Earnings Labs

Banner Corporation (BANR)

Q3 2020 Earnings Call· Thu, Oct 22, 2020

$67.24

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Transcript

Operator

Operator

Good morning, and welcome to the Banner Corporation Third Quarter 2020 Conference Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mark Grescovich, President and CEO of Banner Corporation. Please go ahead.

Mark Grescovich

Analyst

Thank you, Kate, and good morning everyone. I would also like to welcome you to the third quarter 2020 earnings call for Banner Corporation. As is customary, joining me on the call today is Peter Conner, our Chief Financial Officer; Jill Rice, our Chief Commercial Credit Officer; and Rich Arnold, our Head of Investor Relations. Also in his final earnings call for Banner is Rick Barton, our Chief Credit Officer. Rick will be retiring at the end of the month after 18 years with Banner and a 48-year banking career. Rich, would you please read our forward-looking Safe Harbor statement?

Rich Arnold

Analyst

Sure, Mark. Good morning. Our presentation today discusses Banner's outlook, business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures and statements about Banner's general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available from our earnings press release that was released yesterday and the most recently filed Form 10-Q for the quarter ended June 30, 2020. Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations. Mark?

Mark Grescovich

Analyst

Thank you, Rich. It has certainly been an interesting first nine months of 2020, and I hope you and your families are well as we all battle the COVID virus and its effects on our communities and the economy. Today, we will cover four primary items with you. First, I will provide you high-level comments on the quarter. Second, the actions Banner continues to take to support all of our stakeholders, including our Banner team, our clients, our communities and our shareholders. Third, Jill Rice will provide comments on the current status of our loan portfolio and accommodations we have made to assist our clients. And finally, Peter Conner will provide more detail on our operating performance for the quarter and the build of our loan loss reserve associated with the estimated economic impact of the COVID virus on our clients. I want to begin by thanking all of my 2,100 colleagues in our company that are working extremely hard to assist our clients and communities during these difficult times. Banner has lived to our core values summed up as doing the right thing for 130 years. It is critically important that we continue to do the right thing for our clients, our communities, our colleagues, our company and our shareholders to provide a consistent and reliable source of commerce and capital through all economic cycles and change events. I'm pleased to report to you that is exactly what we continue to do. I'm very proud of the entire Banner team that are living our core values. Now let me turn to an overview of the third quarter performance. As announced, Banner Corporation reported a net profit available to common shareholders of $36.5 million or $1.03 per diluted share for the quarter ended September 30, 2020. This compared to a…

Rick Barton

Analyst

Thanks, Mark. Before I turn the microphone over to Jill Rice, I would like to thank all of you for your patience and courtesy over the past decade as I have answered or not answered your insightful questions. Also, I would like to acknowledge how our interactions have deepened and expanded my understanding of the equity markets in general and how each of you view the financial services sector. And lastly, I would like to thank each of you for your interest and support of Banner. With that, I will pass the mic toward to Jill. As you work with her, I know you will recognize and appreciate her experience, intellect and candor as I have over the almost 19 years we have worked together. I can say without reservation that Banner's credit risk management and credit culture are in good hands. My best to all of you and your families and associates and stay safe as we continue to navigate the pandemic. Jill?

Jill Rice

Analyst

Thank you, Rick, and good morning. Before I review Banner's credit portfolio, I would just like to take a minute to thank Rick for everything that he has done to assist me in my career over these past 18 years. It seems impossible that it has been that long, but as I say time flies. Working alongside Rick over the last two decades has no doubt made me a better banker because he is certainly one of the best. I hope that it has made me a better person because while you all know Rick to be an excellent credit professional, I have to say that he is an even better human being, kind, generous and respectful to all. There is no doubt that he will be missed around here. Rick, I wish you and Georgette years of happiness and many great adventures in your retirement. And now before I get choked up, let me review Banner's credit quality. For the past two quarters, we have noted that our credit metrics do not yet capture the changing economic and credit landscape. And that statement is no less true today. Our delinquency numbers are still being muted in part by payment deferrals provided to clients, who have been severely impacted by the economic shutdown and in part by the various fiscal stimulus programs. Before I update the details regarding our payment deferrals, let me make a few comments to summarize our September 30 credit metrics. Banner's delinquent loans in the third quarter increased 2 basis points over the linked quarter and represent 0.37% of total loans as of September 30. This compares to 0.30% as of September 30, 2019. Our non-performing assets continued to decrease in the quarter and now represents 0.25% of total assets, a 3 basis point decline. Non-performing…

