Columbia Banking System, Inc. (COLB) Q1 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking System's First Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Melanie Dressel, President and Chief Executive Officer of Columbia Banking System.

Thank you, Stan. Good afternoon, everyone, and thank you for joining us on today's call to discuss our strong first quarter 2014 results. I hope you all have had a chance to review our earnings press release, which we issued yesterday just prior to our annual meeting. The release is also available on our website, columbiabank.com. Of course, our results reflect the first full year of our acquisition of West Coast Bancorp, which was completed on April 1 of last year. I'm happy to report that the integration is behind us, and we are ahead of schedule for achieving the full benefit of the earnings accretion we had projected. And I'm very pleased that during the quarter, we also recorded $210 million in loan production, our second consecutive quarter with over $200 million in new loan originations. As I mentioned in the release, I'm encouraged to see more of our strong loan production translating to net loan portfolio growth. We have an ongoing commitment to actively managing our capital position. With the quality of our earnings this quarter and our increase in capital levels, we announced a cash dividend of $0.12 per common share, as well as a special cash dividend of $0.12. Both will be paid on May 21 to shareholders of record as of the close of business on May 7. This constitutes a payout ratio of 65% for the quarter and a dividend yield of 3.5% based on our most recent closing price. With total risk-based capital approaching 15% and tangible common equity of 10%, we believe we're still well-positioned from a capital perspective to take full advantage of any strategic opportunities that may arise. Clint Stein, Columbia's Chief Financial Officer, is on the call with me today, and he'll begin our call by providing details of our earnings performance for the quarter. Hadley Robbins, our new Chief Operating Officer, will share his thoughts on loan and deposit production for the quarter and the status of integration of the West Coast Bank acquisition. Andy McDonald, our Chief Credit Officer, will also be speaking this afternoon, and he'll discuss credit quality, as well as our allowance for loan losses. I'll conclude by giving you a brief update on the economy here in the Pacific Northwest, as well as our priorities for the year. We will then be happy to answer your questions. As always, I need 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 2013. And now I'd like to turn the call over to Clint to talk about our financial performance. Clint?

Good afternoon, everyone. We reported first quarter earnings of $19.8 million or $0.37 per diluted common share. Our reported first quarter earnings per share were negatively impacted just over $0.02 by $966,000 in pretax acquisition-related expense and $752,000 of expense resulting from the accounting impact of our FDIC-acquired loan portfolios. Net interest income for the first quarter was $73.9 million, down $3.3 million from $77.2 million in the prior quarter. Roughly $1 million of the decline was due to lower incremental accretion income, of which $925,000 was in the West Coast loan portfolio. The lower discount accretion income was the result of reduced prepayment activity within this portfolio. Previously, we have stated that discount accretion income related to prepayment activity has averaged roughly $2 million per quarter since the acquisition closed. For the first quarter, discount accretion income related to prepayments was $800,000, while normal accretion remained steady with a fourth quarter rate of $4.8 million. Noninterest income before the change in FDIC loss-sharing asset was $18.8 million in the current quarter, a decline from $20.2 million during the prior quarter. If you recall, the fourth quarter was favorably impacted $1 million due to the winding down of a West Coast operating platform. On a comparative basis, noninterest income declined roughly $400,000 on a linked-quarter basis. The decline was centered in service charges and other fees, which were down about $900,000. The lower service charge fee income was tempered by investment securities gains of $223,000 and an increase of $323,000 in other noninterest income. The investment gains stem from the sale of selected low balance securities and are the result of periodic portfolio housekeeping. The additional other noninterest income resulted from $492,000 in increased SBA loan sale premiums. Total noninterest expense was $57.4 million for the current quarter. After taking…

