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…

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…

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…

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.