Peter Conner

Analyst

Thank you, Jill. As discussed previously, and as announced in our earnings release, we reported net income of $36.5 million or $1.03 per diluted share for the third quarter compared to $23.5 million or $0.67 per diluted share in the prior quarter. The $0.36 increase in per share earnings was driven primarily from a decline in credit loss provision expense. Core revenue excluding gains and losses on securities and changes in fair value of financial instruments carried at fair value increased $3.5 million from the prior quarter as a result of growth in core deposits, along with an increase in mortgage and deposit fee income. Core expenses increased $3.6 million due to an increase in the provision expense for unfunded loan commitments and a lower deduction of capitalized loan origination costs. Loan loss provision expense decreased $16 million due to a more modest reserve build as a result of a stable economic outlook, a slowdown in the pace of downgrades and a continuing low level of charge-offs. Turning to the balance sheet, total loans decreased $193 million from the prior quarter-end as a result of pay-downs and lower line utilization. Excluding PPP loans and held for sale loans, portfolio loans declined $148 million due primarily to prepayments in the one-to-four-family mortgage and commercial real estate portfolios and lower line utilization in the commercial business portfolio. Held for sale loans decreased by $73 million, principally due to a large bulk sale of multifamily loans carried over from the second quarter. Excluding the AltaPacific and PPP loans, loans declined by 1.7% over the prior year quarter. Ending core deposits increased to $326 million from prior quarter-end due to a continued increase in overall client deposit balance liquidity, net new account growth and a modest contribution from deposits generated from PPP loan proceeds…

Mark Grescovich

Analyst

Thank you, Peter. Rick and Jill for your comments this morning. That concludes all of our prepared remarks and Kate, we will now open the call and welcome your questions.

Operator

Operator

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

Jeff Rulis

Analyst

Thank you. Good morning.

Mark Grescovich

Analyst

Good morning, Jeff.

Jeff Rulis

Analyst

Maybe I would just follow up on Peter's comment on the branch closure. Just to kind of get the dollar impact, do you anticipate any upfront charges and then maybe expense savings in dollars, and I guess the timing is would that be a full run rate in the first quarter of next year? And lastly, location wise is this exiting certain markets or is it kind of rifle shot a few that are redundant and just kind of what are the branches' profile that you are closing? Thanks.

Peter Conner

Analyst

Yes, sure. Jeff, this is Peter. Yeah. So the answer to the first question, we do anticipate restructuring and exit costs around the $4 million range in the fourth quarter that would cover the usual exit cost in terms of lease termination and writedown on facility assets and some severance related expense. In terms of the timing of the benefits of those branch closures, we'll begin to see them in the first quarter, albeit, we'll see some of the benefits in the impact of some other cost initiatives later in the year. And so in terms of guidance, we are anticipating seeing the impact to our core expense run rate really materialize in the second half of 2021. We will still have some merit increase related increase in compensation that will roll through in the second quarter. So the run rate earnings or the run rate core expenses will really begin to decline in the second half, which will be a function of not just the reduced branch count, but other initiatives related to our support and administrative support functions that will also see some lower expenses as we get further into 2021. In terms of the types of branches that are included in the 20 there, generally we were not getting out of any markets, they're generally branches that are -- where we have solid presence in a given market and we are just reducing the number of branch locations in that market. And as you know, that process of rationalizing our branches is always done in the context of minimizing client impacts, minimizing deposit attrition and allowing us to continue to grow core deposits in the markets we're in. So they are all selected branches across all of our markets that meet those criteria.

Jeff Rulis

Analyst

Great, thank you. And Peter, the range bound margin characterization, any further color -- I mean, in terms of the sequential decline that we've seen, could you quantify? Is range bound -- is there equally some upside and some downside to that figure around $365 million reported, and I guess ex PPP or including PPP impact?

