Banner Corporation (BANR) Q2 2017 Earnings Report, Transcript and Summary

Good day and welcome to the Banner Corporation Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Mr. Mark Grescovich, President and CEO of Banner Corporation. Please go ahead.

Thank you, [Yashmin], and good morning, everyone. I would also like to welcome you to the second quarter 2017 earnings call for Banner Corporation. As is customary, joining me on the call today is Rick Barton, our Chief Credit Officer; Lloyd Baker, our Chief Financial Officer of the Corporation; and Peter Conner, our Chief Financial Officer of Banner Bank. Lloyd, if you could take a moment and read our forward-looking Safe Harbor statement?

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 may also make 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, 2016. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligations to update information concerning its expectations. Thank you. Go ahead, Mark.

Thank you, Lloyd. As announced Banner Corporation reported a net profit available to common shareholders of $25.5 million or $0.77 per diluted share for the quarter ended June 30, 2017. This compared to a net profit to common shareholders of $0.72 per share for the first quarter of 2017 and $0.61 per share for the second quarter of 2016. Excluding the impact of merger and acquisition expenses, gains and losses on the sale of securities and changes in fair value of financial instruments, earnings increased 13% to $25.9 million for the second quarter 2017 from $23 million in the second quarter of 2016. Because of the hard work of our employees throughout the Company, we are successfully executing on our strategies and priorities to deliver sustainable profitability and revenue growth to Banner. Our core operating performance continued to reflect the success of our proven client acquisition strategies which are producing strong core revenue. And we are benefiting from the successful integration of our recent acquisitions which has had a dramatic impact on the scale and reach of the Company and are providing a great opportunity for revenue growth. Our second quarter 2017 performance clearly demonstrates that our strategic plan is effective and we continue building shareholder value. Second quarter 2017 core revenue was a $122.9 million, an increase of 7% compared to the second quarter of 2016. We benefited from a larger and improved earning asset mix, the net interest margin that remained above 4%, and good mortgage banking and deposit fee revenue. Overall, this resulted in a return on average assets of 1.01% for the second quarter of 2017. Once again, our performance this quarter reflects continued execution on our super community bank strategy that is growing new client relationships, adding to core funding position by growing core deposits, and promoting client loyalty and advocacy through our responsive service model, while augmenting our growth with opportunistic acquisitions. To that point, our core deposits increased 8% compared to June 30, 2016. Also our non-interest-bearing deposits increased 8% from a year-ago as well, representing strong organic generation of new client relationships. Our organic net client growth in these product categories is now 93% since December 31 of 2009. Reflective of this solid performance, coupled with our strong tangible common equity ratio of 10.46%. We issued a core dividend in the quarter of $0.25 per share and a special dividend of $1 per share. In a few moments, Lloyd Baker and Peter Conner will discuss our operating performance in more detail. While we have been effectively executing on our strategies to protect our net interest margin, grow client relationships, deliver sustainable profitability, and prudently invest our capital, we have also focused on maintaining the improved risk profile of Banner. Again this quarter, our credit quality metrics reflect a moderate risk profile. As expected due to the addition of new loans and the migration of acquired loans out of the discounted loan portfolio, we recorded a $2 million provision for loan losses during the second quarter. At the end of the quarter, our ratio of allowance for loan and lease losses to total loans was 1.17% and our total non-performing assets totaled 0.24%. In a moment, Rick Barton, our Chief Credit Officer will discuss the credit metrics of the Company and provide some context around the loan portfolio and our success at maintaining a moderate credit risk profile. In the quarter and throughout the proceeding seven years, we continue to invest in our franchise. We have added talented commercial and retail banking personnel to our Company and we have invested in further developing and integrating all of our bankers into Banner's proven credit and sales culture. We have also made significant investments in our risk management and IT infrastructure, positioning the Company for continued growth and scale. While these investments have increased our core operating expenses, they have resulted in core revenue growth, strong customer acquisition, year-over-year growth in the loan portfolio, strong deposit fee income and positive year-over-year operating leverage. Further, we've received marketplace recognition of our progress and our value proposition as J.D. Power and Associates Rank Banner, the number one bank in the Northwest for client satisfaction. The third year, we have won this award, in a small business administration, named Banner Bank Community Lender of the Year for the Seattle and Spokane district for two consecutive years and this year named Banner Bank Regional Lender of the Year for the second consecutive year. Also Banner ranked 29 out of 100 in the Forbes 2017 Best Banks in America. The successful execution of our organic growth plan augmented with strategic acquisitions and our persistent focus on improving the risk profile of Banner has now resulted in 25 consecutive quarters of profitability and our tangible book value increased to $31.21 per share versus $30.86 per share at June 30, 2016. Finally, as announced this morning, we made a strategic in economic decision to sell our seven branches in Utah and focus our future investments on the West Coast. I'll now turn the call over to Rick Barton to discuss trends in our loan portfolio. Rick?

