter is driven by higher service charges which increased roughly $430,000 or 6%, and additional mortgage banking income of $324,000.

Total non-interest expense was $40.9 million for the current quarter, an increase of $1 million from $39.9 million in the second quarter of this year. The increase was due to $1.1 million of expense associated with our recently announced merger agreement with West Coast Bancorp. While there will be ongoing merger expense as we move forward in the process, we don't expect it to be at the same level as the third quarter until we approach the closing date.

Current-quarter merger expenses are significantly impacted by the cost associated with our due diligence efforts and other professional expenses. Absent the merger activity, total non-interest expense was unchanged from the $39.8 million reported in the second quarter of this year, and was fractionally lower than the $39.9 million reported for the third quarter of 2011.

After removing the effect of the FDIC clawback liability and the net benefit of OREO and OPPO activity, non-interest expense increased roughly $400,000 on our linked-quarter basis. The increase was driven by higher compensation expense of $557,000 over the second quarter of this year. The entire increase was the result of obligations accumulated under our incentive compensation program, which is heavily influenced by the production activities of our bankers. We continue to be well capitalized. At September 30, our total risk-based capital ratio exceeded 20%, while the leverage ratio was approximately 12.8% and our tangible common equity to tangible assets ratio was 13.2%.

Now, I'd like to turn the call over to Andy McDonald, our Chief Credit Officer.

Thanks, Clint. During the quarter, our non-covered loan portfolio increased modestly, and growth was again centered in commercial business loans and commercial and multifamily real estate term loans. Growth in business loans remains centered in agricultural, forest and fishing, followed by finance and insurance, and healthcare and social services.

Growth in commercial real estate term loans was centered in office properties, primarily in the owner/occupied bucket along with multifamily. Commercial real estate construction loans also saw some modest growth, with owner/occupied healthcare property types driving this growth. The growth in business loans was, however, offset by a continued contraction in our consumer portfolio, which declined to $6.6 million. As we have seen in the past, the decline was centered in our HELOC portfolio, as homeowners are refinancing to lower, conventional, first mortgage products at historically low rates.

The covered portfolio continued to contract, declining by over $54 million before discounts and loan loss provisions. Most of this decline was due to the resolution of problem loans within these portfolios, as we continued to address the issues associated with loans acquired through FDIC-assisted transactions. The vast majority of these resolutions are occurring in the commercial real estate portfolios, both permanent and construction; and of course, the one-to-four family residential construction portfolios as well. Year-to-date, the portfolio has contracted by $167 million and about 80% or $134 million were problem assets. The balance of the contraction is seasonal line usage along with scheduled payments.

Looking at our non-performing assets, we continue to see these declines and they now represent about 1.2% of our non-covered assets, as of September 30, 2012, down from 1.56% as of last quarter and 2.15% as of this time last year. Year-to-date, we've been able to reduce non-performing assets by 38%.

NPAs to loans and OREO to OPPO for the quarter also improved, declining from 2.7% to 2.1%. As for each of the portfolio segments, they are as follows. Our one-to-four family perm portfolio remained stable. We had about $2.3 million non-performing assets in this category and that kind of remains the same.

In our commercial perm portfolio, we did see improvement this quarter and compared to year-ended 2011, the non-performing assets have declined from 2.8% to 2.4%. One-to-four family construction has improved again and it stood at a 33.9% as of December 31, 2011, and it's now down to 16.8%. Commercial construction saw a nice decline. It went from 19.2% as of December 31, down to 2% this quarter, as we were able to resolve most of our condominium projects. Commercial business saw some modest improvement, declining from 1.9% as of December 31 to 1.2%. And our consumer portfolio has been holding relatively steady at around 1.3%.

For the quarter, the Company made a provision for originated and discounted loans of $2.9 million, down from $3.7 million last quarter. The provision was primarily driven by the level of net charge-offs during the quarter.

With that, I would like to turn the discussion back over to Melanie.

Thanks, Andy. While the economic picture here in the Pacific Northwest still holds challenges, we are seeing uneven but significant improvements in market areas, as the economy moves in the right direction. According to Marple's Northwest Business Letter, large metro areas recovering faster than states overall. They cite our major metropolitan areas of Seattle, Tacoma and Bellevue in Washington and Portland, Oregon as excellent examples. Even though the Northwest's two largest metro areas were hit as hard as Washington and Oregon as a whole, they are setting the pace in recovery with employment rising faster than average. I mentioned last quarter that the Seattle, Tacoma and Bellevue area experienced the nation's second highest rise in wages this past year.

Washington's unemployment showed modest improvement in September, with the jobless rate falling to 8.5% from 8.6% in August. The state added about 1,200 jobs in September, mostly in education and the leisure and hospitality sectors. Our State Chief Economist said that the trend over the past 31 months shows an increasing rate of job growth. For example, from January through September 2011, Washington added over 32,000 jobs whereas from January through September of this year, about 52,000 jobs have been added.

