Banner Corporation (BANR) Q1 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Banner Corporation’s First Quarter 2012 Conference Call and Webcast. [Operator Instructions] Today’s conference is being recorded, April 24, 2012. I would now like to turn the conference over to Mark Grescovich, President and Chief Executive Officer of Banner Corporation. Please go ahead, sir.

Thank you, Alisha and good morning, everyone. I would also like to welcome you to the first quarter earnings call for Banner Corporation. Joining me on the call today is Rick Barton, our Chief Credit Officer; Lloyd Baker, our Chief Financial Officer; and Albert Marshall, the Secretary of the Corporation. Albert, would you please read our forward-looking Safe Harbor statement?

Surely. Good morning, everyone. Our presentation today discusses Banner’s business outlook and will include forward-looking statements. Those statements include descriptions of management’s plans, objectives, or goals for future operations, products or services, forecast of financial or other performance measures, and statements about Banner’s general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management’s discussion. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and a recently filed Form 10-K for the year ended December 31, 2011. Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations.

Thank you, Albert. As announced, Banner Corporation continued our improving performance again in the first quarter reporting a net profit available to common shareholders of $7.2 million or $0.40 per share for the period ended March 31, 2012. This compared to a net profit to common shareholders of $3.1 million or $0.18 per share for the fourth quarter 2011 and a net loss of $9.8 million or a loss of $0.60 per share in the first quarter of 2011. Looking at earnings before preferred stock dividends and discount accretion, Banner’s net income improved to $0.52 per share for the first quarter of 2012 compared to a net loss of $0.48 for the same period 2011. The first-quarter performance provided consistent evidence and confirmed that through the hard work of all of our employees throughout the company, we are successfully executing on our strategies and priorities to strengthen our franchise and deliver sustainable profitability to Banner. And our return to profitability for the last 4 quarters further demonstrates that our strategic turnaround plan is effective and we are building shareholder value. Our operating performance again this quarter showed improvement on every key metric when compared to the quarter one year ago. Our first quarter core revenue increased 7% when compared to 2011. Our net interest margin expanded to 4.11% in the first quarter of 2012 compared to 3.94% in the first quarter of 2011, and our cost to deposits decreased to 52 basis points in the most recent quarter compared to 89 basis points in the same quarter of 2011. These improvements are reflective of our super community bank strategy that is reducing our funding cost by remixing our deposits away from high-priced CDs, growing new client relationships, and improving our core funding position. To that point, our core deposits again increased in the most recent quarter and increased 7% compared to March 31, 2011. Also our non-interest-bearing deposits increased 24% from one year ago. It’s important to note that this is organic growth from our existing branch network. In a momentum Lloyd Baker will discuss our operating performance in more detail. Clearly, improving the risk profile of Banner and aggressively managing our troubled assets has been and will remain a primary focus of the company. Again this quarter we continued making very good progress toward that objective. Our non-performing assets have been reduced nearly 22% compared to the fourth quarter of 2011 and 59% compared to March 31, 2011. Further, the most problematic part of the portfolio, our 1 to 4 family residential construction lot and land portfolio has reduced $61 million from the first quarter of 2011 and nearly $840 million from the peak outstanding. That portfolio now stands at just 7.4% of total loans. In a few moments Rick Barton, our Chief Credit Officer, will discuss the credit metrics of the company and provide some context around the loan portfolio along with our continued successful execution in aggressively managing our problem assets. Although we are making good progress reducing troubled assets, we recorded a still large $5 million provision for loan losses in the quarter. As a result the coverage of our allowance to non-performing loans again increased and is now 126% at March 31, 2012 up substantially from the first quarter of 2011. Also for the quarter, we recorded $1.7 million of valuation adjustments on real estate owned. While credit costs remained elevated in the first quarter and above our long-term goal, Banner’s reserve levels are substantial and have been improving. Our capital position and liquidity remains strong. At the end of the quarter our ratio of allowance for loan and lease losses to total loans was 2.52%. Our total capital to risk weighted assets ratio improved to nearly 19%. Our tangible common equity ratio improved to 10.15% and our loan to deposit ratio was 94%. In the quarter and throughout the preceding 24 months, we continued to invest in our franchise. We have added additional bankers and commercial and retail talent to our company in all of our markets, and we have invested in new sales and credit training programs to further develop our bankers and integrate Banner’s new credit and sales culture. These efforts are yielding very positive results. Recently Banner was notified by the well-known survey agency J.D. Power and Associates that Banner Bank was rated number one of all banks for customer satisfaction in the Pacific Northwest and we ranked in the top 10 nationwide. Finally, our persistent focus on improving the risk profile of Banner that I spoke to has significantly reduced our volume of classified assets, improved our earnings and demonstrated management’s ability to execute our turnaround plan in a very difficult economy. As a result, in the quarter, our Memorandum of Understanding with the Department of Financial Institutions for the state of Washington and the FDIC was terminated. Also, subsequent to the end of the quarter, our Memorandum of Understanding with the Federal Reserve Bank of San Francisco was also terminated. We appreciate this recognition by our regulators of the progress that our company has made. I will now turn the call over to Rick Barton to discuss the trends in our loan portfolio. Rick?

