Banner Corporation (BANR) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, thank you for standing by. Welcome to the Banner’s Fourth Quarter 2012 Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, January 24, 2013. I would now like to turn the conference over to M. Mark Grescovich, President and Chief Executive Officer. Please go ahead.

Thank you, Cathia, and good morning, everyone. I would also like to welcome you to the fourth 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 and safe harbor statement?

Certainly. Good morning. Our presentation today discusses Banner’s business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products 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-Q for the quarter ended September 30, 2012. Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations. Thank you.

Thank you, Al. As announced, Banner Corporation improved its core performance again in the fourth quarter, reporting a net profit available to common shareholders of $13.3 million or $0.69 per share for the period ended 12-31-2012. This compared to a net profit to common shareholders of $15.2 million or $0.79 per share for the third quarter 2012, and a net profit of $3.1 million or $0.18 per share in the fourth quarter of 2011. For the full-year ended December 31, 2012, Banner reported net income available to common shareholders of $3.16 per share, compared to a loss of $0.15 per share for the full-year of 2011. Looking at earnings before tax, preferred stock dividends, discount accretion and repurchase gains and changes in fair value, Banner’s income improved to $0.98 per share for the fourth quarter of 2012, compared to $0.93 in the third quarter of 2012, and $0.40 per share in the fourth quarter of 2011. Again, demonstrated continued improvement in our core operations. The fourth quarter and full-year performance provided unmistakable evidence and confirmed that through the hard work of our employees throughout the company, we are successfully executing on our strategies and priorities to deliver sustainable profitability to Banner. And our return to profitability for the last seven quarters further demonstrates that our strategic plan is effective and we continue building shareholder value. Our operating performance showed improvement on every core key metric again this quarter when compared to the same quarter 1 year ago. Our fourth quarter core revenue increased 8% when compared to 2011. Our net interest margin was 4.09% in the fourth quarter of 2012 compared to 4.07% in the fourth quarter of 2011, and our cost of deposits again decreased in the most recent quarter to 35 basis points compared to 59 basis points…

Thanks, Mark. As I did in our fourth quarter call for 2011, I would like to focus my remarks this morning on the year-over-year improvement of Banner’s credit metrics and make note of important fourth quarter 2012 accomplishments. As you listen to our 2012 results, please remember the watershed year Banner had in 2011 in terms of improving its credit metrics. Now, let’s recap 2012. Net charge-offs were $18 million down from $49 million 1 year earlier. This is a decrease of 63%. And net charge-offs has now declined for 9 consecutive quarters. Total nonperforming assets declined from $119 million to $50 million, a reduction of 58%. Stated as a percentage of total assets, nonperforming assets went from 2.79% to 1.18%. Nonperforming loans decreased from $75 million to $34 million during the year, an improvement of 54%. This puts nonperforming loans at 1.05% of total loans, compared to 2.3% and 4.5% at year-end 2011 and 2010, respectively. REO fell from $43 million to $16 million during 2012. This was a decline of 63%. REO dispositions during the year were $41 million on which we realized a net gain of $4.8 million. New foreclosures were $14 million, compared to $53 million in 2011. This year's REO valuation adjustments were $5 million, a decrease of 66% from the preceding year. Healing of our residential construction and land portfolio continued during 2012. Total loans outstanding at year-end were $238 million; while nonperforming loans totaled only $3.6 million or 1.5%. At year-end 2011, nonperforming loans were $26 million in a portfolio of like size. Classified loans in Banner's portfolio were $131 million versus $202 million at year end 2011. This is a decrease of 35%. During 2012, delinquent loans, including nonperforming loans, decreased 47%, falling from $85 million to $45 million. As a percentage…