Thanks, Clint. Noncovered loans before deferred fees and other adjustments were $4.3 billion at March 31, 2014, up $77.6 million or about 2% from $4.2 billion at December 31, 2013. Total deposits at March 31 were $6 billion, an increase of $84.9 million or 1% from $5.9 billion at December 31, 2013. About 63% of the deposit inflows during the quarter were in the noninterest-bearing deposit accounts. Core deposits comprised about 96% of total deposits and were approximately $5.8 billion on March 31. The increase in noncovered loans was driven by new loan production of approximately $210 million during the quarter. The mix in new production largely consisted of commercial business loans, about 54% of new production, and commercial real estate term loans, about 33%. In terms of geography, Washington generated 65% of new production during the quarter; and Oregon, 35%. Commercial business loans ended the quarter at $1,640,000,000 or 2.5% from year end 2013. Most of this growth was dispersed across a few key business sectors, including finance and insurance, healthcare, manufacturing, wholesale and community. It's important to note that growth in commercial business loans was impacted by the seasonal contraction in agricultural, forest and fishing industry segment. As mentioned by Andy last quarter, the segment has become more meaningful relative for our total commercial business loans and represents about 14% of the total commercial business loan categories at March 31. Typically, usage increases in the second and third quarters with paydowns occurring in the fourth and first quarters. Last quarter, the ag portfolio declined $26 million, in this quarter it declined about $25 million. Growth in commercial real estate term loans was centered primarily in nonowner-occupied properties, principally in medical and in dental office buildings. Multifamily also saw growth, however, we continue to be very selective in this…

Thanks, Hadley. Nonperforming assets continued their decline this past quarter and now represent 75 basis points of our noncovered assets. The reduction in nonperforming assets was centered in OREO assets, as nonaccruals remain relatively unchanged from the prior quarter. At the end of the quarter, we also had approximately $13.1 million in recorded investments in TDRs, of which about $961,000 is included in the NPA category, leaving $12.1 million of performing TDRs. For the quarter, the company had a provision recapture of $500,000 for noncovered loans. $250,000 was associated with the discounted Bank of Whitman portfolio, and $250,000 was associated with the discounted West Coast Bank portfolio. There was no provision or recapture for the originated portfolio in the first quarter. The net recapture was driven by improving credit quality, a continued decline in loss rates and the liquidating nature of the Bank of Whitman and West Coast Bank loan portfolios. Net charge-offs were $1.3 million for the quarter and were centered in the originated portfolio as both the Bank of Whitman and West Coast portfolios enjoyed modest net recoveries. Most of the charge-offs were centered in the commercial real estate portfolio, where we had one loan that was charged down from $2.6 million to $1.6 million upon the receipt of an updated appraisal. This appraisal reflected the fact that the building is now 2/3 vacant and significantly has a lower net operating income level, which is impacting the valuation. Outside of this one charge-off, we only had $326,000 in charge-offs for the quarter. So very modest. As I mentioned before, the provision recapture was also due to improving credit quality within the various loan portfolios. As such, I would like to note that despite the lack of decline in nonperforming loans, classified loans, which include nonperforming loans, actually declined during the quarter from 3.42% of noncovered loans to 3.14%. In fact, since the acquisition of West Coast Bank, we have reduced classified loans from their peak of 4.94% in June of 2013 by 180 basis points or 36%. This, of course, will be detailed in our first quarter 8-K. Past due loans at quarter end were 43 basis points compared to last quarter when they were 57 basis points. With that, I'll turn the call back over to Melanie.

Thanks, Andy. We're continuing to see many signs of optimism here in the Pacific Northwest, as economic pace picks up speed and improvement is evident across a wide range of indicators. This is the case in both Washington and Oregon, particularly in our metropolitan areas of Seattle, Tacoma and Bellevue and the Portland, Vancouver markets. Of course, there is still room for improvement. The recovery is not yet complete. The labor market still shows some weakness in many non-metropolitan areas of the Northwest. Oregon's economy is continuing to expand at a slightly above average pace. The unemployment rate for March was 6.9%, the lowest level since August of 2008, and the state's monthly job gain of 7,500 in March was the largest since November of 2005. It was the ninth consecutive month of job growth in the state, and all major industries added jobs. In fact, sectors including construction, leisure and hospitality and healthcare added more than 1,000 jobs each. Construction remains the fastest growing industry with job growth 4x faster than the overall economy. And construction surpassed 80,000 jobs for the first time in 5 years, shooting up by 1,800 jobs in March. Manufacturing also continues to power Oregon's economy. The state's manufacturing output is the 10th highest in the country and about 70% of which is in computer and electronic product. Additionally, we've seen a return of labor force growth in Oregon. Economists from the University of Oregon believe the rapid job growth in recent months may be pulling people back into the labor market. They also expect job opportunities and job creation to increase in the coming months. There's been a rebound in building permits, too. Commercial construction, especially at Intel's Hillsboro campus, has been a big contributor. In December, Oregon ranked third in the nation for…

[Operator Instructions] Your first question comes from the line of Joe Morford of RBC Capital Markets.