Thanks, Mark. My comments this morning will be brief. Mark has already noted that our quarterly results again show solid progress in our credit quality metrics. I would like to highlight and comment on several of them. Net charge-offs were $6.4 million, down 22% from the linked quarter and down in absolute dollars for the sixth consecutive quarter. Non-performing assets now stand at 2.24% of total assets and for the quarter decreased $26 million, down 22%. Non-performing loans decreased by 14% and now are 2.1% of total loans. In the residential construction portfolio workout activities have reduced non-performing loans to $16.9 million divided between construction, $6.3 million and land, $10.6 million. Non-performing 1 to 4 family permanent loans however increased during the quarter by almost $2 million reflecting continued weakness in home prices. This fact of life will continue to impact this sector in future quarters but we do not expect that, that impact will be outsized. We also should note here that the credit metrics of our Northwest Home Rush Peace of Mind portfolio remains stable with the delinquency rate of less than 1%. REO decreased $15 million or 36% during the quarter. On $15.4 million in sales during the quarter, we realized a nominal gain on sale of $100,000. Residential construction and land remaining in our REO are only $1.1 million and $13.3 million respectively. Classified loan totals decreased $19.9 million during the quarter to $193.7 million, a reduction of 9.4%. Total delinquent loans decreased to 2.45% of total loans from 2.59% in the linked quarter. Loans 30 to 89 days past due and on accrual did increase during the quarter by $4.4 million. This increase was caused by a single relationship. All loans in that relationship are now current. The reserve is the source of strength for the company. Our riskiest portfolios, residential construction and land, continued to shrink as already discussed. Coverage of non-performing loans continued to increase during the quarter and stand at 126%, up from 110% last quarter. The reserve to total loans stayed level quarter to quarter at 2.52% which is very strong from a historical perspective. We feel this level of reserve is warranted as the economic environment remains challenging and fragile and as the levels of classified and non-performing loans in the portfolio remain unacceptably high. During the quarter, we received the written report for our annual regulatory examination conducted during the fourth quarter of 2011. This report substantiated preliminary exam findings and was a cornerstone in lifting our MOUs with the FDIC in the State of Washington and the Federal Reserve. Good progress has been made in healing our loan portfolios but be assured the necessary special asset teams will remain in place until the job is finished. As this is occurring, we also are focusing attention on supporting and managing new loan growth and making sure our credit infrastructure is efficient and ready to address future challenges and opportunities. With that I’ll turn the stage over to Lloyd for his comments. Lloyd?