Thank you, Rick, and good morning everyone. As Mark and Rick have already indicated, and as reported in our press release, our operating results for the fourth quarter capped a very good year for Banner Corporation, and while our operating results for the quarter and year ended December 31, 2012, reflect further progress during the quarter, they also are the result of the cumulative impact of the significant progress that has been occurring over the past 2.5 years. As we have continued to execute on strategic initiatives designed to strengthen our franchise and build shareholder value. That progress has resulted in much improved credit quality and lower credit costs, strong revenue generation, significant growth in client relationships, particularly for core deposits, and increasing core profitability. In fact, as noted in the release, this marks the 13th consecutive quarter that we have realized year-over-year increase in core revenues. However, I think it is also important to note the clear impact, both positive and negative, of the very low interest rate environment that is also evidenced in these results. Exceptionally low interest rates have pushed our funding costs to near 0, and produced record volumes in profitability for mortgage banking. But exceptionally low interest rates have also meant declining asset yields and pressure on the net interest margin, as well as an impairment charge for mortgage servicing rights in the current quarter. Further low interest rates continue to reflect a sluggish economy which makes revenue growth particularly challenging looking forward. Nonetheless, for the quarter ended December 31, 2012, our revenues from core operations, which includes net interest income before provision for loan losses plus other non-interest operating income, that excludes fair value and other than temporary impairment adjustments, increased to $54.5 million, to slightly more than the immediately preceding quarter, but again…

Thank you, Lloyd and Rick. That concludes our prepared remarks and [Cathia] we will now open the call and welcome your questions.

[Operator Instructions] Our first question comes from the line of Jeff Rulis with D.A. Davidson.

Question on the mortgage banking revenue, Lloyd, you mentioned expecting maybe a few more quarters of pretty good volume there. I guess I’m having a tough time forecasting it. I guess in terms of your budgeting purposes would you expect, I guess, 2013, a fraction of 2012 levels or any sort of additional color on kind of what the levels you’re maybe anticipating.

Sure, Jeff. Unfortunately though, (inaudible) and the other governors haven’t included me in their deliberation. So I’m not sure how long rates are going to stay down this low. Clearly, the first half of the year is looking very strong and we’re actually expanding our capacity as well. So we’re optimistic looking at 2013 for the mortgage business. But at some point in time, you have to believe that the refinancing activity is going to slow down to some degree.

So in that -- possibly if activity falls off a bit, you may be able to make up some as you expand a portion?

Well, that’s certainly our expectation in our plan. It is refinancing declines, the purchase business will remain strong and because of increased capacity that will make up some of the difference there. Obviously, as well as refinancing activity, I’ve made the comment before, that margins are exceptionally wide in that business right now. So you have to believe that if there is any sort of a slowdown in activity that the margins are going to come in a little bit as well.

Jeff, this is Mark. Recall, we made a fortuitous business decision some 30 months ago when we decided to add a substantial number of mortgage bankers to realign that business with our branch delivery system; that has worked out very well for us as interest rates have stayed low and volume of cross sell has increased for our company. So that type of volume and investment was very well-received and very timely. At the same time now, we have been investing and will continue to re-invest in additional mortgage bankers in anticipation of the purchase business starting to take over much more versus the refinance business as the housing market in the Northwest rebounds. So that’s the overarching business strategy.

Right, okay. And maybe, Mark, one for you on the -- I guess as you look out, you’ve cleared the decks a little bit with the preferred gone and some things that are kind of in the rear view. As you look forward on sort of M&A opportunities, could you catch us up on kind of the dialog out there and what fits best with kind of what your expansion plans are at this point?

Yes, I may expand on that question just a little bit. Recall that our capital management philosophy was to repurchase and redeem the remaining perpetual preferred securities as a primary use of our excess capital. And then we would look for the waterfall of dividend increases and potential buybacks along with reinvestment in the company. We have -- certainly the dialog for M&A has improved, most importantly because of the progress of the company and the successful execution of our business model, and that our client base in the Northwest is very receptive to this business model. That has allowed us the opportunity to review potential M&A from a strategic standpoint in fill-in markets for us. We will remain extremely disciplined in our approach to that. Should an opportunity present itself in our core markets or our expanded markets, where we’re seeing rebounds in economic activity. We'll certainly take advantage of that. As you know, our capital base, our reserve levels and our balance sheet are in a position to absorb a reasonable sized M&A transaction.

Our next question comes from the line of Jackie Chimera with KBW.

I was wondering, just touching back on the mortgage a little bit, if you have the average gain on sale margin for the quarter and where that was in regards to the third quarter?