Peter Conner

Analyst

Yeah. And the context of that comment really are driven by the uncertainty of the excess deposit liquidity trajectory. So we -- as of today, we foresee that the PPP loan balances will stay generally flat for the fourth quarter as the rules around SBA forgiveness have shifted back the timing of the prepayment activity in that portfolio. So we, at this point, foresee that much of the forgiveness and acceleration of the processing fee related to prepayments will benefit the margin in the first and second quarter of '21. In terms of the fourth quarter, the variable will be principally the level of excess deposit liquidity and where that goes. If it stays more or less flat to the third quarter and the PPP loan balances stay stable, we would expect very modest decline in the margin all things equal, we will have some modest core loan portfolio decline due to natural repricing of term loans that will be parsed out if there was some continued declines in deposit cost. So the comments around range bound a really tied to the level of deposit liquidity and the PPP portfolio, which at this point we think is fairly static. We have intentionally remained short in investing that excess deposit liquidity and overnight funds mix between the Fed and some money market balances and we are doing that intentionally due to the liquidity -- the potential volatility in deposit liquidity and then to maintaining optionality for higher yields as we go forward and further not risking any AOCI losses down the road by taking excessive duration right now.

Jeff Rulis

Analyst

Got it, OK. Thanks, Peter. And Rick, I appreciate all your help over the years. All the best ahead to you and look forward to Jill's input to so a great team. Thank you.

Rick Barton

Analyst

Thank you, Jeff.

Operator

Operator

The next question is from Andrew Liesch of Piper Sandler. Please go ahead.

Andrew Liesch

Analyst

Good morning, everyone. And congratulations, Rick, certainly well deserved. I'm just wondering if you guys can provide a little bit more detail on some of the underwriting behind some of the hotel properties and some of the retail properties, just LTVs maybe backing these properties but certainly appreciate the reserve build that you've had so far this year and the proactive downgrades. But I'm certainly curious on what you might have protecting the collateral behind that as far as underwriting is concerned.

Jill Rice

Analyst

Hey, Andrew, this is Jill. So as we look at the hospitality portfolio, pre-pandemic underwriting criteria would have suggested that loan to values would have been below 60% and that service coverage would have been north of 150 on the hospitality. The other category you asked was office -- or retail?

Andrew Liesch

Analyst

Retail trade. Yeah, I guess, some of that [indiscernible] properties.

Jill Rice

Analyst

So retail pre-pandemic, same thing. Our underwriting there -- we went into the pandemic with an average loan to value less than 50% on our retail portfolio and debt service coverage averaging 175 and above.

Andrew Liesch

Analyst

Okay, that's helpful. But you said you've been trying to get updated property values, I mean, I can imagine there are too many transactions that are going on, so lower property values have truly gone. But I mean, have you been like when you've been taking on this project, have you been lowering the property values along with what you've been seeing going on, you've split the business activity.

Jill Rice

Analyst

You're correct, There haven't been a lot of transactions. We have developed an internal model for bringing into the borrowers' expectations for operations and discounting the lost revenue over the period of time we think it will take to return to a normal stabilized operating value. So across the board, coverages may be gone from collateral at a 65% loan to value to estimating closer to 75 to 80 on a couple of the hospitality loans we've looked at. When we look at the retail properties, we have seen very strong rent collection and are not estimating any significant decline in value right now based on that data.

Andrew Liesch

Analyst

Okay, that's helpful. And then just generally, what are your borrowers saying about their businesses, have they been able to just change how they operate? I mean, obviously, it sounds like, it will be more stressed in the hotel and hospitality area, but have they been able to adjust operating cost and try to find other ways to grow revenue in the midst of the pandemic?

Jill Rice

Analyst

Certainly, that's client by client, but, yeah, they're shifting as they can whether if you're thinking restaurants, outdoor dining, ghost kitchens, ramping up delivery versus just the dine-in operation and hospitality reducing staffing and opening only certain floors, things like that to reduce some of their expenses. So they're doing what they can to mitigate some of the reduced top line revenue.

