Good day and welcome to the Umpqua Holdings Corporation Fourth Quarter Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Ron Farnsworth, CFO. Please go ahead sir.

Okay. Thank you, Stephanie. Good morning, and thank you for joining us today on our fourth quarter and full year 2018 earnings call. With me this morning are Cort O'Haver, the President and CEO of Umpqua Holdings Corporation; Tory Nixon, our Chief Banking Officer; Rilla Delorier, our Chief Strategy Officer; Dave Shotwell, our Chief Risk Officer; and Frank Namdar, our Chief Credit Officer. After our prepared remarks, we will then take questions. Yesterday afternoon, we issued an earnings release discussing our fourth quarter 2018 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both of these materials can be found on our website at umpquabank.com in the Investor Relations section. During today's call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the Safe Harbor provisions of federal securities laws. For a list of factors that may cause actual results to differ materially from expectations, please refer to Page 2 of our earnings conference call presentation, as well as the disclosures contained within our SEC filings. And I will now turn the call over to Cort O'Haver.

Okay. Thanks, Ron. Let me begin by providing a brief recap of our fourth quarter and full year 2018 performance and accomplishments. Ron will discuss the financials in more detail and then we will take your questions. 2018 was a great year for us, highlighted by strong financial performance, continued loan and deposit growth and tremendous progress made implementing the initiatives organized within our Umpqua Next Gen strategy. We have a solid fourth quarter with earnings per share of $0.36. Financial results reflected 11% annualized loan and lease growth, 6% deposit growth, higher net interest margin and lower non-interest expense. This is down from the $0.41 we earned in the prior quarter, but up from the $0.34 in the fourth quarter of 2017. With respect to the decrease in earnings per share from the prior quarter, there were several notable items that impacted the fourth quarter financial result, including a $16.1 million in fair value decrease on the MSR asset and swap derivatives. For the year, we earned $1.43 per share, which represents a 30% improvement over 2017 earnings of $1.10 per share. With one year of our Umpqua, three year Next Gen strategy in the books, I'm extremely pleased with the progress we have made and how it sets us up for continued success in this year and beyond. Next Gen is an ambitious, multifaceted plan to transform Umpqua, and I could not be more proud of the hard work, dedication and resolve of all of the associates last year. Let me highlight some of our 2018 accomplishments across our three Next Gen strategic priority areas, balanced growth, operational excellence and human digital. I will start with balanced growth. For the year, we grew loans and leases by $1.4 billion or 7% and deposits by 6%. This strong growth…

Okay. Thank you, Cort. And for those on the call, who want to follow along, I will be referring to certain page numbers from our earnings presentation. Turning first to Page 7 of the slide presentation and also in the earnings release, which contains our quarterly P&L. GAAP earnings were $0.36 per share this quarter, a $0.05 decline from the third quarter, driven primarily by fair value losses on the MSR and CVA evaluations, stemming from the market volatility late in the quarter, leading to a decline in treasury yields. Ex the two fair value swings, as compared to Q3, we had $0.02 of benefit from higher net interest income and $0.02 of benefit from the gain on sale of Pivotus assets, offset by a $0.02 drop from the higher provision for loan losses and $0.02 drop from seasonally lower mortgage contribution, ex the MSR. Turning to net interest income and margin on Slides 8 and 9, and noted on Page 7 of the release, net interest income increased $6 million or 2% from Q3. Interest income increased $10.6 million, with three quarters of that related to loan interest supported by the strong growth this quarter, along with another prime rate increase. Discount accretion is becoming a non-event as that declined again as expected this quarter to $4.2 million. Also our taxable investment income increased related to lower premium amortization. Our interest expense increased $4.5 million or 10 basis points, based on continued average balanced growth and rising interest rates. And our cumulative deposit beta based on the Fed rate increases to-date was 26%. Our past quarter beta was 48% and we expect deposit costs to continue to increase over the coming year with quarterly betas moving closer to historical norms of 60% to 65%. As reflected on Slide 9,…

[Operator instructions] And we will take our first question from Michael Young with SunTrust.

