Banner Corporation (BANR) Q2 2012 Earnings Report, Transcript and Summary

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Banner Corporation's second quarter 2012 conference call and webcast. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. [Operator Instructions] This conference is being recorded today, July 26, 2012. I would now like to turn the conference over to Mr. Grescovich, President and CEO of Banner Corporation. Please go ahead.

Thank you very much, Erin and good morning, everyone. And let me add my welcome to all of you to the second 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?

Certainly. Good morning. Our presentation today discusses Banner's business outlook and will include forward-looking statements. Both 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 March 31, 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, Albert. As announced, Banner Corporation continued our improving performance again in the second quarter reporting a net profit available to common shareholders of $23.4 million or $1.27 per share for the period ended 6/30/2012. This compared to a net profit to common shareholders of 7.2 million or $0.40 per share in the first quarter of 2012 and a net profit of $224,000 or $0.01 per share in the second quarter of 2011. Looking at our earnings before preferred stock dividends, discount accretion, and changes in fair value, Banner's net income improved to $0.68 per share for the second quarter of 2012 compared to $0.42 in the 1st quarter of 2012 and 0.02 per share in the second quarter of 2011. The second quarter core 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 strengthen our franchise and deliver sustainable profitability to Banner. And a return to profitability for the last five 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 a year ago. Our second quarter core revenue increased 8% when compared to 2011. Our net interest margin expanded to 4.26% in the second quarter of 2012 compared to 4.09% in the second quarter of 2011 and our cost of deposits decreased to 48 basis points in the most recent quarter compared to 80 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 TDs, growing new client relationships and improving our core funding…

Thank you, Mark. My comments this morning will be brief and mirror those made during our first quarter call. Our quarterly results again show solid progress in the company's credit quality metrics. I would like to highlight and comment on several of them. Net charge-offs declined for the 7th consecutive quarter. When compared to the linked quarter, they were down by $1.1 million or 17% to $5.3 million. Total non-performing assets declined to 1.73% at total assets, a reduction of 51 basis points when compared to the first quarter and 275 basis points from a year ago. The quarter-to-quarter dollar reduction was $19.9 million or 21%. Reduced non-performing loans accounted for most of the quarterly reduction in non-performing assets. They decreased by $17.5 million or 27%. A good chunk of this improvement, $8.3 million came in the residential construction and land portfolios, where non-performing loans are now just $8.6 million. Other portfolios showed more modest improvement except for the consumer portfolio where non-performing loans increased by $300,000 to $2.8 million. New non-performing loans during the quarter totaled only $6.4 million, the lowest new quarterly total since early 2008. REO decreased modestly by $1.9 million or 7% during the quarter. This slowdown in REO liquidation was not unexpected to us as the remaining REO portfolio is very granular. Our team did dispose of $7.8 million dollars of REO during the quarter realizing a gain on the sale of almost $600,000. Residential, construction and land remaining in our REO are only $800,000 at an $11.2 million respectively with both categories declining during the quarter. 1-to-4 family real estate in the REO portfolio grew by $1.1 million dollars during the quarter to $7.7 million and now makes up 30% of the REO book. This is reflective of decreased housing values and the fact…

Thank you Rick and good morning everyone. As Mark and Rick have already indicated and as reported in our press release, Banner Corporation's operating results for the quarter and six months ended June 30, reflect the further progress during the quarter and perhaps more importantly continuation of the significant progress that has been occurring over the past 2 years. That progress has resulted in much improved credit quality, strong revenue generation, increasing operating profitability and now five consecutive quarters of net income including $25.4 million of income in the current quarter and $34.6 million in the first six months. Of course I'm emphasizing the continuing nature of this progress to confirm our belief that this profitability is the predictable result of our improved operating fundamentals and our conclusion that sustained profitability is clearly expected going forward. Our confidence in that conclusion of sustained profitability of our earnings coupled with our improved risk profile led us to the 2 substantial although largely offsetting adjustments to the significant accounting estimates reflected in the current quarter's financial results, specifically the reversal of most of the valuation allowance for our net deferred tax asset and the large fair value charge associated with revaluing our junior subordinated debentures. I will discuss those estimates in a little more detail later, however as Mark has noted, the real highlights for the quarter were the continuing trends that supported these decisions. So first I will spend a few minutes reviewing those trends. Rick has already addressed the improved credit quality metrics thoroughly but as a recap the continuing trend of improving credit quality has resulted in lower levels of loan-loss provisioning, collection costs and expenses related to real estate owned and has also significantly contributed to our improved net interest margin as the drag from non-accruing assets has…

Thank you, Lloyd. That concludes our prepared remarks and Erin, we will open the call and welcome your questions.