Andrew Liesch

Analyst

Okay, thank you for taking my questions on credit, I will step back. Thank you.

Operator

Operator

The next question is from David Feaster of Raymond James. Please go ahead.

David Feaster

Analyst

Hey, good morning everybody. First, I just want to echo the comments. Congrats. Rick, on your retirement and Jill excited to be working with you. I just wanted to start on loan growth. Originations have been strong. You're clearly open for business, you've got an appetite for credit, just curious to get your thoughts on pay-offs and pay-downs, is it the competitive landscape where it's just competitors are pricing things, they just don't make it worth it or is it borrowers paying down lines? And then just how do you think about net growth going forward?

Jill Rice

Analyst

David, starting with the line activity, we haven't seen borrowers tame down their lines, that much line usage is what it has been on average. When we went into the pandemic, we would have expected it to increase may be. And we didn't see that either. So that's running about average. The decline in loan growth, as I said in my prepared comments, is really driven by the low rate environment and the continued residential refinances coupled with -- we're seeing some of that in the commercial real estate as well as people are shopping. What do we see for loan growth? We've said that 2020 will remain flat because of these payoffs. And then any loan growth in 2021 is going to be based on, in our view, a sustained improvement in the economy coupled with the development of a vaccine and the overall improved confidence. So I would expect that the loan growth as it picks up in the 2021 will be more back loaded as the commercial customers become more confident.

David Feaster

Analyst

Okay. That's helpful. And then just following back on the branches, so I guess how -- what kind of attrition do you expect with these? I guess, just given the current environment and higher adoption of technology, would you expect attrition to be kind of less than what you've seen in the past and how has attrition been on the recent branches that you've closed? Just curious any thoughts on there? And then just what do you expect the earn back to be on these branch closures?

Peter Conner

Analyst

Yeah, David, it's Peter. So, yes, the branches, as I mentioned earlier, they generally are smaller balance locations. So they -- in most cases, they are dilutive to ROA and for the whole -- and the retail organization. And so they are typically smaller balance locations and they typically are relatively close to the next closest branch and so we do expect some attrition. It's a little bit different by location, depending on what market it's in, how far away it is from the next closest branch. But it's typically mid-single digit type attrition assumptions on balance across the portfolio of branches we're getting out of. But they are also relatively small. So it's actually a fairly small total of our total deposit balance represented in those 20 locations. So, again, it's -- in terms of payback, we typically look at -- rather than pay back, we look at the ongoing economic benefits to the Company and the accretive value closing them post exit costs. Most of these branches, they are a mix of owned locations and leased locations. This group that's going in the fourth quarter is more heavily on the owned side. So we've included expectations for any losses on selling the real estate in the $4 million estimate, I mentioned earlier.

David Feaster

Analyst

Okay, that's helpful. I appreciate that. And then just -- you guys have done a terrific job on the deferral front, I mean, the deferrals have come down materially. Just curious, your approach to the second round deferrals, how are those conversations? Did you require any additional collateral or anything like that? And then for those borrowers that need additional relief, how do you -- after the second round of deferrals expire, how do you plan to address that? I mean, would you potentially grant a third-round or at that point take it to either non-accrual or TDR and work it out? Just curious of your thoughts there.

Jill Rice

Analyst

The general answer to that question is that whether it was first round, second round or as we look into potential additional deferrals, it really is case-by-case specific and a function of not only how that specific asset within our borrowers portfolio is performing but their global picture and what kind of support they can bring. Are we getting additional collateral? Certainly if there is collateral to get, we're doing what we can to shore up some of that, sometimes it's not really about collateral and it's working out a longer time period to recover. So will we grant more? It's possible and especially in our markets where if you look at Oregon, where we don't really have an option as to whether we grant deferrals with the Governor's law 4204, if there is real-estate secured loans in Oregon that were impacted by COVID, if they can show us that we have to give them a deferral through the end of the year. So, again, it's going to be case-by-case and sometimes out of our control. Would we work them out? Would we put them on nonaccrual? Certainly if we get to a point where we think that there is a chance that we have loss and if they're not going to be able to service the debt with reasonable bank concessions or other collateral sources, we're going to put it on nonaccrual take losses as we see them.