Oregon's unemployment rate also dipped slightly in September to 8.7% from 8.9% in August, the state's lowest rate since October 2008. A year ago, the state's rate was 9.4%. The leisure and hospitality and financial activities sectors added workers during the month, while government and professional service sectors decreased. We continued to see some positive signals toward a real recovery in the housing market. Although sales have plateaued during the quarter, prices continued to gain as inventories dropped. The Urban Land Institute has listed the Seattle area as one of the country's top markets, ranking our area number seven for investment, development and home buildings. According to this institute, Seattle's attractiveness comes from the diverse economy, high quality of life, and being one of the nation's quote brainpower centers.

For the nation overall, or like the nation overall, housing starts, particularly multi-family, are up considerably in Oregon from their recessionary lows. Sales of single-family homes have improved as well, although progress is a bit bumpier. Expectations are for these gains to continue moving forward. The region's largest private employer is Boeing who continues to hire as firm orders roll in, adding to their backlog for commercial airplanes. The company is predicting that they will hire hundreds of new production workers, perhaps close to 1,000 to staff assembly lines in Renton, Washington for its current best-selling 737 and one line for its newest variation, the 737 MAX. Boeing will also add hundreds of engineering staffs for the MAX.

Other types of manufacturing, electronics, fabricated metal, machines, food products, and industrial equipment continued to do very well, also in Washington and Oregon. Manufacturing is a big player in Oregon, particularly Portland which has over 100,000 manufacturing jobs, 17th among American metro areas. Nearly 20% of Oregon's state gross product comes from manufacturing, which has been a bright spot for the state, primarily due to Intel and the high-tech industry.

And talking about the economy of our area, I must also mention our military with its $3 billion payroll in Washington State. The headquarters for the new division at Joint Base Lewis-McChord is now fully operational and is adding in more personnel.

Agriculture-related industries in our region continued to do very well, building on last year's production record, driven by exports to Asia, especially China. For example, Washington's apple harvest looks to break records for both price and production, since much of our agriculture has benefited from the difficult weather conditions that afflicted so much of our country this year. Washington State could account for as much as 65% of all apples grown in the US, which is up from the usual 50% to 60%.

The Pacific Northwest has some real advantages that we believe will help us outperform the nation as a whole going forward. Certainly, the improving economy has been a factor in our good progress in resolving problem assets in both our covered and non-covered loan portfolios.

I'd like to give you a quick update on the merger with West Coast Bancorp, which we announced on September 25. We look forward to receiving shareholder approval from both companies most likely late in the fourth quarter and expect the transaction to be completed sometime in the first quarter 2013. Our strategic plan to integrate Columbia and West Coast is underway with cross-functional teams from both banks playing essential roles. We anticipate a smooth transition and we're anxious to join forces with West Coast's great team of bankers.

For the past four quarters, we have provided a full payout of earnings with our regular and special dividends since we didn't see the need to accumulate capital and our high capital ratios allowed us to remain in a position to take advantage of any strategic opportunities which might arise. This scenario has, of course, changed with our announcement of our acquisition of the West Coast. We're discontinuing our special dividend and we'll pay a regular cash dividend of $0.09 per common share on November 21, 2012 to shareholders of record as of the close of business on November 7. This $0.09 regular dividend represents a dividend yield of 2%.

With that, this concludes our prepared comments this afternoon. As a reminder, Clint Stein, our Chief Financial Officer; and Andrew McDonald, our Chief Credit Officer; are with me on the call to answer any questions you might have. And now, Martina, will you open the call for questions, please?

Certainly. (Operator Instructions). Joe Morford, RBC Capital Markets.

Hi, Joe.

Thanks. Good afternoon, everyone. Hello, Melanie. I guess two questions. First is sort of more of a housekeeping one, but the remaining accretable yield of $188.5 million, kind of over what period do you currently expect to realize that income stream or when will it be exhausted?

It's, for the most part, probably over the next four years to five years. It's been running on a carry-value basis at about $35 million in terms of the portfolio runoff, $35 million a quarter. As it gets smaller, then that quarterly run rate is going to get lower, but the bulk of it, let's say, probably within the next four years.

Okay. Perfect. And then, the other question is just, the loan growth was a little bit [slow release] on an end-of-period basis relative to the second quarter. Was that somewhat seasonal and as we get into the fall, are you seeing more of a pickup at all, particularly on the commercial side or are people still pretty cautious going into the fiscal [cliff lifts] and things like that?

Andy?

