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,…

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…

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…

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…

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.