David Feaster

Analyst

Understood. Thank you.

Operator

Operator

[Operator Instructions] The next question comes from Christine Bohlen of KBW. Please go ahead.

Jacquelynne Bohlen

Analyst

Hi, it's Jacque Bohlen. I'm not sure where the Christine came from. Hi, good morning everyone. Just wanted to quickly get some -- couple of clarification questions on the expenses. The branch consolidations, are any of these in any way related to M&A?

Peter Conner

Analyst

Hi. Yeah, Jacque, it's Peter. No, no, these are all core branches for us, they are not related to any of the prior acquisitions we've done. Some of them have come from prior acquisitions but they're not tied to any new M&A activity.

Jacquelynne Bohlen

Analyst

Okay. I had thought that all those had already been completed. I just wanted to double check on that. And then, you had referenced to low to mid-single digit percent decline in expenses, what do you use as the base for that calculation?

Peter Conner

Analyst

Yeah, that's a good question. We're using our core expense base in 2020. So we're thinking about it in terms of our full-year 2020 core expense run rate and then relative to that number, what our run rate expenses will be in the second half of 2021.

Jacquelynne Bohlen

Analyst

Okay. And how do you describe the processes gone through when looking at these expenses? What I mean by that is has this been a very thorough scrub in which you've looked at different areas and really evaluated all the branches or is this an ongoing process where maybe this might be the bulk of what you do, but there could be other incremental cost saves in the future.

Peter Conner

Analyst

Yeah, this is a -- we've taken a comprehensive enterprise review behind the numbers that I provided, they will -- the timing on when those cost savings are implemented, however, are spread out. So they don't all happen in a single quarter. In addition to the branch closures, there's a series of initiatives that will take effect quarter-to-quarter as we go through '21 and even some that will take effect in '22. So it will be kind of a slow ramp down to that baseline over time. And then as we go through that, yes, there may be some additional opportunities or adjustments that materialize against that number that will be addressed at that point. So I would characterize it as, it is an enterprise effort but it will be scheduled out over the next six quarters and there may be some additional savings that materialize, but we're not committing to those at this stage.

Jacquelynne Bohlen

Analyst

Okay. Thank you. That's helpful. And then just lastly, in terms of mortgage banking, I am realizing that we're still pretty early in the quarter, but how does the momentum compare in October versus what you saw in the third quarter and also the gain on sale margin?

Peter Conner

Analyst

Yeah, it's been -- the pipelines are still remarkably robust for this time of the year as we typically see a big slowdown in mortgage activity in Q4 and Q1 due to the weather, but they continue to be very strong going into the beginning of the fourth quarter we do --. That being said, we do anticipate a slowdown from what was a record third quarter for the Company but we still see there's a lot of pipeline out there yet to process that will carry some of this additional volume all the way through Q1. So we think the elevated level will continue, albeit, at a lower level in Q4 and in Q1, before it really begins tapering down as some of the burn out around refinance begins to take a hog. But we will see some decline, but we still see good momentum going into Q4.

Jacquelynne Bohlen

Analyst

Okay. And how about the gain on sale margins?

Peter Conner

Analyst

That's still holding up. But as you know we've said, we're seeing gain on sales in the mid-4% range, that's likely to begin to come down a bit, too. It's been remarkably strong because of the demand and our ability to throttle that demand with increased pricing. So we think that gain on sale is going to come down a bit from where it's been, but it will still be above our long-term average.

Jacquelynne Bohlen

Analyst

Okay. Great, thank you. And I echo everyone else when I say congratulations, Rick, and best of luck in the future.

Rick Barton

Analyst

Thank you.

Operator

Operator

The next question comes from Tim Coffey of Janney. Please go ahead.

Tim Coffey

Analyst

Great, thanks. Good morning, everybody. First off, Mr. Barton, thanks for your help through the years and I wish you the best going forward as well. If I can start with kind of the deferrals, the loans that received a second deferral, when did the majority of those happen?