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

Lloyd, a follow up on the non-interest expense. A pretty significant drop in the FDIC deposit insurance costs. Anything one time in there? Is that the run rate that you expect going forward?

No, there is nothing unusual in that. It is a run rate. It's reflective the changes in the fee structure that occurred as a result of Dodd Frank. It's also reflective of smaller asset base. And its reflective of a specific reduction in the fee charge to Banner.

Okay, and then I guess a similar question on the comp line was down considerably and maybe a big Q1 but given the mortgage banking revenue produced. Is that a line item that's oddly low going forward?

No. it's not oddly low. It's pretty much a run rate. I think the difference between the first quarter and the second quarter is pretty much insignificant there Jeff.

Okay and then so I guess balling that up and your comments we could expect flat to down expenses overtime, the one factor being OREO expenses, you alluded to eventually working that down albeit elevated in near term.

REO’s expense was just under $2 million for the quarter, we think there is further room for improvement there over time, there is a few expense items that are volume related and as we continue to go and have success you would expect some of those to go up but there is others that we would expect additional efficiencies on so.

Again expense control, I think has been pretty solid for a number of quarters now.

Switching gears a little on the -- a pretty big bump up in the shares out, any comments on the DRIP program or expectations for additional share creep going forward?

Yes, Jeff, the DRIP program as you know has been an important part of our capital management through this sort of difficult period of time that we have experienced over this cycle. Having said that, we know that we now are very capitalized and our Board of Directors just recently took action to reduce to discount that we offer to purchasers under that program, de minimis purchasers. We actually haven’t done any what we refer to as waiver transaction so only transactions under the de minimis amount have been occurring for the last couple of years. But we are adjusting the discount on that effective August 1st from 3% down to 1% our expectation is that will pretty nearly shut that program down.

Got it, okay and then last one if I could. If you can just give us an update Mark or Lloyd on the sort of the preferred stock outstanding and kind of what your hurdles are there, you know whether it's capital on hand at the bank or holding company and just kind of an update on ideas now that the DTA is behind you.

As we have said in the past and I will repeat what was said before, prudent capital management is something that we take very seriously, so we are exploring all options in terms of deployment of the capital that we have. One option is obviously retirement of or repurchase of some of the perpetual preferred depending on when the interest rate kicks up but there are also other options in terms of deployment of capital and we are exploring all those.

Thank you. Our next question comes from the line of Joe Fenech with Sandler O'Neill.

Lloyd, just a question on the remaining $7 million associated with the DTA, are you anticipating any additional write-ups of the sub-debt as an offset or is that pretty much behind you at this point you get a full benefit of the $7 million in the back half of the year?

We anticipate write-up of the sub-debt over the remaining life of it but that’s a very long slow process. We don’t anticipate any major revaluation of it unless market conditions should change dramatically. There will be -- the valuation of net debt is influenced by things like the level of LIBOR that we don’t have control over but our anticipation is for nothing unusual there and that the remaining $7 million in the valuation allowance will be an offset to the tax accruals over the next 2 quarters and then beginning in 2013 first quarter will go to a normal tax provision and process. So there will be a little bit of adjustment in the taxes because obviously the $7 million is based on an estimate, we don’t know what certainly what the third and fourth quarter is going to look like but we don’t expect much of an impact on taxes for the rest of the year other than…

So that basically just drops to the bottom line. Okay and then Mark with the regulatory agreements behind you, you mentioned other capital management alternatives the preferred redemption. Could we see something else maybe before we see the redemption of preferred, like dividend or share repurchase or that sort of the next leg after you get the preferred out-of-the-way?