Thanks Mark. Credit quality at Banner during the second quarter of 2017 remain stable as it has over the last several quarters. Our portfolios moderate risk profile is clearly demonstrated by the credit metrics that I will now briefly recap. Before doing so however, I want to repeat the comment we have made in our last several presentations that the Company's credit metrics are at historically favorable levels and are unlikely to improve further. Delinquent loans were 0.44% compared to 0.51% last quarter and 0.52% a year-ago. This type of fluctuation is to be expected when delinquencies are at low levels. The Company's level of adversely classified assets remains low and decreased slightly during the quarter. Non-performing assets increased 3 basis points during the quarter to 0.24% of total assets. Again, this type of fluctuation is common when a metric is at a low level. Not reflected in these totals are the remaining non-performing loans of $9 million acquired from Siuslaw and AmericanWest Banks, which are not reportable under purchase accounting rules. If we were to include the acquired non-performing loans at our non-performing asset totals, the ratio of non-performing assets to total assets would still be a modest 30 basis points. Performing troubled debt restructures declined to 18 basis points of total loans down from 23 basis points in the linked quarter. Gross charge-offs during the quarter were $1.6 million versus $2.1 million last quarter. After loan loss recoveries of $1.7 million that cannot be considered to be recurring, the Company was in a modest net recovery position for the quarter. The allowance for loan and lease loss provision for the second quarter was again $2 million. After this provision, the core – and the quarter's net recovery position just discussed, the allowance for loan and lease losses for the Company now totals $88.6 million and as 1.17% of total loans level with the linked quarter. The remaining net accounting mark against acquired loans is $26 million, which provides an additional level of protection against loan losses. Loans increased by $131 million from the linked quarter and $226 million when compared to June 30, 2016. Quarter-over-quarter increases in commercial business and agricultural loans accounted for $92 million of the growth. The growth in business loans reflects both marketing successes by our bankers and good economic activity in our markets. The increase in agricultural loans is a typical seasonal increase. Also increasing during the quarter or multi-family loans $34 million, home equity lines of credit $34 million, and one to four-family construction loans $14 million. Permanent commercial real estate loans decreased by $37 million during the quarters as several significant loans were paid as borrowers took advantage of attractive loans structures and interest rates. All other loan categories as shown in our press release had nominal increases or decreases. Overall, on an annualized basis, the Company's loan portfolio grew by approximately 7%. And as noted in the press release, our loan origination pipelines indicate the potential for significant future loan growth. In summary, Banner’s loan portfolio and credit metrics were marked by stability during the just completed quarter further seasoning the portfolios moderate risk profile. With that, I'll turn the stage over to Lloyd for his comments.