Ron, just wanted to start with the Next Gen and the cost saves. So if I'm kind of reading this right, we have got $6 million to $8 million remaining from Phase I by midyear and then just taking the midpoint of the range roughly $9 million or so from Phase II by year end. And then, I assume that's going to be offset by some normal expense inflation throughout the year. So net-net do we end up just a little bit lower kind of on a run rate basis from where we started the year?

Year-over-year, that's the goal to have lower expense in 2019. I would characterize it best though by talking about the efficiency ratio, where we expect that to continue to drift lower, seasonally over the year, it will be a bit higher in the first two quarters, lower in the second two. But year-over-year, we are targeting somewhere in that mid to upper 50% range, which puts us in good shape for the 2020 goals year out. In terms of the cost saves, you will have normal inflation. Recall, we will have the payroll tax curve over the course of the year ramping up in Q1 and then down for the balance of the year. But then I would also characterize it to around certain cost saves, we will continue to reinvest roughly a quarter to a third of those cost saves in new technologies and initiatives. That's all factored into of course, the year-over-year expense number I talked about earlier.

Okay. And then you kind of mentioned the potential to rationalize, maybe the mortgage kind of fixed cost, as we move into the back half of the year depending on the outlook for volumes. Could you maybe just talk about maybe the magnitude of that incremental from where we are today? And then also just maybe pair that against how much production you expect to retain next year versus on balance sheet versus sale?

Sure. I think on the last question, we will have a similar mix here over the course of the year, just in terms of for sale versus as a percentage of total origination, just given where the markets are. In terms of the bigger question around the profitability of the unit, I want to know, and I think we will have a good sense by late spring if somewhere in the high 2% range is the new normal for gain on sale margins, if that's the case then I'm going to want to lower the - we are all going to lower the 2.5% roughly expense on volume. Part of that's going to be through certain direct or centralized channels that we have, which right now is maybe 20% of our overall volume is flowing through direct channels. We will be looking to increase that. But I must save further comments on that probably till we get into late spring and through the summer, just to see how it shakes out on the gain on sale margin.

Okay. And one last one if I could just sneak it in. I know you guys did a review of the MSR and hedging and elected not to do that. Any changes or any changes in the macro that would cause you to reevaluate that?

No. I have just seen it over a long period time that hedging can create more of a problem than just watching, as yields move up and down what is going to happen to the MSR. So additional cost and it doesn't necessarily reduce volatility.

Up next is Jeff Rulis from D.A. Davidson & Company. Please go ahead with your question.

[Indiscernible] On just the long growth. I guess, anything notable about that the net pickup. Maybe the question would be, do you have payoff activity quarter-to-quarter what was the trend this year versus last or this quarter versus last?

Hey, Jeff, this is Tory Nixon. We had payoffs in Q4. We are down slightly from Q3, which were also down slightly from Q2. So they are relatively close in terms of total dollars, but we have had a decline over the last two quarters to three quarters.

Got you. And then, I guess as we look at into 2019, I think you have been running down the auto portfolio. Maybe you could tell us about what is remaining to go there. And I guess, overall expectation should that headwind negate kind of your growth outlook for 2019?

No. It's in the growth outlook, just given we factor that in when we laid out the overall assumptions for the three years and right now that's roughly $450 million and that's running down at a pretty consistent clip on a quarterly basis, so actually that'll continue.

And then maybe one other one. Ron, I think you mentioned the bulk of the charge-offs have been in the FinPac portfolio, I think you mentioned for the year, but did that accelerate into Q4, I think you mentioned that the FinPac is kind of the leading indicator. But what was the makeup in Q4 or was it similar with the kind of legacy, well, I guess not legacy, but FinPac versus other loans?