I guess first question was just on the margin. Looking at the sequential quarter comparison from the fourth quarter, recognizing that the bulk of decline was just kind of day count, and then you had loan growth more towards the end of the quarter, do you see this adjusted core margin or operating margin stabilizing then in this kind of 4.15%, 4.20% range going forward? Or what would be your expectations on the outlook at this point?

I would hope so, but there's a lot of variables that come into play. During Hadley's prepared remarks, he commented on the level of LIBOR-based lending that we're doing. We think that's a good thing from an interest rate risk standpoint. But with weighted average rate in the 3.30% range, that's going to weigh on the margin some. So about a little less than 40% of our production in the quarter falls into that category. And so I think that it depends on the level of loan production and loan growth, as well as the mix between fixed and floating. And I think our bias is towards floating where we can get it. And then through discussions like this, we will talk about what impact that had on the margin.

Sure. Okay. That makes sense. Just another question just on expenses. The compensation line was down quite a bit sequentially and a few million dollars below the run rate we've seen for the last 2 quarters. Do you see that kind of holding at this level, maybe continuing to trend down? And was there any kind of seasonal impact in the numbers this quarter from payroll taxes, FICA, stuff like that?

The answer, I think, to all of those is yes. If we back up to the fourth quarter, we had about $3.5 million of merger-related compensation expense in there. And so that, obviously, wasn't repeated during the first quarter. In the first quarter, we had a little over $400,000. So there's a $3 million swing there. There are some seasonal aspects that happen in the first quarter of every year. Payroll taxes get reset. That has some expense. 401(k) match, incentive payments, things of that nature. So those were some of the, I guess, the headwinds in the first quarter or in the -- yes, in the first quarter that we would expect to have a diminished impact on the other 3 quarters for this year.

Can you quantify kind of that seasonal stuff combined, recognizing that it doesn't all necessarily go away, but...

It's -- I can, but once again, there's a lot of different elements to it. The things off the top of my head related to some of the 401(k) contributions and some of those things that happened in the first quarter and start to decrease over time, the FICA tax and those things. About $1 million is what those add up to. The other thing that comes into play is our health care costs and what do those do for the rest of the year. And we had pretty good experience rates in the first quarter. So we would hope that, that would continue. But if our health care costs pick up in the second quarter, then that could create a headwind.

Your next question comes from the line of Brett Rabatin of Sterne Agee.

I wanted to make sure I caught all the comments correctly. I appreciated the color on LIBOR versus fixed-rate lending and what you're seeing there in terms of yields. I missed what you were saying, although, on the production going forward in terms of what you are expecting from a mix perspective of new generation of loans.

Yes, the -- in looking at the pipeline, I would say that the mix that we're looking at there is fairly similar to what we've seen in the way of new production in the first quarter. And in the first quarter, about -- let's just say, roughly about 50% of the new production was floating, and most of that is LIBOR based, 1-month LIBOR, 3-month LIBOR. And we also have fixed rates, and those fixed rates are typically going to be based on a Federal Home Loan Bank fixed offer cost of funds. So I assume those proportions will remain constant as we look forward to the second quarter.

Okay. And I was also curious around fee income. Just -- see any thoughts on seasonality in deposit service charges and kind of where that might go going forward?

Yes. I -- it's premature for me at this point to try to point a direction. I can say that there is some seasonal pattern there, but I'm not going to assume that it's a seasonal pattern. We're looking at ways to address generating more noninterest income. And in part, we're looking at our product set and looking at pricing and fees relative to deposits. But those are all part of what our ongoing activities are. But they'll get some increased attention this coming quarter. And I'll probably have more to report in following quarters on that.