Thank you, Rick, and good morning again, everyone. As Mark just noted Peter Conner, our Chief Financial Officer for Banner Bank is again with us here today. And after a few general remarks for me, Peter will provide more detailed insight into the second quarter results. Again this quarter, our core operations were very consistent with the trends we have reported for a number of periods, in fact for a number of years. Banner Corporation's second quarter and year-to-date 2017 operating results continued to reflect successful execution on our strategic initiatives including significant benefits as a result of the acquisition of AmericanWest Bank, as well as meaningfully increased regulatory costs as a result of our approach to and subsequent breach of the $10 billion in total asset threshold. Our financial performance in the quarter was driven by strong revenue generation reflecting the increased scale of the Company, additional client acquisition and a continued positive operating environment. We had an expected increase in revenues compared to the immediately preceding quarter, as a result of normal seasonal patterns as well as the full impact of the renewed re-leveraging of the balance sheet as we crossed the $10 billion thresholds. And compared to the same quarter a year earlier, growth in average earning asset balances coupled with an expanded net interest margin, and growth in non-interest income allowed our revenues from core operations to increase by 7% year-over-year. Similar to previous periods, fully appreciating Banner's core operating results for each of the periods presented requires a clear understanding of the impact of the merger and acquisition related expenses on last years performance, as well as the valuation adjustments for certain financial instruments that we carry at fair value and win material gains and losses on the sale investment securities. For the second quarter of 2017, Banner reported net income of $25.5 million or $0.77 per diluted share. This amount was net of $650,000 of charges for the valuation adjustments for financial instruments, and $54,000 net loss on the sale of securities, which together net of related tax effects reduced earnings for the quarter by $0.01 per diluted share. Fair value adjustments and securities transactions had a similar $0.01 per diluted share negative effect on the immediately preceding quarter and reduced earnings by just 3% per diluted share for the first six months of 2017. By comparison, acquisition related expenses were $2.4 million in the second quarter of 2016 which along with $377,000 of fair value charges and $380,000 of securities losses, reduced earnings net of taxes by $0.06 per diluted share for that quarter. For the first six months a year ago, acquisition related expenses were much larger $9.2 million, while fair value charges and securities losses combined were $1.4 million. All of which together net of tax effects reduced earnings by $0.18 per diluted share for that six-month period. Excluding the acquisition related expenses, fair value adjustments and securities gains and losses, our earnings from core operations were $25.9 million or $0.78 per diluted share for the current quarter compared to $24.2 million or $0.73 per share for the immediately preceding quarter and $23 million or $0.67 per diluted share in the second quarter a year ago. For the first six months of 2017, our earnings from core operations were $50.1 million, or $1.52 per diluted share compared to $45.1 million or $1.32 per diluted share in 2016. As a result of these increases in total earnings from core operations as well as the reduction in average shares outstanding as a result of stock repurchases in the second half of last year, our earnings per share from core operations increased by 16% and 15% respectively compared to the same quarter and six months periods a year earlier. As we have done in previous earnings releases, again this quarter we have included a reconciliation of earnings from core operations and other non-GAAP financial information in our press release which I encourage you to review. As I noted, underlying this earnings growth, our revenues from core operations which is revenues excluding the gains and losses on the sales of securities and fair value adjustments, we are strong and hit a $122.9 million for the quarter ended June 30, 2017 were 7% greater than the same quarter a year ago. This solid core revenue generation continues to reflect the successful execution of our super community bank business model and the increasing value of the Banner franchise. Second quarter net interest income before provision for loan losses was particularly strong at $99.7 million compared to $94.9 million in the preceding quarter and increased 7% compared to $93.1 million in the second quarter a year-ago, reflecting increased earning asset balances and a stronger net interest margin. Similarly, our net interest income for the six months of 2017 was 6% greater than the same period a year earlier. Our reported net interest margin increased 4.33% for the quarter ended June 30, 2017 and 8 basis point increase from the preceding quarter and 13 basis points above the second quarter a year-ago. More important, excluding the impact of acquisition accounting, our contractual net interest margin for the second quarter of 2017 was 4.18% compared to 4.15% in the preceding quarter and 4.01% in the second quarter a year-ago. Again this quarter, loan yields and net interest margin were positively impacted by increased market interest rates, while deposit pricing remained generally unchanged. In addition, the timing worked well for us as we re-leveraged the balance sheet above the $10 billion mark with first quarter purchases that boosted yields on the securities portfolio. Deposit fees and service charges rebounded to $13.2 million in the second quarter from $12.2 million in the preceding quarter, in line with our seasonal expectations. Deposit fees and service charges increased 8% compared to the same quarter a year earlier, a direct result of growth in core deposit accounts and related transaction activity. As noted in the press release, mortgage banking revenues increased to $6.8 million for the second quarter compared to $4.6 million in the first quarter and $5.6 million in the second quarter a year-ago. The increase in mortgage banking revenues compared to the preceding quarter, reflected in expected seasonal pattern from one to four family loan originations, dampening somewhat by the adverse effect of higher interest rates. In addition, gains on the sale of multi-family loans increased significantly in the current quarter with good volume and improved margins for loan sales compared to the first quarter. Total non-interest operating expenses were $81.9 million in the second quarter compared to $78.1 million in the preceding quarter and $79.9 million in the second quarter of 2016. In total, non-interest expenses were in line with our expectations. Although there were some unusual items in the preceding quarter, which Peter will address in his comments that make comparison a bit more challenging. I will leave most of the balance sheet discussion to Peter as well. However, I do want to remind you that we had particularly strong first quarter deposit growth and that which was not entirely in line with our normal seasonal experience, which generally results in modest first and second quarter balance growth with stronger growth usually concentrated in the second half of the year. As a result, core deposit balances were essentially unchanged at the end of the second quarter compared to the immediately preceding quarter, but they were 8% greater than the same date by year earlier. Finally, I believe it's worth noting that despite a strong earnings, our tangible book value per share decreased to $31.21 at June 30, 2017, compared to $31.68 at March 31, 2017. As a result of the $1 per share of special dividend and the $0.25 per share regular dividend declared in June. I will notwithstanding those dividends and other regular dividends that together totaled a $1.96 per share as well as stock repurchases that we executed in the second half of last year, Banner’s tangible book value per share increased by $0.35 over the 12-month period from June 30, 2016 to 2017. This concludes my prepared remarks. In summary, Banner Corporation had another good quarter and an encouraging start to first half of 2017. As always I’ve look forward to your questions, but first Peter will add some more color on the quarter.