Jackie, this is Lloyd. The average margin was about 2.5% which is up a little bit. Actually that’s probably close to the average for the whole year. It may have been just slightly stronger than that in the fourth quarter. I think I had indicated about 2.25% in the third quarter. And as I noted before, those are exceptional numbers for a business that didn’t historically generate those kinds of margin.

No, definitely understood. And then, do you have the breakdown and I’m sorry if you already gave this and I just missed it on what was refi versus what was purchase for the volume in the quarter?

That's been running pretty consistently 65%, 70% refi for an extended period of time now, which I think is very consistent with what you're seeing out of the industry in general.

So just knowing what we know now and the drive towards that, the Pacific Northwest economy continuing to improve as it is. Do you think that we could see purchase volumes just overall pickup?

Absolutely, it has picked up, and looking forward we would expect that it will expand further. And as we’ve noted, we think that it will be taking a bigger part of the market, more market share in that process as well.

[Operator Instructions] Our next question comes from the line of Tim Coffey with FIG Partners.

Mark, a couple of question about your forward earnings growth strategy here. I’m assuming that a big part of that includes growing a loan portfolio. To what extent does the forward earnings growth strategy include additional securities purchases?

Well, obviously we want to first grow the loan portfolio and we’ve stated our target of maintaining our loan-to-deposit ratio between 90% and 95%. We've been able to advance our C&I and Ag portfolio 3%. I think it’s pretty clear that we’ve gone through the churn of troubled assets in our company. So we believe that we’ve plateaued in terms of a contraction in the other parts of the portfolio. And as the housing market rebounds and the company has capacity for additional real estate based on our risk profile and our capital allocation, we are in a position, I think, to advance the loan book and that is -- organically, and that is our first priority. We’ve been able to advance our market share gains as evidenced by the significant account growth that we've had. So that is the primary focus. Securities are not -- I'll let Lloyd comment additionally, but are not a very attractive vehicle to us. We want to keep our duration low given we don't have a crystal ball. Our interest rates are going to go. But primarily, the fact that there is not enough yield in the securities arena for us to make that attractive to grow that book. Lloyd, if you have additional comments?

Actually, I think Mark covered it pretty well. I mean, the yield opportunity in securities is very, very minimal without taking additional duration risk and you're not getting paid for credit risk out there as well. So to the extent that we find ourselves with an excessive amount of cash, we’ll continue to be buying securities from time to time. But we’re not looking to add leverage in that area, if that’s what you’re suggesting, Tim.

It is, it is. You, across my coverage, have one of the lowest percentages of securities to average earning assets. Just by looking at those numbers it would seem that you would have opportunities there. But it's clear that’s not what you’re looking at. And then the loans that you added this quarter, what was kind of the average, the blended rate of those new loans entering the portfolio?

Tim, this is Rick Barton. The average rate probably is really driven by the type of loan that we’re talking about. There is quite a wide disparity between the rates we’re able to get on some of the real estate construction loans, particularly in the residential arena which are north of 5.5%. If you look at some of the very competitive aspects of the C&I business in the Northwest, the rates are significantly less than that, more in the 4% range.

Okay. C&I loans are in the 4% range or is that 5.5%?

C&I in the 4% range.

Okay. All right. And then any plans, Mark, Lloyd to reduce non-credit operating expenses in ’13?

Tim, this is Lloyd. As we noted last quarter, we did make a decision to close a couple branches. And you can see some of the impact of that in our occupancy line. We’ve been really quite disciplined in managing expenses across the footprints for a couple of years now. We’ll continue to look at areas where there may be opportunity, but it’s not going to be a dramatic, wholesale, across the board slashing of expenses. There's not that kind of opportunity really in this operation right at the moment.

Great call, Tim, this is Mark. Our strategy here is to make sure that we’re growing into our balance sheet once we've fixed and healed the balance sheet. So to the extent that we’re going to see additional organic growth along with revenue generation, we will manage and we’ve done a very good job of managing our expenses effectively. To the extent that, that does not occur does not present itself in the Northwest; then we will look to do a sharp refined point on the expense structure. But we will constantly rationalize our branch distribution accordingly to make sure that we are in a position to take care of all opportunities. I think it is important to look and note that our overall expenses, operating expenses are down 10% year-over-year.

