Columbia Banking System, Inc. (COLB) Q3 2021 Earnings Report, Transcript and Summary

Welcome to Columbia Banking System's Third Quarter 2021 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to your host, Clint Stein, President and Chief Executive Officer of Columbia Banking System.

Thank you, Norma. Welcome, and good morning, everyone, and thank you for joining us on today's call as we review our third quarter results. which we've released before the market open this morning. The earnings release and accompanying investor presentation are available at columbiabank.com. Before we begin, I want to welcome the nearly 200 new Columbia Bank employees who joined us from Bank of Commerce Holdings on October 1. I've spent a lot of time over the past few months getting to know the California team, and I'm excited about their contribution to the future growth of our company. Today, we reported third quarter net income of $53 million or $0.74 per share. The third quarter was very busy as our bankers deepened relationships in our existing markets, resulting in substantial growth in both our core loan and deposit portfolios. Fee income rose across the board, and expenses were well controlled. Our operational teams worked tirelessly to ensure an efficient and successful close of the Bank of Commerce Holdings acquisition, finalizing our entry into the California market. And shortly after the third quarter ended, we announced our planned combination with Umpqua Holdings. We expect the momentum to continue in the fourth quarter and into next year as our bankers remain laser-focused on expanding existing relationships and winning new business. On the call with me today are Aaron Deer, our Chief Financial Officer; Chris Merrywell, our Chief Operating Officer; and Andy McDonald, our Chief Credit Officer. Following our prepared remarks, we'll open the line for questions. I do need to remind you that we may make forward-looking statements during today's call. For further information on forward-looking comments, please refer to either our earnings release, our website or our SEC filings. At this time, I'll turn the call over to Aaron.

Thank you, Clint. Good morning, everyone. During the third quarter, Columbia generated net income of $53 million or $0.74 per share, driven by solid fundamentals. Adjusted for $2.2 million of acquisition-related costs, pretax pre-provision income of $70.8 million was our second best quarter on record, trailing only the second quarter of 2020 when we recorded a large gain on our Visa B shares. Deposit inflows remained exceptional with balances up $608 million during the quarter to $16 billion at September 30, representing an annualized growth rate of 16%. Over the past 12 months, deposits grew by $2.4 billion or 17%. Our cost of deposits in the third quarter remained at a historic low of just four basis points. Total loans net of PPP increased by $183 million or 8% annualized to $9.2 billion at September 30. Remaining PPP loans totaled $337 million at period end, and the remaining net deferred fees still to be realized was $8 million as of September 30. We originated $366 million of new loans during the quarter. This new production was brought on at an average tax-adjusted coupon rate of 3.59%, which compares to the overall portfolio rate, excluding PPP, of 3.83%. Our investment securities portfolio was $6.9 billion as of September 30, which was a linked quarter increase of $692 million, driven by $971 million of purchases. Purchases had an average weighted yield of 1.48% and a duration of 5.5 years. The portfolio's expected yield is 1.78% with a duration of 4.9 years. The net interest margin rose one basis point linked quarter to 3.17%, and net interest income rose by $7.1 million. Overall, loan income rose on a linked-quarter basis benefiting from the accelerated amortization of PPP loan fees, partly offset by lower interest income from declining PPP balances. Excluding the impact of PPP, the net interest margin declined 15 basis points to 3%, reflecting continued asset yield pressures and increased balance sheet liquidity. But as interest rates in the operating environment improves, we expect our margin to rebound as existing and variable - as existing variable and floating rate loans reprice higher and cash flows from the securities portfolio are redeployed into higher-yielding loans. Noninterest income rose $1.2 million on a linked-quarter basis to $24 million. Part of the increase was from a $750,000 gain on the sale of HSA accounts, with the remainder of the increase largely due to higher loan revenue, though all business lines posted solid results. Noninterest expense of $90 million included merger-related costs of $2.2 million for the Merchants Bank of Commerce transaction, excluding acquisition costs, noninterest expense of $87.8 million increased $4.2 million on a linked-quarter basis. Much of this increase stemmed from a smaller FAS 91 benefit on the compensation line as the previous quarter had elevated loan originations due to PPP activity. Meanwhile, the September quarter also had some outsized facilities maintenance and technology costs. Lastly, the provision for income taxes decreased $1.1 million on a linked-quarter basis to $13.5 million, representing a 20.3% effective rate. We continue to expect our 2021 tax rate to be in the range of 19% to 21%, though the higher end of that range is looking more likely. And with that, I'll turn the call over to Chris.