Thank you, Lloyd, and good morning, everyone. I will provide some addition detail on the elements of our second quarter financial results. As Mark and Lloyd noted and as we announce in our earnings release, we reported net income was $0.77 per share for the second quarter. $0.05 per share increase from the prior quarter was due to the following items. Net interest income increased $0.10, due to a combination of higher loan yields and growth in the average investment portfolio balance as a result of the re-leveraging completed in the first quarter. Non-interest income increased $0.03 due to increased mortgage and multi-family loan gain on sale and kind of coupled with growth and deposit fees. Non-interest expense increased $0.08 due to credit related expense recoveries in the prior quarter and increases in compensation in the second quarter. There were no earnings per share impacts due to changes in share account or the effective tax rates. Ending assets grew at $130 million in the second quarter to $10.2 billion. The investment portfolio grew $41 million to $1.7 billion at quarter end. However, the average investment portfolio balance increased $265 million or 20% over the prior quarter due to re-leveraging activity in the first quarter. Growth in the average investment portfolio balance coupled with the 5 basis point increase in average securities yield resulted in $1.8 million in additional investment portfolio-related interest income in the second quarter. Total loans increased to $131 million from the prior quarter end due to growth in C&I and HELOC loans along with seasonal increases in agricultural land usage. On a combined basis, loans held for sale and non-earning assets declined $40 million from the prior quarter. As Lloyd mentioned, core deposits were flat compared to the prior quarter. A change from the seasonal pattern at modest growth Company normally experiences in the second quarter. This bring from normal deposit seasonality was due to the outflow of funds stemming from inflows in prior quarters related to the proceeds from the sale of two commercial client-owned businesses. Total time deposits grew $61 million due to the issuance of brokered CDs, which in total represents 3% of total deposits at the end of the quarter. The total cost of deposits was 15 basis points up 1 basis point from the prior quarter due to a higher mix CDs. Net interest income increased $4.8 million due to an increase in loan yields and an increase in the average investment portfolio balances as discussed earlier. Loan yields are positively affected by $1.3 million increase in acquired loan accretion interest income recorded in the second quarter compared to the first quarter. Loan yields increased 18 basis points to 4.98% in the second quarter. Accretion accounted for 16 basis points of the loan yield in the second quarter compared to 9 basis points in the previous quarter. The contractual loan yield excluding accretion increased to 11 basis points. The net interest margin increased 8 basis points at 4.33%. The effects of purchase accounting including both loan accretion and time deposit premium amortization accounted for 15 basis points of the net interest margin in the second quarter compared to 10 basis points in the previous quarter. The contractual margin including the effects of purchase accounting increased 3 basis points in the second quarter. Core non-interest income excluding gains and losses on securities sale and fair value adjustments on securities and debt instruments carried at fair value increased $1.6 million from the prior quarter. The increase was driven by increased mortgage and multi-family gains on sale coupled with growth and deposit fees. The growth in fee income in the second quarter was partially offset by a $2.5 million gain on the sale of a special asset loan in the first quarter. Total income increased 33% in the second quarter as a result of a one-time gain on an insured beneficiary. Non-interest expenses increased $3.8 million in the second quarter from the previous quarter. Personnel expense increased $3 million due to the impact of bank-wide annual merit increases, one-time market adjustment increases, increased loan and deposit commission expense, and staff growth across the banks risk management and compliance infrastructure associated with processing the $10 billion asset threshold. In addition, the bank experienced an increase in healthcare costs due to a higher claims experience in the second quarter. Professional services expense reflects ongoing consulting engagements, facilitating the enhancement of the banks compliance and DFAST capabilities. However, this line item declined $865,000 from the previous quarter primarily due to reduction in the amount of outside audit expense from the prior quarter. Real estate operations expense increased due to the gains on OREO sales recorded as a credit to expense in the first quarter. Miscellaneous excess increased in the second quarter as a result of a $1.2 million credit to expense in the first quarter from a partial release of the unfunded loan commitment reserve associated with the single barrower. This concludes my prepared remarks. Mark?