Okay. And then just a last quick one around capital, with the dividends. I guess I'm curious, Melanie, and I know I've asked you this before, but are you any more comfortable with what sort of the right capital ratio might be? And how much excess capital you kind of view yourself as having and thoughts on deploying it?

Well, certainly, we wouldn't want to drop below 12% total risk-based capital and 8% on tangible. But that gives us a lot of room, too, if we have an opportunity to do an acquisition. So -- but we also feel that we don't need to continue to accumulate capital, and therefore, we decided to do a special dividend this quarter. I just want to make sure that nobody is interpreting that, that we are not interested in doing acquisitions. It's just that we don't see a need to continue to accumulate it. Does that answer your question, Brett?

Yes, maybe we can follow-up offline a little more.

Your next question comes from the line of Jackie Chimera of KBW.

Talking back on the NIM and just on the new production, that was really great color about the mix between LIBOR and fixed rates. Just trying to reconcile how the NIM can stabilize if you are planning on having a lot more production -- not a lot more but same levels of LIBOR-based production.

Clint?

Well, we'll have -- one of the benefits is we'll have more days of interest accrual, so that helps. The -- in terms of -- I guess from our standpoint of thinking about the NIM and looking at where it's at, even if it does come down a little bit from 4.19%, we still feel like we're in a pretty good spot relative to our peers in where we see their NIM levels at. And I guess, back to my prior comment to Joe is that at this point, with our balance sheet, I would rather take a little bit of NIM compression and have the offset on the interest rate risk side and the benefit in an uprate environment than to book longer-term fixed-rate loans that in 2 years, 3 years or 4 years or whenever we get into a rising rate environment, that we wake up and begin to regret. And so does that address your question?

Yes, it does. And I -- not to imply that I disagree with that theory, I was just curious on the mechanics behind it. And then also, how does the percentage of the variable rate lending that you've been booking in the past quarter, in 1Q, how does that compare to prior quarters?

I think -- I don't have that information directly available to me. And I think that in prior quarters it would be comparable, but I can't say within a margin of certainty. Do you have that, Clint?

Yes, I believe I have that here. And I'll echo your sentiment, Hadley, that it's comparable to what we've seen probably over the past year. What I don't have, necessarily, is how much was specifically linked to LIBOR versus maybe prime or some other indexes.

So does the LIBOR-based lending versus prime and other indexes that you've used, does that come in at an initially lower rate?

On prime versus LIBOR?

Yes.

LIBOR tends to be lower than prime in terms of what the actual coupon is.

Okay. And then just one last one. What -- how is this impacting your asset sensitivity on a go-forward basis? I know that the production relative to your overall portfolio is very small. But I'm just wondering how it's shifting you as we move into a rising rate environment, hopefully?

Yes.

Yes. Well, we're still asset sensitive, and this helps. When we think about loans that have floors, we have about 60%, I believe. Let me get the number for you. About -- we have $1.9 billion of loans with floors. And about 60% of those, or a little over $1.1 billion, are in the money. And $700 million of that $1.1 billion moves off their floor in an up-100-rate scenario. So I think that what we're doing now isn't going to diminish that and create a bigger hurdle when rates do finally rise in terms of the lag before things move off their floors. I do have the number for you in terms of the -- your prior question on the production balance. What we had in LIBOR-based originations in the fourth quarter is about 27% of the origination activity. In the third quarter of last year, it was 5%. So this quarter was a little heavier than what we've seen, and I assume that's probably based on the asset class that we were seeing the production in.

Okay. And you said this quarter was about 40%?

Yes. In total, LIBOR is actually like 37%, 38%.

Your next question comes from the line of Jeff Rulis of D.A. Davidson.

Not to beat up the expense topic too much, but I think, Clint, you mentioned core expenses at $56.1 million. There's a couple of mentions in the press release about improving operating efficiency. And while that had been, I guess, through the course of the West Coast integration, a big focus, does that suggest you'd attack that number further? And maybe you could put either a dollar figure against that $56 million or maybe even just some broad kind of efficiency ratio-type goals?