Yes. So excluding, the leasing portfolio was roughly $4 million of charge-offs for the quarter, it was $10 million for the year. So I guess, if you do the simple average on a quarterly basis, it is up a bit, but it's bouncing along the bottom. When it comes to the leasing portfolio, charge-offs have been pretty consistent on that front, and again recognize that Page 19, we added in there hopefully gives us some good stats on the overall quality of the portfolio with loan to values and DSCs. I will reiterate that FinPac leasing portfolio is roughly 10.5% yield and I know, I have used the term, the [indiscernible] is still flying. So we don't see anything near-term on that front to cause a difference in expectations.

And without substantial change on a lot of fronts, the provisioning level kind of the range we saw in 2018 is comparable to 2019 or any kind of change structurally that you would see that ramping?

Yes. No, no structural change. It's been pretty consistent trends. Provisions will exceed charge-offs and in terms of the overall quality of the portfolio again that page at the end shows just the drop in classified down now to 8%. I'm not saying that's going to continue into 2019, but I would expect provisions to continue to exceed charge-offs and the reserve just to ramp up slightly over the course of the year prior to CECL.

Up next, we have Steven Alexopoulos from JP Morgan.

Ron, let me follow-up on credit [indiscernible] into my questions because you did see a modest pickup in net charge-offs in the quarter, I know the credit metrics are stable. What exactly drove that this quarter?

Two loans within the bank portfolio. Nothing significant. Nothing out of the ordinary for $4 million.

Okay. Got it. And then on margin, the guidance you gave is helpful in terms of starting point. But given that the comments and thoughts around deposit betas continuing to normalize, if we get no additional hikes out of the Fed, how do you see the NIM progressing from here?

Sure. So if we think about the 2020 target, we had a 3.9% to 4% and that assumed there were additional rate hikes coming into 2019 and some in the high [3.8s] (Ph) and there is no additional rate hikes. We will continue to see pressure probably in the low 3.8 range by the end of the year. That just seems continually, you know, call it 45% to 50%, even 55% on the beta side, just with those costs increasing. But that all gets back down to then all the initiatives Cort and the team talked about earlier in terms of our deposit growth initiatives that our target is not to bring in high rate money, is to continue to grow the core consumer base.

Yes. And along those lines. Final question. So looking at the decline in non-interest bearing deposits in the quarter, was that customers just moving cash into higher yielding alternatives or something else driving that?

Little over half of that was simply timing on ACH between 12-31 and January 2nd.

So it's a timing issue, you're not seeing customers move cash, non-interest bearing out is what you're saying?

Not in a large way.

Okay. Thanks for taking my questions.

You bet. Thanks.

Jackie Bohlen from KBW. Please go ahead with your question.

Ron, I want to make sure that I understand the premium amort movement that happened in the quarter, so rather than a reduction, it was actually a positive benefit of $5.9 million to the margin, right?

Correct.

Okay. So if we move back to the historical level that gives you that 3.89% that you were talking about. What rate movements would you need to see in order to get to that point?

Probably a decline in longer term yields, which would cause an increase in mortgage refinance activity and then hence MBS prepayments would increase.

Okay.

In reality, in the short term, my guess is, they will be somewhere between the two, but I do not expect another recapture in Q1. If anything just the smaller amount of amortization.

Okay.

Might not be back all the way to the lows we had in early 2018, but I just want to lay out the range there.

That's helpful. And last quarter you talked about the margin being in a range of 3.85% to 3.90% understanding that there is this premium amort that's moving and it was a big benefit in the quarter. How did where you stand today compared to where you stood a quarter ago when you gave that range?

Well, again that was a function of recapture just based on a continued decline in MBS prepayments. So as I look into early 2019, I expect we will still be in that range of 3.85% to 3.9% probably over the better part of the year. But if prepayments continue to slow, we probably be on the high end of that if not above and just given again lower amortization on that front.

Okay. And then did I hear you right where you said if rates stop increasing then the margin would trend down and get toward the low 3%?

I would assume that is the case not the low 3% range. No, I said we were continuing to see pressure on deposit costs. I think that would be the case not only for Umpqua, but for everybody in the industry, just given there is going be some tail on that, right. So I expect they would be probably on the lower end of that range if not somewhere in the 3,8% to 3.9% range, not low threes. Sorry

Okay. I knew, I misheard it. I just wanted to clarify it. Okay.