Thank you, Peter, and Lloyd, and Rick for your comments. That concludes our prepared remarks. And Yashmin, we will now open the call and welcome your questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Jeff Rulis with D.A. Davidson.

Thanks. Good morning, guys.

Good morning, Jeff.

Peter, quick question on the expense side, could you keep us up to date on the – because your identified DFAST cost of the [$4 million to $5 million] and how far out – or how much your spent incurred to date?

Sure, Jeff. This is Peter. So as you mentioned, our expectation for the total run rate cost of the fully implemented DFAST and enhanced compliance infrastructure is expected to be around $5 billion a year once it fully implemented. Through the second quarter, we’ve recognized approximately 70% of that $5 billion build. So if you think about the quarterly effect, there's another $1 million to go approximately in the quarterly run rate.

And just to clarify, you expected all to be incurred by the end of this…

Yes. There is some lumpiness to the professional services related to the compliance in DFAST that will remain elevated in the third quarter and then begin to diminish in the fourth quarter. The personnel component of that of course is going to be a permanent increase along with some ongoing software and outside consulting expenses that will be part of the permanent program, but we do anticipate a decline in the consulting engagements that are going on now related to those enhancements in the fourth quarter.

Okay. I guess I wasn't aware that there's maybe a – so the build to $5 million occurs this year, but thereafter there could be a modest, at least for that cost alone that could be a modest decline.

Yes. I mean to characterize, it is very modest and it’ll only show up in the professional services line item.

Got it. Okay. And then Mark just a question on the strategy of kind of the Utah branch. I think you've indicated in the past that you continue to look at that footprint since the acquisition. I guess how does that sync up with kind of the other strategy of kind of ramping scale to offset the $10 billion cost and maybe just kind of characterize what led to the Utah sale?

Sure. This is Mark. Thank you for the question Jeff. Well, first of all let me just say, as I've said in the past that we actually like the market quite a bit, like the business climate in the state of Utah, and the staff that we have with the branches there, and our commercial banking staff I think is very solid. However, as I’ve indicated before, our business model works best when we have scale and we didn't see a path to achieve that scale in a reasonable timeframe. So we made a decision that to exit the market there and focus our investment and management oversight into the West Coast.

Okay. And just a couple of quick follow-ups. Is that early or late in the quarter of Q4? Do you expect to see a gain? And lastly, is there any other portions of the footprint potentially in Southern California that you would see that could also be at not at risk, but under watch for additional disposal of other assets?

Jeff. This is Mark. I'll answer the second part of your question and then ask Peter to comment on the economics and timing of the economics. First of all, as I’ve said in other parts of our footprint, we're very excited about the economies there and we feel like we have some excellent banking staff there to take advantage of the marketplace. And quite frankly, there are multiple options for scale improvement specifically in California and the Northwest that we feel we’ll be in a position to take advantage off.

Jeff. This is Peter. In terms of the timing, so we anticipate the closing to occur early in the fourth quarter. As noted in the press release, there's [$269 million] of loans and approximately [$189 million] to deposits that will go away with the transaction. We also expect to record a net gain on sale approximately $11 million after accounting for the write downs of the related goodwill core deposit intangible and net operating losses, associated with that part of the franchise. In terms of the economics that business was somewhat diluted to the rest of the organization in terms of the traditional efficiency metrics, although it's such a small component of the overall organization. We don't anticipate any material changes to our overall efficiency ratio, once the transactions completed.

But there maybe more specifically the expense side of things. Is there a expected maybe not all in Q4, but carry forward of cost saves from supposing of that?