Sure. So this is a matter of leveraging your existing infrastructure then. _

Correct.

Okay. Then has the competitive environment then changed? Has it improved in the last quarter, the last half year or so?

I think the competitive environment is still quite fierce. There is not enough economic growth to present itself for the banks to be expanding their margins at this point with the low interest rate environment. So it’s a very competitive posture and you have to have a very well-refined value proposition in the markets in which you do business in order to take market share. We’ve said for the last several quarters and prepared our business plans based on 2012 and forward into 2013 that this was going to be a market share game and we had to execute effectively to take market share and not rely on significant rebound in the economy.

Our next question comes from the line of Don Worthington with Raymond James.

In terms of the -- given the strong reserve coverage and reduction in nonperformers, would you consider being more aggressive in terms of releasing reserves, perhaps even a negative provision?

Don, this is Lloyd. I think we would be hard pressed as a management group to get to a negative reserve position. But clearly as the credit metrics continue to improve, we have been providing at West the net charge offs as Rich indicated for about 7 quarters and I don’t think it’s inconceivable that we get to some quarters where there’s no provisioning.

[Operator Instructions] Our next question comes from the line of Joe Stevens with Stevens Capital.

My question is actually pretty simple. Most of my other questions were already answered. But on the tax side, on a go forward basis, can you give us sort of just a better ballpark about where we’re going to be on a go forward basis on the tax rate?.

You bet, Joe. I wish taxes was a simple question, but actually it is looking forward. This year was a little complex as you can see for this year and for the fourth quarter. But on a go forward basis, as we’ve indicated, our normal run rate is around 32%, 33% effective tax rate, that’s we kind of -- we have a statutory rate of about 36% when you throw the state taxes in. And then we have some tax exempt income from the municipal bond portfolio and a few tax credits and stuff that make us pretty consistently in that 32%, 33% effective range.

We have a follow up question from the line of Jackie Chimera with KBW.

I have 2 quick follow-up questions. The first one, I just want to make sure that I understood something that I wrote down from your prepared remarks. I’m not sure who had said it, but someone said that credit costs were about your long-term goal. Was that in reference to the current quarter or was that more broadly speaking?

Jackie, this is Mark. That’s more broadly speaking in terms of 2012 charge-offs. We want that charge-off rate to be down along -- coupled with clearly the additional credit costs in the company for the full year are still a little high.

Okay. That makes much more sense given how low credit costs were in the current quarter. And then also I wondered, maybe Mark if you could just give some color on your outlook for SBA sales and if you think that could be meaningful going forward as it was in the quarter?

Yes. I think that for 2013, we’ve started the year off very well with the pipeline. If you do recall, we made a sizable investment in our SBA capabilities some 30 months ago by bringing in a team of experts that were in a position to make us a preferred lender for the SBA across our footprint. That has been rewarded very well. We’ve hit the ground running and we are actually the #1 7(a) program lender in the Seattle, Spokane marketplace and our pipelines are very strong. So we are being recognized as one of the premier SBA lenders in terms of community banks in our footprint I would expect that to continue. I think very similar to what Lloyd outlined with the spreads in the mortgage business. In terms of sale, the spreads in the SBA business right now are quite high as well and higher than I’ve seen them in a long time. So to the extent that those spreads stay advantageous to us, we will continue to sell those into the market.

And then, in the event that those spreads narrow a bit, that’s something you might look to portfolio for some loan growth in the future?

Correct.

There are no further questions at this time. I would now like to turn the call over to Mr. Grescovich for closing remarks. _

Thank you, Cathia. We’re very pleased with our fourth quarter and full year 2012 performance, and our improvement demonstrated that we’re 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, our deposit franchise, and improving our core operating performance. I would personally like to thank all my colleagues who are driving the substantial improvement and performance for our company. Thank you for your interest in Banner and for joining our call today. We look forward to reporting our results to you again in the future. Goodbye everyone.

Ladies and gentlemen, this concludes the Banner Fourth Quarter 2012 Conference Call. If you would like to listen to a reply of today’s conference, please dial 303-590-3030 or 1-800-406-7325 with the access code 4583551#. ATC would like to thank you for your participation, you may now disconnect.