Thank you, Rick, and good morning everyone. As noted in our press release, Banner Corporation’s improved operating results for the quarter ended March 31, 2012 reflect further progress during the quarter and significant progress over the past year, highlighted by much improved credit quality, strong revenue generation and net income of $9.2 million. And importantly, this net income reflects progress that we believe should result in sustained profitability going forward. Rick has already addressed the improved credit quality metrics thoroughly. So I will again just note the obvious. The significant reductions in non-performing loans and real estate owned are having a very positive impact on reported earnings. For Banner this trend of improving credit quality has resulted in lower levels of loan loss provisioning and expenses related to real estate owned. And it has also significantly contributed to our improved net interest margin as the drag from non-accruing assets has been substantially reduced. While our provision for loan losses for the first quarter again matched the $5 million that we recorded in the third and fourth quarters of 2011, it was well below the amounts recorded in earlier periods including the $17 million provision in the first quarter a year ago. In addition, our expenses related to real estate owned, although still high, were further reduced in the quarter. While these credit costs remain above long-term acceptable levels, we expect that our extended trend of improving asset quality will result in further reductions in credit costs in future periods. The first quarter of 2012 was also highlighted by the continuing trend of strong revenue generation that we have commented on for more than 1 year now. This was particularly encouraging since revenues for the first quarter of each year are generally adversely impacted by the fact that there were fewer days in the quarter as well as other seasonal patterns that affect our local economies. As I’ve noted before, the trend of year-over-year increases in core revenues that we have been reporting has been driven by significant improvement in our net interest margin and resulting net interest income as well as solid deposit fee revenues fueled by growth in core deposits. However for the current quarter the increase also reflects a large increase in revenues from mortgage banking operations, which increased by $1.7 million or 175% to $2.6 million for the quarter ended March 31, 2012 compared to slightly under $1 million for the first quarter a year earlier. As a result, for the quarter ended March 31, 2011 our revenues from core operations, which includes net interest income before provision for loan losses and other non-interest operating income, but excludes fair value and other than temporary impairment adjustments to revenues from core operations were $50.4 million, a modest decrease from $50.5 million in the immediately preceding quarter, but $3.4 million or 7% greater than the first quarter a year ago. Our net interest margin was 4.11% for the first quarter of 2012, a small increase from the preceding quarter, which in part reflects the effects of the shorter quarter on the annualization process, but about 17 basis points stronger than the first quarter a year ago. The year-over-year margin improvement again reflects meaningful reductions in our funding cost, and as I previously noted a significant reduction in the adverse effect of non-performing assets. As a result, for the first quarter of 2012, Banner Corporation’s net interest income was $41.1 million, which although slightly lower than immediately preceding quarter because of the shorter day count, was 3% greater than the first quarter of 2011. Deposit costs decreased by another seven basis points during the first quarter and were 37 basis points lower than a year ago, reflecting further changes to the deposit mix as well as downward pricing on maturing certificates of deposit and on transaction savings accounts. These are trends that have been dramatically contributing to our improved margin and increased net interest income for a number of quarters and resulted in an average cost of funds of just 66 basis points for the first quarter of 2012 compared to 100 basis points for the first quarter of 2011. As a result of the growth in transaction and saving accounts and planned reductions in high cost certificates of deposit, core deposits now represent 65% of total deposits compared to 59% a year earlier and 51% just 2 years ago. Importantly, we are not just adding balances but instead continue to see solid deposit -- excuse me -- solid growth in the number of accounts and customer relationships significantly contributing to increased deposit fee revenues. Of course the very low rate environment continue to put downward pressure on asset yields, however our net interest margins further benefited from changes in the mix of average assets to include proportionately more loans and less interest earning cash and securities than in the immediately preceding quarter as well as significantly decreased levels of non-accruing loans in REO compared to a year earlier, both of which combined to offset some of this pricing pressure. As a result of the mix changes, the yield on average assets at 4.72% declined by just two basis points compared to the fourth quarter. Although reflecting the rate environment, it was 16 basis points lower than the first quarter of 2011. The yield on loans was 5.44% in the first quarter of 2012 which was 9 basis points lower than the fourth quarter of 2011 and 22 basis points lower than the first quarter a year ago. The adverse margin impact of non-accruing loans decreased to 13 basis points in the current quarter compared to 14 basis points in the preceding quarter and 27 basis points in the first quarter a year ago. While the continuing reductions in non-accruing loans and other non-earning assets, particularly REO that we have achieved will be helpful to our net interest margin in future periods, yields on performing assets should continue to decline in the current interest rate environment. And although we expect further reductions in the current quarter, we will also have less opportunity to reduce funding costs in future periods. As a result, further improvement in our net interest income will become much more dependent on growth and earning assets going forward. As noted in our press release, for the first quarter loan balances decreased slightly compared to the fourth quarter primarily as a result of expected seasonal pay-down of agricultural loans, the impact of refinancing activity on residential mortgage loan prepayments and further planned reductions in land development loans. However, despite a still challenging economic environment, we did experience modest growth in commercial business loans as well as reasonable demand for and production of commercial real estate loans although prepayments of these loan types were also accelerated in the low rate environment which curtailed growth. Looking forward, we remain optimistic that the well-focused efforts of our bankers will continue to attract business clients and expect that the normal seasonal pattern will result in increased balances in agricultural loans and to a lesser extent construction loans as the year progresses. As we have discussed before, in addition to positive effect on our net interest margin, the other important aspect of continuing growth in deposit and core deposit accounts has been the impact on deposit fees. This was again evident in the first quarter as total deposit fees and service charges, which were nearly unchanged compared to the fourth quarter despite normal seasonal slowdown in the shorter first quarter, were 11% greater than the same quarter a year ago. Also, as I noted before, revenues from mortgage banking activities picked up further from the strong pace of the second half of last year, increasing to $2.6 million for the first quarter of 2012 compared to $1.9 million in the fourth quarter of 2011 and $962,000 in the first quarter of 2011. Of course the very low mortgage rates currently available in the market have caused the application activity to remain high which likely will positively impact revenues for at least the second quarter of 2012 as well. Expenses related to real estate owned was still high, declined reflecting the reduced number of properties owned and few evaluation adjustments. Although we expect these real estate owned expenses and other credit related costs to remain elevated for a little longer, we do expect that they will continue to decrease over time as additional problem asset resolution occurs. Similar to recent periods for the first quarter other operating expenses in aggregate were reasonably well behaved. Although increases in compensation expense in part reflecting the increase in mortgage banking activity as well as increased health insurance cost offset a meaningful portion of the decreased REO expense. While revenue growth will continue to be important, effectively managing these controllable expenses is an area of critical focus for us going forward. Fair value adjustments for the first quarter of 2012 resulted in a net gain of $1.7 million, generally reversing a net charge of $1.8 million recorded in the preceding quarter in each case primarily reflecting changes in the level of 90-day LIBOR. By comparison, fair value adjustments resulted in a net charge of $256,000 for the first quarter a year ago. Finally, as Mark noted, the capital base of the company and the subsidiary banks increased during the quarter and is substantial. At March 31, 2012 Banner Corporation’s ratio of tangible common equity to tangible assets increased to 10.15%. Its total risk-based capital ratio increased to 18.98% and its Tier 1 leverage capital ratio increased to 14%. Further, Banner Bank and Islanders Bank both enjoy similarly strong capital positions and reserves for loan losses that are substantial. As I’ve noted before, the strong capital position is significantly above the current regulatory guidelines, is also well above the levels that most observers expect will be reflected in future guidelines and should allow Banner considerable flexibility with regard to capital management as we move forward. So with that final thought, I’d like to congratulate our employees for a very good start to 2012, and I will turn the call back to Mark. As always, I look forward to your questions.