Yes, obviously all the direct expense associated with operating those branches gives away. There is a portion of overhead and then also well go away with the divestiture, although we will routine some of the existing overhead for the rest of the organization as additional capacity to run the rest of the organization. In terms of the net income impact of the company I’d estimated approximately $1 million of net income after tax decline in the Company's consolidated results. Once Utah goes away, but as I said earlier, there will be no impact to the overall efficiency ratio or other return metrics.

Okay, thanks.

Thank you, Jeff.

The next question comes from the line of Tim O'Brien of Sandler O'Neill. Please go ahead.

Good morning.

Good morning, Tim.

Another question for Peter, stayed in municipal business use taxes that line, I was down and catch in your – when you're going item by line item on the call discussion there. Was that – can you give a little color on why that was relative to trailing five quarter's?

Sure. We incurred refunds from the State of Washington that was recognized in the second quarter. This was actually a multi-year effort of reconciling and assessing our VNO tax obligation going back a few years and that credit was recorded in the second quarter. I would anticipate our VNO taxes to resume the normal level that we saw in the first quarter going forward.

How big was that credit?

I don't know that precise number with me Tim, but it was approximately 500,000.

Great. And then the other question that I had for you, can you give a little bit of color. There was a downgrade this quarter, I didn't catch – you said it was a commercial loan I think or the 3.8 million increase in non-accruals? What's the story behind that?

Tim, this is Rick Barton, and I’ll address that one. That was in the commercial portfolio. It was centered in a credit that we've been working on for some time. It's something that I would consider to be an outlier from the rest of the portfolio given the business that it is in. And quite frankly when you've got non-performing assets below a quarter of 1% some fluctuation like this should be expected.

And just qualitatively did you guys set aside any specific reserve against that credit qualitatively? You don't have to give me the number if you don't want to.

We assessed it in our normal reserving process and feel that we're appropriately reserved.

So no specific reserves against our credit.

We have reserves that are associated formulaic with all credits, but nothing specific beyond that.

Okay, all right. Thanks for answering my questions.

Thanks Tim.

The next question comes from Matthew Clark of Piper Jaffray. Please go ahead.

Good morning.

Good morning.

Just curious on the run rate of expenses you talked about the step-up for crossing 10 billion and that's kind of baked in the outlook. But just curious about the comp line and whether or not there was anything unusual there this quarter and how you think about the overall run rate of expenses in the second half of the year?

Good morning, Matt. It’s Peter. The comp expense line as I mentioned in my prepared remarks increased due to the normal season merit increases that are generally done annually in the second quarter coupled with some one-time market adjustment increases and then additional staff growth primarily related to enhancements in our risk management infrastructure. Going forward, we still expect some additional build in compensation as we complete the build out of the DFAST and compliance infrastructure. Also the other element of the second quarter I want to highlight in fact that we had approximately $800,000 of increased loan deposit commission expense in the second quarter versus the first quarter. And that was due to an increase in loan and deposit production in the second quarter. And so part of that growth is variable comp related to the production activities. But going forward, they anticipate in more modest growth in compensation as we go forward and complete the build out of some of those staff roles in that compliance infrastructure.

Okay. And then any updated guidance in getting to your targeted efficiency ratio range. I think you’ve talked about in the past is 62% to 65%?

Yes, I think obviously the efficiency ratio is a function of revenue growth and expense growth – and we do anticipate continued improvement in the efficiency ratio as a function of the growth in our core deposits and continued growth in fee income. I do want to note that in the second quarter, we regenerated approximately $1.2 million in multi-family gains on sale. That was a result of selling approximately $110 million in loans in the second quarter, but it's also a function of a hedging program we put in place on multi-family in the second quarter, which will have the benefit of reducing the volatility in multi-family fee income going forward. So we expect a more recurring and regular pattern of multi-family income going forward that will benefit the non-interest income line. But our expectation is that – as we’re going for a bit of an [indiscernible] and building out the compliance infrastructure. So we're going to see somewhat of a slowdown in our normal pace of efficiency ratio improvement and that will accelerate again beginning in the fourth quarter and into 2018.

Okay. And then just on the balance sheet leverage strategy, securities portfolio I think flat linked quarter, obviously on an average basis that reduced your loans to earning assets this quarter. I guess where do we stand in that build out that we largely done here or is that going to continue securities grow from here?

It was largely done. You will see an increase proportionate to the total asset growth of the company, but it's going to be very modest going forward.

Okay. And then last one just on capital management around share repurchase. Any appetite there? I know you guys obviously did the special dividend, but also curious about your thoughts on M&A of late?