Well, I think long term, we've often said that we'd like to get into the mid-50s, but that would take some time. But it isn't all just relative to more that we can do as a result of cost saves, for instance, from the former West Coast side of the equation. It's more that this is only the second time in, I believe, 5 years when we haven't been in the process of preparing for operating system conversion because of all the acquisitions that we did over the last 5 years. So this really gives us an opportunity to kind of have things a little bit clearer, not as murky, just because we don't have those -- a conversion underway or we don't have people that are on retention bonuses to get through a conversion and those sorts of things. But we really feel as though our industry as a whole is just going to have to figure out ways to become more efficient. And we are no different from anybody else, and we'd like to use technology more efficiently than we have. And that's probably where we're going to see the bulk of our efforts, is just replanning our application of technology that allows us to do more things without having to add more people.

Okay. That helps. And maybe another granular question on the capital side, Melanie. On the -- I guess, with the special 65% payout, was there any -- you mentioned you don't intend to grow capital any further. That would imply that you grew it a bit. I guess, going forward, would the idea be, all things being equal, you'd push closer to kind of a 100% payout? Or I guess. was this just an initial first wave?

This was -- we review this on a quarter-by-quarter basis and just kind of what we see ahead of us. And when we did special dividends before, we did end up paying out 100% of the prior 4 quarters' earnings, if my memory serves me well. But again, it was the set of circumstances, and we just feel as though we -- by paying a special dividend this quarter, it doesn't prevent us from doing other strategic activities.

[Operator Instructions] Your next question comes from the line of Aaron Deer of Sandler O'Neill + Partners.

I wanted to follow up on Hadley's comments earlier about the pricing and the competitive environment and look at it from the perspective of a competition, how that's affecting pricing. But also, I've been hearing from a number of management teams over the past week or so about the -- some of the larger banks, in particular, giving up on structure. And I'm just wondering how you guys are managing to compete on that front without relaxing your terms and continue to win deals.

Well, we're not relaxing structure in major ways at all. Where we're running into the price competition is primarily related to high-quality larger deals, which we had a few of these last quarter, that the price competition is much more intense on. Although we tax affected the rates that we talked about, there were a few municipalities that were in that particular group of loans that came through in the first quarter. But I would say that is a general sense of some, there's a lot of capital chasing a few deals. And those deals that merit the attention of the competition is driving price down. And we've seen that fairly consistently over the last stretch of period -- stretch of time. And I think it's more of a function of the opportunity that we had this quarter than anything else.

Okay. And then you also mentioned amongst your commercial real estate activities, medical and dental. And I think that's a product type that you've done for a long time but haven't necessarily singled it out. So I just wondered, have you hired any teams in that particular practice? Or is there a reason why you've selected -- why you mentioned that this particular quarter?

I think that it's a product type that appeals to us, and it's one the board trusts to consistently go after. And I think it's more momentum in that area. We don't have a team per se designed around health real estate, but we do have a focus on dental and healthcare in terms of practices.

Okay. And then -- sorry, go ahead.

Well, I was just going to say that we've added a couple of people that have that kind of background, but not a team acquisition. We've just continued to build out the team that really focuses on dental and, actually, debts as well.

And Melanie, you also mentioned in your introductory remarks the volume of construction picking up in the region is. I know you guys had a small uptick in your own construction portfolio. Are there more opportunities emerging there for you? And is the pricing on that product something that is more attractive than what you're getting elsewhere?

You want to take that?

Yes. This is Andy. Yes, the construction bucket continues to be focused on builder banking, which we've had good success in that area. But we're primarily centered in the King County market, and it's spinning pretty quickly, which is nice from an income standpoint, it doesn't build a lot of totals. The other area is owner-users are pretty much the other segment that we have that seems to be gaining some momentum. We still find in the commercial real estate market, in general, across all of our footprints, that it's still cheaper to buy than to build. So the opportunities in construction are much fewer, and they tend to be very competitive because there are not a lot of opportunities.

There are no further questions at this time. I will now turn the call back over to you, the presenters.

Okay. Well, thanks, everyone, and we'll talk to you next quarter. Thank you very much.

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