Jill Rice

Analyst

So that's been a moving target as well, Tim, first deferral starts in March and continued to come on throughout that first quarter and even into second quarter. And so some of the second deferrals, people went back to payments and then have come back and said, all right, I've made a couple of payments, but now I'm heading into what I am concerned about in terms of thinking hospitality the November, December, January winter month. And so they've come back and requested deferrals. So it's a moving target. That's the short answer.

Tim Coffey

Analyst

Okay, Appreciate that. And then the length of the deferral period, are those still 90 days or just stretched about to 180?

Jill Rice

Analyst

Oh, no. By and large, all of our deferrals first or second were limited to 90 days, so that we could reassess, get more updated information and make another informed decision as to what to do in that second half.

Tim Coffey

Analyst

Sure. Okay, makes sense. And then, is there a commonality among the hotels that received the second deferral? Is there a common trend among the group?

Jill Rice

Analyst

[Indiscernible] reduced occupancy from more of the urban central hotels, so significantly reduced occupancy would be the trend for the second deferrals.

Tim Coffey

Analyst

Okay, alright.

Jill Rice

Analyst

Okay.

Tim Coffey

Analyst

And you said, those were in urban areas.

Jill Rice

Analyst

Yes.

Tim Coffey

Analyst

Just kind of a general question about -- given your footprint in the different states sector and have the restrictions on business activity in those different states significantly impacted borrowers in the last couple months?

Jill Rice

Analyst

Has the business activity significantly impacted borrowers?

Tim Coffey

Analyst

Or just the restrictions by the different states that you operate in.

Jill Rice

Analyst

Right. Where I was going was that most of them have pulled back, so we're in Phase 2 and 3 in most of our states, so economic activity is picking up. And so to that regard, it's benefiting borrowers. The question becomes what happens as we go into the fall with the virus and associated pullbacks.

Tim Coffey

Analyst

Okay. And Jill, some of the comments you've made on the call today kind of make it sounds like the demand shock that we're seeing right now could be temporary in that there's money on the sidelines, a vaccine develops things start to turn getting better in terms of dealing with the cases of COVID, that all that money could come back off the sidelines and start getting back into the economy. Is that accurate? Does that describe how you're feeling actually?

Jill Rice

Analyst

I think that people are just reserved right now waiting to see what happens, what happens with the election, what happens with the virus. I think we need to get through the winter months and see if there is more pull back before they'll start making the capital investments that were may be teed up before we went into COVID-19.

Tim Coffey

Analyst

Okay. And the demand shock isn't unique to Banner, we've seen it across a bunch of the banks in the last -- this quarter were commercial real estate, for instance, those types of borrowers have been moved into the sidelines, I'm just wondering that if this does -- this uncertainty does continue through the end of this quarter, that maybe loan growth could be lower than what you guys have been talking about? Is that possible?

Jill Rice

Analyst

Well, we have been saying that through 2020, our loan growth is going to be flat and I think that's where we'll be. So we're slightly down 1.6% I think it was year-over-year and driven primarily by that residential refinance. So I think that we're going to be flat for 2020 and then we'll see some pickup in it in 2021 later in the year.

Tim Coffey

Analyst

Okay, great. I appreciate. Those are all my questions. Thank you.

Mark Grescovich

Analyst

Thank you, Tim, this is Mark. Let me just say that what we're seeing in the pipeline book as it relates to commercial demand is it's not deteriorating farther. So it's kind of plateaued, which may be a harbinger for more activity going into 2021 if there is some resolution in some of the items that Jill had already mentioned.

Operator

Operator

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

Mark Grescovich

Analyst

Great. Thanks, Kate. As I've stated, we are very proud of the Banner team as we continue to do the right thing as we battle this COVID virus. Want to thank you all for your interest in Banner and for joining our call today. We wish Rick well in his retirement. He will still have some participation through the end of the year in assisting us but we look forward to him enjoying his retirement into 2021. And thank you, again, for your time, and your interest in our company and we look forward to talking to you in the future. Have a great day, everyone, and be safe.

Operator

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.