M&A of late, do you have any specific references? There’s been a number of them.

No, just for yourselves, I guess just updated thoughts on the M&A landscape in which you might be looking at things you are considering or is it really quiet?

Well, first and foremost I say, you watched our tangible book value increase year-over-year and the Company had some very solid earnings. So we make these decisions on capital deployment based on the same cascading effect and strategically that we have said in the past, which is first and foremost as investment, the franchise. Second is profitably M&A sale in markets that will add additional density for us. And then we would look finally to special dividends and/or stock repurchases and quite frankly we've done both; the stock repurchase last year and the recent special dividend that we've done now. So that's kind of the deployment of capital philosophy. Going forward when you consider M&A as you might suspect, there is a bit of activity out there in terms of potential combinations. And we're going to stay focused on our organic business model and should opportunistic situations arise within the footprint that we're concentrated in on the West Coast. We hope to take advantage of that.

Okay, great. Thank you.

Thank you, Matt.

The next question comes from Jackie Bohlen of KBW.

Hi. Good morning, everyone.

Good morning, Jackie.

Looking to the HELOC growth that you had in the quarter and when those loans booked? Did they fund immediately or is there more utilization that could come in the third quarter and beyond?

Well, there always is some immediate funding when HELOC goes on because quite often it's refinancing another HELOC or in conjunction with some other specific activity that client is undertaking. It's rare for something to be drawing down 100%. So I think you could anticipate that there would be some additional drawdowns in the future.

Okay. So kind of a nice benefit that you could get going forward from that portfolio growth?

Yes, Jackie.

And then are you offering any incentives to either customers or your lenders in order to generate the added business?

Yes, Jackie, this is Peter. We do have a campaign on the HELOC program and there is some incentive that the loan program itself has a fixed initial rate for a period of time and then it reprices to a prime base adjustable spread after that initial rate is over. So as loans come on they put on it at fixed rate that we do enjoy repricing benefit in that initial fixed rate period is over. And of course, there is some incentive costs, it goes with that campaign, that's paid out in the form of loan commissions in our compensation expense line item.

Okay.

Jackie, this is Mark. We were on campaigns all the time on specific products that we want to try and attract into the market or cross-sell our existing relationships.

Okay. And then on average how long is that fixed rate period for?

Depends on the particular campaign, but it's anywhere from one to two years typically.

Okay. And does the changing rate environments have anything to do with the focus here or was it another driver?

It's just part of our general retail business model to offer that product to our retail customers. I will note as you mentioned interest rates that we did enjoy an improved loan yield margin of 11 basis points over the prior quarter. And that's directly a function of two rate hikes in March and June and the effects on our floating rate loan portfolio, which is approximately 33% of the total book. And within that 33% of the total loan book, 25% of loans are tied to Prime and another 9% tied to [life float] from LIBOR. So we are enjoying the benefits of the Fed activity.

You took my next question right out of my mouth. So understanding that the June rate increase, obviously you didn't have very long with that. Can we anticipate additional increases in rates next quarter in terms of the loan book?

I think that’s fair. All things equal and we only had two weeks of the rate hikes in the second quarter results in a full quarter of the higher rate in the third quarter. We will see some modest improvement in loan yields. Again I wouldn't characterize it as dramatic. But we do expect to have a modest benefit going into the third quarter of the rate hike both interesting.

Jackie, this is Lloyd. Two other things that I think you should consider in connection with that first. In addition to the rate hike in the second quarter, we had some pretty robust activity in our construction portfolios in terms of loans – home sales and loans paying off and that accelerates recognition of some deferred fees that was the contributor to the loan yield along with the rate hike. And second, the caveat me very well that caveat it is out here of course is what's going to happen with deposit pricing. But as I noted in my comments, to date that we haven't seen any meaningful adjustment in deposit pricing in the cost of funds and that’s of course supported by significant by the fact that we've had great success growing non-interest bearing accounts. But at some point in time, it's like with there's going to be some funding pressures as well, to this point the rate movements have all been beneficial to us.

Okay. So the high velocity of turnover in the construction bucks that we've discussed on the past that drove other portion of the linked quarter increasing core loan yields?

Yes, it was a good quarter for a turnover in that portfolio.

Okay. Just an apples-to-apples basis, do you have a sense for what kind of a core increase in loan yield would have been in the quarter, if construction activity would have been similar?

No.

Okay.

No, I think not up the top of my head.