Yes, we didn't get any lift this quarter from line usage. It remained relatively unchanged from last quarter and I think that does reflect some of what you're talking about in terms of businesses being a little bit more cautious in terms of making investment. We did see a lift in our ag and fishing portfolio. But when you look at the amount of activity in there, the dollars in and the dollars out, depending on which commodities you are in, we did see in that case, which is a good thing, guys selling stuff and paying us down there as well, but certainly commercial real estate continues to be a pretty good area for us and at quarter-end, although it doesn't show on the balance sheet, we had $40 million in closing.

And the pipeline.

$40 million in terms of the pipeline or in terms of the closed at the quarter-end?

No, in terms of deals that we're in closing, but not closed as of September 30.

Okay.

The press line is still really strong in retail and commercial banking as well.

Okay, that's very helpful. Thanks so much.

Thanks, Joe.

Jeff Rulis, D.A. Davidson.

Hi, good afternoon.

Hi, Jeff.

Congrats on the brainpower designation in the region.

Yes, we have to check that one.

Right. The question on the -- really just on the merger expenses expected, you stated at $30 million, was hoping to get a little bit of sort of timeline on that. You did the close in a little this quarter, but maybe if you could comment on what you're expecting in Q4 and then really in Q1, do you think the bulk of them come then? Some color there would be great.

Sure. Well, for Q4, there is certain expense and we talked about -- there is a considerable expense associated with our due diligence efforts and we had that in the third quarter and then we had some advisory fees and things of that nature. So in terms of what we are looking in the fourth quarter, we won't have the due diligence expense. We'll still have some odds and ends of just as we work towards the close and work towards the integration, developing the integration plan. But, I don't want to really give you a number because there are so many factors in terms of what it would be, but it will be considerably less than the $1.1 million is what our expectation is right now.

For the first quarter, and the timing of the close, really where the $30 million -- the bulk of the $30 million in anticipated costs come in is either at the close, right after the close. So, I think that there could be an uptick in the first quarter, late in the first quarter. I don't have a good estimate to give you for that, but I think the bulk of the cost will be immediately following the close. And so depending on the timing of the close, if that hits first quarter, if it hits the second quarter, it's -- just depends on what the actual effective date of the merger is.

Okay. So maybe a better way to put it, you'd expect the $30 million to be basically recognized by the end of Q2, that's pretty range bound, but it's not stretched across the year?

Yes. I would say that there will be some that will come in because part of what we factored into that is our conversion expense and integration expense, and that will take a couple of quarters or so after the close. But then, there is a lot of the -- and probably more. I would say that the majority of it would occur within a quarter of closing. But there will be some fairly significant expense going out two quarters or so.

Okay. That's all I had. Thanks.

Thanks, Jeff.

Brett Rabatin, Sterne, Agee.

Hi, Brett.

Hi. Good afternoon, Melanie. How are you?

Good. Great. How about you?

I'm great, thanks. Wanted to go back to the commentary around just the margin and some pretty good color around loan production raise you're during there. But I wasn't clear on where you're buying securities today and how much maybe Clint and you are expecting that you have to put back in the portfolio from cash flow and kind of give us maybe a little better picture on what you're investing in and how much you're going to have to do?

Sure. Well, when we think about our operating margin for the third quarter and looking at what we've seen from others who have released earnings prior to us, we didn't have as much compression as what probably the average is of the reporting banks have had. But the challenge that we have is and what I wanted to illustrate with my prepared remarks was that we do have significant cash flows that have come in off the investment portfolio to the extent that we can put them to work in the loan portfolio, that's obviously our preference.

And as Melanie mentioned, our commercial and retail pipelines look good. So, the hope is that a lot of that cash flow gets absorbed through loan growth. There is some cash requirements related to the merger and so that will take some of that. And so if you look at to build out some facts we had in the third quarter, a little bit of that is in preparation for our expectations of needs over the next six months. But, the fact that what we are doing in the investment portfolio really, it's a challenge. I think anybody they could talk to is going to feel the same way.

The challenge right now to do anything in the investment portfolio, it gives you a decent return. And, so our approach is, we want to be measured. We're not interested in increasing our exposure to mortgage-backed securities from where it's traditionally been. So I guess, we would look for maybe a little more diversification within the investment portfolio and with an eye towards certainty of cash flows.

Okay. And then, you were talking about loan growth. Did you give us an idea of how much in loan payoffs you had during 3Q?

Yes. Let me see.

So, I assume that impacted the -- you mentioned $130 million of loan production. I don't know if you had the utilization factor while you were looking for that too.

We're looking, yes.

Okay. And then, just lastly, I was kind of curious, I know you still got some accounting adjustments to make, but was just kind of thinking about pro forma capital post the transaction. And [didn't know], Melanie, if this was -- West Coast was a big enough deal where we'd keep you from doing anything else or if you were seeing other deals out there or maybe you could give us a little update on M&A while you're looking for those numbers?