Thank you, Lloyd. That concludes our prepared remarks. And Alisha, we'll now open the call and welcome your questions.

[Operator Instructions] And our first question comes from the line of Jeff Rulis, DA Davidson.

Maybe a question for Lloyd, just a follow-up on those operating expenses. If you exclude OREO expense, operating costs were up 3% in the quarter and again the comp side was a little elevated, and you’ve alluded to mortgage banking being a component of that. Would you expect, I guess, stripping out mortgage banking, if that stays steady, any falloff in operating expenses or is this a good base to grow off of?

Well, I think it’s a pretty good base to grow off of, Jeff. The increases, as I noted, in addition to mortgage banking health insurance costs jumped pretty substantially from a year ago. And we also had -- a year ago we were just coming off of a period of extended control of compensation expense. We instituted some changes there. We were a little less optimistic a year ago about incentive accruals than we were in the first quarter of this year. So that number is up a little bit year over year. We’ve added talent, as Mark mentioned, throughout the organization and that’s having a bit of an impact as well. I think the health insurance cost could come down a little bit compared to what we accrued in the first quarter, but beyond that I think it’s a pretty good base at this point in time.

Got it. Okay. And then kind of housekeeping, I’ve got to ask on that, any updates given the profitability of the franchise on DTA timing and perhaps if you could update us on the net DTA benefit now that you’ve had another quarter of, I guess, without tax liability? So, I guess the question is timing and amount.

I am really surprised to get that question, Jeff. We discussed that yesterday and my smart aleck remark was we’re 90 days closer to that event than we were when we last talked to you. We still believe it’s sometime this year and the size of the net adjustment recall is about $35 million in the DTA allowance, but coincident with that we expect to make an adjustment to the fair value of the senior subordinated debentures and the net benefit, as we noted before, is probably in that $12 million to $15 million range.

So, that wasn’t lowered with the profitability this quarter?

Well, it was by -- we tagged the deferred for about a little over $3 million this year, for this quarter rather. That brought the allowance down from the $38 million that it was at year-end.

Okay, okay, got you. And then lastly, if I could, I guess with the MOUs lifted and the TARP auction complete, just any general thoughts now that dust has settled on perhaps partial or whole TARP repayment or redemption when that could occur?

Jeff, this is Mark. First of all, it is no longer TARP. It is a preferred debt instrument, preferred stock instrument. It’s in the secondary market. So as you know the secondary market can behave differently in terms of redemption based on trading price. Also we still remain to have all of the options available to us that were in the original offering by the treasury. So we can redeem at any time that we decide. So our philosophy has not changed from the last quarter which is we want to make sure we have complete clarity as to where the economy is going, and we’ll be prudent with our capital management and redeeming that debt.

Would it be safe to say the priority would be to retire the preferreds before any dividend payment was -- or an increase in the dividend?

Certainly, once that increase goes to 9% that’s very expensive capital.

Our next question comes from the line of Tim Coffey with FIG Partners.