Thank you, Aaron, and good morning, everyone. Our peers have been busy generating strong loan production of $366 million in the third quarter with nearly $1 billion produced in the past six months outside of PPP. At the same time, we have actively replenished our pipelines, which remain to our satisfaction. Deposits have continued to rise at an annual rate that has stabilized in the 16% to 17% range and fee income is up across the board. We are winning new business by taking advantage of the disruption in the marketplace because of who we are. Simply said, we have followed a different process. We believe that people want community and personal contact in their banking relationships, and we have delivered on that on a multifaceted level. Quarterly loan production was predominantly C&I and CRE focused. New business was centered in real estate leasing, construction and health care sectors across our markets. Line utilization, which has been low throughout the pandemic, rose slightly to 44.9%, with commitments rising by $141 million to $5.1 billion and exceeding $5 billion for the first time in our history. The quarterly production mix was 58% fixed, 40% floating and 2% variable. The overall portfolio is now 4% PPP, 52% non-PPP fixed, 33% floating and 11% variable. The composition of the loan portfolio remained relatively unchanged. As Aaron mentioned, deposits grew by $608 million during the quarter and by $2.4 billion over the past 12 months. The quarterly inflows have trended towards demand accounts over the last year, and as a result, the split has changed from 51% noninterest-bearing and 49% interest-bearing to an even split of 50-50 between the two as of September 30. Fee income continues to be a bright spot. Card fees are up during the quarter from increased transactional volumes. Loan fees are up in alignment with loan production. And CB Financial and Columbia Trust Company continued their breakout year with yet another record quarter. Residential mortgage activity remained strong in the third quarter, with approximately 65% related to refinancing and 35% related to purchases. As part of our ongoing branch rationalization process, we consolidated three branches in September and October. We have announced another to occur in January of '22. And in light of our announcement of the Umpqua partnership, we are now evaluating our retail delivery strategy across the combined footprint. Now I will turn the call over to Andy to review our credit performance.

Thanks, Chris. This quarter's allowance for credit losses remains at $143 million, resulting in no new provisioning for the quarter. All of our credit metrics improved which offset any additional provision requirements from loan growth and a weakening economic forecast. The IHS Markit economic forecast we use, assumes a full year GDP growth of 5.7% and for 2021 and 4.5% for 2022. The current forecast is less favorable than the forecast used for last quarter when the full year GDP was forecasted at 6.7% for 2021. We ended the quarter with an allowance relative to period-end loans of 1.5%. And adjusting for PPP loans, the allowance to period-end loans increases to 1.55%. NPAs for the quarter remained stable at 13 basis points. Past due loans for the quarter were eight basis points compared to 17 basis points last quarter, and net charge-offs were minimal and only amounted to about $200,000 or one basis point annualized. Problem loans, which we define as loans watch or worse, declined from $804 million last quarter to $724 million as of September 30. We are continuing to see credit quality improve across the whole portfolio, including the COVID-sensitive segments. When you compare it to a year ago when problem loans were about $1.1 billion, you can see the healing within the portfolio. Now while consumers are shopping again, they may not like the wait time for their products or the sticker prices of those products. Businesses are dealing with supply chain problems as well as labor shortages. All of this is causing increased inflationary pressures. So we remain watchful of the impact these forces may have. Nevertheless, we remain confident in the resiliency and strength of the overall portfolio. Clint?

Thanks, Andy. We expect to finish the year strong as our bankers maintain an external client-centric focus with the objective of growing our existing loan and deposit portfolios. We have a deep bench of talented team members who, in the coming months, will complete the integration of Bank of Commerce Holdings while working toward finalizing the combination with Umpqua. Our current and future prospects are very bright, and it is a privilege to lead such a talented team. This concludes our prepared comments. As a reminder, Andy, Chris and Aaron are with me to answer your questions. And now Norma, we'll open the call for questions.

[Operator Instructions]. And our first question comes from David Feaster from Raymond James. Your Line is open.

I just wanted to start out on growth. It's - growth was again stronger than expected. Production is holding up well. Payoffs and paydowns are still a headwind. But just wanted to get some of your thoughts on the drivers. How much of this the strength do you think is just from a general improvement in the economic backdrop versus the new hires you've made in the client - PPP client acquisition? And just whether you think this high single-digit pace of growth is sustainable?