Well, on a pro forma basis, post closing, we had expected that our capital ratio would be about 14.6%. So, we still have a healthy capital level. I would say that the consideration of other deals would not necessarily be precluded because of any capital issues. The one thing that we do want to do is to make sure that the integration of West Coast goes very smoothly and that our focus is on that. So for the next several months, that's what we're going to be spending our time doing. But I do think there is going to be continued consolidation of banks from the Pacific Northwest.

Okay. Great. I didn't know if [quite a few] were able to find those -- the payoff number?

Yes. The -- and sorry for the delay. We've got a report here and it's just sequenced a little differently than how your question was phrased. So it was about $55 million.

Okay. Okay. Thanks for the color.

Thanks, Brett.

Aaron Deer, Sandler O'Neill & Partners.

Hi, Aaron.

Good afternoon, everyone. How are you doing, Melanie?

Just great. And you?

Just getting back to the kind of line of questions regarding the margin outlook. I'm just wondering what more do you think might be able to be done on the funding side. I think you touched on deposits a little bit, maybe just talk about that a little more. And then, also, I think there might be some FHLB advances or repos on the balance sheet. Any consideration there in terms of paying those down?

Sure, Aaron. We've spent a lot of time here recently focused on the liability side of the balance sheet and the majority of the Federal Home Loan Bank advances, and in my prepared remarks, I noted it was $105 million of the $113 million will mature between basically now and early February, and we're going to include a table in our 10-Q this quarter that highlights that. The challenge is, is that it will help, but it's $105 million on earning assets of roughly $4.250 billion. So -- while that will help give us a little bit of boost if not going to crop up or support the -- operating them.

When it comes to the repurchase agreement or the remaining $8 million of Federal Home Loan Bank advances, we have looked at those and if it makes economic sense, we'll consider prepaying those. But there is a lot of variables that we have to take into account when we're looking at that.

On the deposit side, we're pretty low. Melanie always says that how much lower can we go, and in the second quarter, at least 23 basis points. And now, with the third quarter, our answer is updated to say 20 basis points. But, we are -- we've been pretty aggressive with our deposit pricing, and we've actually taken steps to reduce those further here as we move forward.

Okay. And I apologize. I got on the call a little late. So I apparently missed it. But on those FHLB advances that are maturing, what's the current rates on those?

They are about 2.5%.

Okay. So, it's not huge. The --

And there is a little bit -- the reason I say about is because there is a little bit of noise in there because some of those were ones that we inherited through our assisted transactions. So, they have a little higher rate, but then there is a premium that we offset that with.

Okay. And then, lastly, Andy, on the credit side, you had a lot of success in getting things resolved over the course of the year. In terms of what's -- how things look forward heading into the fourth quarter, there is much in the way of contracts or you expect maybe to close out some of these OREO properties or anything?

I don't really have like a pipeline report in terms of -- that I can give a number on that. We do have a number of things that are under contract, but I just -- I'm one of these people that I don't try to celebrate the victory until the game is over.

Okay. That's great. Thanks for your help.

Thank you.

(Operator Instructions). Jacque Chimera, KBW.

Hi, Jacque.

Hi, good afternoon, everybody. Hi, hi, Melanie. Hey, I just had a question related to the economic update that you gave and thank you for all of the color, that was very helpful. I just wanted to see it -- my interpretation with that, you sounded pretty positive about the areas within your footprint and I wanted to see looking at the longer time frame how that translates into maybe some fee generation and loan growth and what do you think the economy improvement will be for those.

Well, I still wish that I could equate improvement in the economy to what the loan growth is. It's just a little bit hard to judge that because so much of it is just psychological and are people really ready to make capital investments. We're still seeing a lot of the loan growth coming from the larger institutions where perhaps people are really wanting to gravitate back to a community bank experience, but it doesn't necessarily mean that no -- new loans are being generated in the region.

What we are seeing on -- is more interest in the Pacific Northwest from companies outside of the Pacific Northwest that really wants to be here and that could equate to new loan growth. We're just seeing in general good C&I loan growth, but again, it's just coming from transferring debt. People are trying to do more with less employees, so we're not seeing a lot of net new loan growth in our more traditional longstanding small businesses. So I guess, long story short, it's really hard to judge, Jacque, but I do feel very optimistic about our economy overall and feel that when people really do have more confidence in the stability of the economy that our region is going to come back more soundly than maybe some other parts of the country.

Okay. Thank you, that's very good color and that's what all I had, the rest of my questions have been answered.

Okay. Thanks, Jacque.

We have no further questions in queue. I'll turn the call back to the presenters for closing remarks.

Okay. Thanks, Martina, and thanks everyone for joining us. We'll look forward to talking with you after the first of the year.

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