I think we've indicated before it's kind of a waterfall, the first deployment of capital is obviously a reinvestment in the company and franchise. The second deployment would be if we have excess capital that preferred along with its dividend is fairly expensive capital and then we would look to other alternatives or alternative use of capital such as increasing in dividends and then any type of buyback would be down the road substantially.

Okay. And then with respect to the allowance, if you guys are expecting continued credit improvement from here, that would seem to imply that there is plenty of room to allow that allowance ratio to drift lower especially since you are resolving these problem loans without taking big charges to do it. So can -- is it possible we could possibly see an allowance ratio below 2% at some point the next year, what do you guys sort of look at is sort of the minimum threshold that you won’t go below?

I think depending market conditions and the economy and I want to be clear on that because there are still some uncertainty out there in terms of what the economic climate is going to be like but obviously if we have a modest growth economy and it stabilizes to a point where we see that its but not going to deteriorate, that 2% number is a reasonable number.

[Operator Instructions] And our next question comes from the line of Timothy Coffey with FIG Partners.

I was wondering if you can walk me through the revaluation of the sub-debt, what was the discount rate and what was kind of the approach that you used?

As you and I think others know from reading our 10Qs and 10Ks for a number of quarters, we were previously using a discount rate of LIBOR plus 800 basis points. Based on the changes that were evident in market conditions and in Banners credit standing and other issues, we settled in LIBOR plus 550 for the current quarter. Applied that to ourselves as well as I think you know we have a small amount of assets that are in similar institutions and so we applied it to them as well. And previously those had been valued at anywhere from LIBOR 600 to LIBOR 800, so all of those assets now at 550.

And you said it was based on market conditions?

Obviously we have to go out and support that, we work with some consultants on that and support it with the what market data we can find. There's not an active market in small bank trust preferred but there are similar capitals and someone is out there that give us some indication and then we apply what we think are appropriate adjustments to those indications.

Kind of looking at the loan yields, the last four quarters, was trending a very narrow range. I wonder too going forward, is that sustainable or do you see the low interest rate environment catching up to your loan yields, average loan yields?

This is Lloyd again. Obviously I've been pretty wrong on that. I continue to believe that the rate environment is going to put pressure on those yields over time and in fact on a year-over-year basis that’s the case. But what’s been occurring with us is very clear that we continue to have reductions that are meaningfully in non-performing assets and REO and the like that are meaningfully impacting that and holding those yields up. But this is very, very, very low interest rate environment and over time, it's going to take a toll on everyone.

Okay. And then the kind of looking at the net charge offs for the second quarter, is that seasonal or is it just a product of the diligence that you have been applying to the credit portfolio?

Well I think it's product to the diligence that we have been providing to the loan portfolio.

Do you have a feeling of that that is sustainable at this low level?

I would imagine that as we go forward, Tim, that we would see it continue to drift down.

Our next question comes from the line of Kipling Peterson with Columbia Ventures Corp.

First, of do you have a feeling for the percentage of the deposits at 0% interest that maybe parked there simply because the FDIC has an unlimited guarantee that should that guarantee go away would be at risk moving out of the bank?

Kipling, we are fairly convinced that the insurance issue is a bit of what’s contributed to the build-up in cash balances on our business customers in particular but not as big of an issue actually is, they are just accumulating cash. We talk about a fragile economy and yet businesses are making a lot of money but they are not investing it, they are accumulating cash. And in the current interest rate environment they don’t see a lot of opportunity to move it into other instruments and earn a little bit money. So while the insurance issue is out there, I think the bigger question Mark with respect to those, what has been referred to by many of surge balances, is what will happen when interest rates go up and in our case I think I have made it clear in the past that we would like to see interest rates go up. So while that will adversely impact some of the dollars in that category, rising interest rates would still be a good thing.

That is why our strategies around client acquisition are so important and as Lloyd said in his comments, we have made some substantial in-roads and market share gains for our new clients.