I'm glad you got that clarified. Thank you.

Yes. That would be a big jump. And then…

Talking about [indiscernible].

Just one last question. Historically you have said that the normalized level of amortization and the MSR portfolio is around $3 million to $5 million. Does that still hold outside of rate movements?

I would say it's probably closer to $5 million to $7 million, here over the last couple of quarters.

Okay. Thank you.

You bet. Thanks.

Aaron Deer with Sandler O'Neill and Partners. Please go ahead.

I just want to go back to the mortgage outlook, a couple of things there. One is just in terms of your expectations for production volumes, as you look out to the year. At this point in fact we are using kind of the MBA forecast or does your outlook differ from that?

Does not differ from it. We outperformed it this past year compared to what we thought. But that's what we are using for planning for 2019.

And I don't know if you have done any sales this quarter into the secondary market. But what are your expectations just kind of as you look at that market and today where gain on sale premiums are likely to be and what is your expectation there?

Yes. It's interesting because at a low level, they are still being priced right around 3% or in the low 3% range. It was 2.83% for the fourth quarter just because we have the fair value, the change in lock pipeline. So part of the answer to your question remains what do I expect the lock pipeline to be in March compared and December and ideally that's going to be roughly flat just with an overall lower level of volume through the quarter. So ideally we will be closer to 3%. If we are below it is going to be because of a drop in lock pipeline. I think bigger picture though if we get into late spring and from competitive standpoint, you haven't seen some players exit the market. We will be talking about different items on just in terms of the structure of our delivery, just given that spread is pretty tight.

And if you can give a sense of the size if there - if you do look to restructure that business, what kind of cost savings do you think they are possibly could be pulled out of it?

Well, right now it's roughly 250 basis points for the overall cost on the volume. It's too early to talk about detail plans there. It's something we will save comments on probably until late spring summer, if we do not see a recovery in the gain on sale margin.

Okay. Good stuff. Thanks for taking my questions.

Of that 250 bps, roughly two thirds of its variable.

[Operator Instructions] We will move on to Matthew Clark from Piper Jaffray. Please go ahead.

Just on the [NIM] (Ph) statements, should we assume if that's largely done here or should we expect any additional adjustments going forward?

Well, again, this quarter was related to premium recapture under retrospective bond accounting because the MBS prepayments have slowed. If they slow further, we might have lower amortization or some more recapture, but that gets back to the kind of they are at - earlier, where if our premium amort would normalize back to the levels they were at in early 2018, we will be somewhere around 3.89% for the core NIM.

Okay. That's right. it's retroactive. Okay. And then just on capital, any update on your M&A appetite desire to maybe buyback some stocks with where your shares are trading?

Let me start on the buyback side. We will continue to focus on the dividend and a healthy payout ratio. I think the buyback is pretty short term focused and I expect that excess capital to decline slightly over the coming year. It's a good amount of excess amount and egregious amount. And keep in mind, we also have lease accounting, which we will probably use that $12 million to $13 million of that capital this quarter, and then we will be running parallel on CECL talk about that over the course of the year. So no plans to do anything out of the ordinary on buybacks, just repurchase shares issued under comp plans.

And Matt, it's Cort. On M&A like we have talked about the last couple of years, we are still going to continue to stay focused on operating the company. And I think we have shown you all that we are continuing to decrease the efficiency, increase the efficiency and continue to run a more profitable organization. We have always been opportunistic on potential acquisitions. We will continue to be opportunistic. We do track a couple of markets, where we think additional density would be good or adjacent markets, where we would like to get into those markets. But we will look at it on an opportunistic basis and if a deal makes sense both financially and strategic, we are not opposed to look at.

And it appears, there are no further telephone questions. [Operator Instructions] And there are no further questions in the queue. I would like to turn the call back over to Mr. Ron Farnsworth.

Okay. Thank you, Stephanie. And well, thank you everyone for their interest in Umpqua Holdings and attendance on the call today. This will conclude the call. Goodbye.