This is probably my last question. Would there be any interest in doing a partial redemption of the preferred debt instrument in conjunction with recapture of the DTA?

I think that is all -- first of all, Tim, all options are on the table. So, we are viewing all of our capital management plans to make sure that we have the proper capital structure to maximize earnings and shareholder value. So, all options are on the table.

Okay. Was there a second part or was that just it?

No, that’s pretty much it. I mean -- we’ve been pretty consistent in our message.

Right, okay, okay. Since you have been looking at the adjustments to the fair value of your subordinated debt in the past year or so, have your inputs to whatever model you might use to affect discount rate changed at all? Have you changed -- have you lowered the discount rate at all?

Tim this is Lloyd. The only thing that’s changed is of course 90-day LIBOR moves around. And so 90 days ago, it was a little bit higher than it was at March 31 and that had a small impact. That really created most of the swing in fair value adjustments between the 2 quarters that I mentioned. The other thing that of course changes is 90 days of time passes, so it’s a little shorter, but the more important point is the spread that we are using to create the discount rate, we have not made any adjustment in that spread from what we’ve been utilizing for quite a few years now.

Okay, okay so the spread you’re using is actually a few years old?

Yes, and again remember the conversation that we’ve had a number of times. We believe that if you come to the conclusion that it’s appropriate to remove the allowance on the deferred tax asset because sustainable profitability is now more likely than not, that improvement in our credit standing should also be reflected in an adjustment to the discount rate that we are going to use on the junior subordinated debentures.

Okay, okay, [indiscernible]. You also made some comments in the conference call this morning about elevated REO expenses going forward. I am wondering if there is particular period in the next 3 quarters where scheduled appraisals are greater than other quarters. And if so, what quarter would that be?

Tim, this is Rick Barton. I don’t think that, that’s a factor. We re-appraise our REO on a 6-month rolling cycle basis. So that cost is fairly well spread throughout the year.

So, Tim now this is Lloyd. That was my comment in well $27 million, $28 million of REO is a substantial improvement over where it was. It’s still high by historical standards and that was the basis for my comment that that we will still have carrying cost related to REO as we work through that process. So high by historical standard but certainly room for continued improvement compared to recent periods.

Right, that was my understanding of it, yes. Okay, well thanks, gentlemen. Those are all my questions.

Our next question comes from our line of Kipling Peterson with Columbia Ventures Corporation.

This is a question on the TARP. When the treasury auctioned off the TARP preferred, it looks like they did it at about $0.88 on the $1. Two other banks were allowed to repurchase some or all of their TARP preferred. And I’m wondering did you ask your regulators if you could participate in the auction? And if so, did they say no or yes? And I’m just wondering, it seems at $0.88 on the $1, Banner probably have the funds to purchase some of the TARP preferred, and I’m just wondering what your view of that was?

It’s a good question, Kipling. Thank you. This is Mark. Thank you for asking it. Our view -- first of all, we have consistent conversations on a regular basis with our regulators not only in regards to the financial performance of the company but also capital management. My view on the redemption of the TARP from the treasury being asked to bid in a Dutch auction of such magnitude philosophically has caused a reputational issue for me. Every day we make loans to our client bases, and we expect those loans to be paid back in full. Banner took out an obligation with the treasury and made an arrangement to repay that in full with the treasury. That it had done. We had consistently paid dividends, had not missed a beat in terms of payment and our obligation which would have been to pay back the treasury funds which were taxpayer money at 100 cents on the dollar. And that’s -- that was what we -- that’s the obligation we created and that’s what we’re really going to live up to. So to bid it at a discount reputationally would have caused -- I don’t think -- there was not enough economic gain to offset the reputational risk. So that’s why we chose not to bid.

Do you feel the same way in the secondary markets?

Now it’s a very different market.

Thank you. [Operator Instructions] And I’m showing no further questions in the queue at this time. I’d like to turn the conference back to Mr. Grescovich.

Thank you, Alisha. For the first quarter of 2012, our performance continued to demonstrate that we are making substantial and sustainable progress on our disciplined strategic plan to strengthen Banner by achieving a moderate risk profile and at the same time executing on our super community bank model by growing market share and improving our core operating performance. As Lloyd mentioned, I’d like to thank all our employees for their dedicated hard work at returning and restoring this company to sustainable profitability. Thank you for your interest in Banner and for joining our call today. We look forward to reporting our results to you again in the future. Have a good day, everyone.

Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a replay of today’s call, please dial 1(800) 406-7325 or (303) 590-3030 and enter the access code of 4527868 followed by the pound sign. Thank you for your participation. You may now disconnect.