And finally in reference to what had been known as TARP, if you folks decided this morning to pay off $20 million of the preferred, would you be able to do that or without getting any permission from regulators and you just decided that retiring 5% money is a good thing to do, could you do that without getting any permission.?

We are in constant as I said last quarter, we are in constant contact with our regulators, we have a very good relationship with them and we communicate with them in terms of capital management on a regular basis. So we will look at those opportunities as they arise.

So that’s a no, you would have to get permission from the regulators to pay off any amount?

Clearly, we are not under any regulatory restrictions at this point. That does not mean we don’t discuss issues with our regulators.

Our next question comes from the line of Fred Cannon with KBW.

On your expenses I was wondering if you could size a little bit how much of the non-interest expense outside of ROE is devoted to kind of credit workout at this point in time.

Too much. We are probably spending still in the neighborhood of $600,000 to $800,000 a quarter in legal related to collection activities.

The historical number, Fred, that we have outlined in the past on an annual basis, it's been about 16% of the expense ratio is related to collection costs and you're starting to see from the peak of the beginning of 2011, that number start to come down. So you know it's not unreasonable to assume that numbers at a 10% clip.

There is another hidden cost there which is inside the compensation line. So…

So that’s why I said, you could accumulate that number around 10%.

And as you keep reducing the number of problem assets in REO and the like, there is a compensation expense that can be reallocated to other productive uses.

Thanks, that’s helpful. And just on the loan book, kind of looking for when we get a real turn in growth, one-to-four family construction was up I think meaningfully at least at the end of period. Is that area where you can believe you can start to see some growth or is that still one where it's just going to kind of bounce around for a while?

Well I think in the short run there is an opportunity to see some growth the in that loan category. Fred this is Rick Barton. Both in the Portland market and the Seattle market, we have had good success in making some loans this year and the Portland market commitments for new construction loans total about $55 million and it's about twice that amount in the Seattle metropolitan market. We can -- think that there will continue to be an opportunity to do that for the balance of the area as there are certain submarkets were the housing stock, in terms of completed new homes is almost nonexistent. And there is a very small outstanding inventory of resale homes as well in those submarkets.

Fred, this is Mark again, I think some of the guidance we have given in the past is that portfolio is right now on the res between the construction and residential portfolio was about 7.4% of the overall loan portfolio. Under a normalized cycle we would be okay with that running up to 10%.

[Operator Instructions] And we do have a follow-up question from the line of Jeff Rulis with D.A. Davidson.

Hey, Lloyd, I had a quick one on the tax rate for next year. Is there an appropriate assumption you would give us when you’d return to full taxpayers status?

An effective tax rate usually for us is going to run somewhere 32% - 33%; it depends on the level of tax credit investments, municipal securities and things along those lines. So marginal tax rate is at 35 -- effective will be a little lower.

Got you, I guess you just sort also gave us the earnings in Q3, Q4 this year, I am kidding on that one.

If want to do that math but as I pointed out there's a lot of uncertainty in Q3 and Q4, so there will be an adjustment to that $7 million number, I am not sure whether at which direction it will go.

Okay, fair enough. And then one quick last one on the mortgage banking business has been strong. Maybe just a quick comment how that’s proceeded in Q3 so far this quarter?

Activity continues to be strong as I pointed out in my comments, the level of interest rates continue to do encourage refinance activity. For us it's running about 70% which is fairly common I think in the market today. So our volumes this year were more than double what they were in the first half of last year. They are continuing in the third quarter right at the moment and I don't see why is that would change a great deal; we've actually devoted more resources there. The people are doing a great job; the volume of activity is such that there is a little bit more profit margin in that right now than some other times.

Thank you. And I am showing no further questions at this time, I would like to turn the call back to management for any closing remarks.

Thanks, Erin, this is Mark again. For the second 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. I would like to thank all of my colleagues who are driving this substantial improvement and performance for our company. Thank you for your interest in Banner and your questions and for joining us on the call today. We look forward to reporting our results to you again in the future.

Ladies and gentlemen, this does conclude today’s conference call. If you would like to listen to a replay of today's conference, please dial 1800-406-7385 and enter access code 4548321. Thank you for your participation and you may now disconnect.