You don’t want to me, my work for me Lloyd.

This is just me being cautious that yes, the last rate hike was midway through June and yes we should benefit from that, but let’s not get overly enthusiastic about that.

Okay, fair enough. And then just one last quick one, and the multi-family increase in the held for investment portfolio in the quarter, is that related to the decrease in commercial real estate and meaning not for a quite some time we've watched the on balance sheet multi-family balances decline? I know they were up just a little bit in 1Q, but they were up more significantly in 2Q. As commercial real estate has declined has that increased your appetite for balance sheet multi-fam?

I think that while there is some linkage between the two categories they operate independently of one another, and it's more driven by the fact that as we go through the construction cycle on the multi-family construction loans. One of those goes to permanent and the plant elects to keep the permanent loan with the bank for a period of time. You will see lumpy increases in the multi-family category and that's what happened in this quarter.

Okay, so we could see some more of that going forward?

Occasionally, yes.

Okay, great. Thanks everyone.

Thank you, Jackie.

The next question comes from Don Worthington of Raymond James.

Well, good morning, everyone.

Good morning, Don.

In terms of the gain on sale, I guess just mortgage banking revenue, I think Peter commented on the multi-family piece. But in terms of single family mortgage banking income were – where do you kind of see that going into the second half?

Don, this is Peter. So just to give a bit of color on the mortgage component of the gain on sale, mortgage generated about $200 million production in the second quarter compared to $175 in the first quarter. We saw a pretty significant shift in the mix of refi purchase between the first and second quarter, refi volume was 36% of the total production in the first quarter and it dropped to 22%. In the second quarter and the reason we still have the increase was that we have a significant growth in the purchase activity. In our mortgage business, mortgage is a seasonal business. We typically have growth in the second and third quarters and then it begins to diminish in the fourth quarter due to weather primarily in the Pacific Northwest. So the pipelines in the trajectory for the third quarter it looks very similar to what we experienced in the second quarter in terms of mortgage production.

Okay. Great, thanks. And then sort of just a relatively small increase in FHLB advances in the quarter about $50 million probably to smooth the gap between loan growth and deposit growth, but what type of maturity was that?

We typically ladder our FHLB advances with a combination of overnight advances and interim advances that typically are 12 months or less.

Okay, great. And I guess one last question. How much exposure do you have to the retail sector in your commercial lending and whether you've seen any weakness there recently?

Don, this is Rick. I’ll try to take that question on. We’ve taken a look at what we consider to be our core retail outstandings. The C&I portion of that is slightly over $100 million or about 1.5% of the loan portfolio and about 10% of risk-based capital. If you take a look at the brick-and-mortar portion of the retail portfolio that is about 12% of the portfolio split about 9% in investor real estate and 3% in owner occupied real estate. So on combined basis about 13% of the portfolio is linked quarter retail. And the only other thing that I might point out is that the average loan sizes under $0.5 million, so that’s not made up of large exposures.

Okay, great. That's good color. Thanks Rick.

Thanks Don.

[Operator Instructions] We have a follow-up question from Tim O'Brien of Sandler O'Neill.

One follow-up question for Peter. You might have touched on this, the service charges – the increase in service charges this quarter to $13.2 million. Was there some seasonality in that? You described the seasonality there. What's the seasonality trends – what are the seasonality trend suggests in the third quarter on that number? Do you expect that number to be seasonally higher again based on historic trends?

Tim, this is Peter. We do typically see some improvement in the third quarter on the overall core deposit base and coming with that is associated deposit fees. These are also a function of our success in growing accounts in the second quarter. And can acquisition benefit on a number of accounts to generate the fees. So it’s a combination of good consistent account generation along with some seasonality that we normally see in the second quarter that typically continues into the third quarter.

All right. Thanks a lot.

Thanks Tim. End of Q&A

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Mark Grescovich for any closing remarks.

Thank you. As we’ve stated, we're pleased with our solid second quarter 2017 performance and see it as evidence that we’re making substantial and sustainable progress on a disciplined strategic plan to build shareholder value by executing on or super community bank model, by growing market share, strengthening our deposit franchise, improving our core operating performance, maintaining a moderate risk profile, and prudently deploying excess capital. I'd like to thank all my colleagues who are driving this solid performance for our Company. Thank you all for your interest in Banner and joining the call today. We look forward to reporting our results to you again in the future. Thank you, everyone. Have a great day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.