Well, I'll start, David. This is Clint, and then I'll quickly turn it over to Chris. This is something that I think is a result of a very intentional approach that we took in the middle of the second quarter of last year, and that was a mindset of continuing to operate in a business as usual or - and is near normal of a capacity as possible in spite of the pandemic and the disruptions created from that. And I think that our thought at the time was that this should give us momentum as society started to reemerge towards more of a normal operating environment. And I think if you look back at our growth and our production over the past four quarters, you'll see that, that momentum has continued to build. And that's why, I think, sprinkled throughout our prepared remarks, you probably noted a lot of optimism. And so I'll step back now and let Chris add some additional context.

Yes, David, I believe it hits on all of the things that were embedded in your question there. But as Clint said about our process, I think a lot of the credit goes to our teams and how they approach being open, being in front of clients being there when they had questions, they could still come in and make a deposit, and they still have bankers that were actively involved in reaching out and talking to them. That's helped with our existing clients and our retention. But more importantly, what we saw is relationships from other institutions that followed a much different process that are moving and voting with their feet, if you will, because of what we did and that we were open when clients don't have access to branches or to bankers, they begin to look for other options. And I think we've been the beneficiary of that. And so again, I would say a lot of the credit and the congratulations goes to our teams for being open in a safe manner and continuing to prospect.

Okay. That's helpful. And then maybe just - could you give us an update on the Bank of Commerce deal? I know that's gotten somewhat overshadowed a bit, but this is your first foray into California. Just an update on how the integration has gone? How is production trending over there? And - just as you've gotten any deeper into that transaction now that they're part of the bank, just any updates on your thoughts on that deal?

Sure. It maybe externally has been overshadowed by the announcement of our combination with Umpqua, but certainly, internally, it hasn't. I'll make my second trip to the Bank of Commerce footprint next week, my second trip this month. And hence my prepared comments about over the past several months getting to know our team members that joined us from BOCH. And I'm excited. I'm as excited or more excited about what they bring to the combined organization as I was the day that we announced it back in June. And I think that with all of the things that we had envisioned our entry into California, it was just that it was an entry. And our strategy has always been to have a much, much larger presence throughout California. And the combination with Umpqua accelerates that dramatically. And I think that it also accelerates opportunities that we solve with the Bank of Commerce combination or acquisition. And that's having the size and scale where clients don't outgrow their bankers being able to continue to grow with those businesses, being able to bring some of the business back on the balance sheet, being able to pursue relationships that maybe they had in - at prior institutions that were too large for the balance sheet at Bank of Commerce as well as additional career opportunities and development opportunities that being part of a larger organization will provide to all of the folks that joined us from Bank of Commerce.

And then I just wanted to touch a bit on your asset sensitivity and kind of how you guys are thinking about managing liquidity at this point. I guess what's the strategy going forward? And I know you guys have been active and innovative in the past, managing your sensitivity just with the rate collar that you guys have done. Just curious if there's any thoughts on swaps or other derivatives at this point just in light of the potential steepening of the curve?

David, no, I guess, derivative strategy are being considered at the moment. But we feel very good about our positioning in terms of our asset sensitivity. I put in some additional detail or some new detail, I guess, I should say, in our investor deck that helps you kind of better understand how the portfolio will behave. But I think it's also worth noting that the how - we think about that and how we model that internally and what we share is pretty conservative. One thing to think about is when you look at the, say, the asset sensitivity table that we put into our Qs and Ks, that has a deposit beta sensitivity of about 50%. But if you look back at the last rating cycle, the reality was is that our actual performance was less than 20%. So our asset sensitivity is obviously very strong, and we feel like we're very well positioned for what we hope to be a rising rate environment, hopefully, in the not too far future. Certainly, the trends that we've seen of late on that front in terms of some steepening of the yield curve are very encouraging. And to further benefit that, we hope to see a remixing from the secured - investment securities portfolio into the loan portfolio. Obviously, we've got tremendous on-balance sheet liquidity. And right now, that investment portfolio has grown off about $700 million annually that we can redeploy into loans and that amount actually increases as we go forward. So it's - we're very well positioned and comfortable about how that looks going forward, especially in a rising rate environment.

Our next question comes from Jeff Rulis from D.A. Davidson. Your line is open.

Question on - maybe Aaron, I might have missed in your prepared remarks the discussion on the margin, specifically, you mentioned anticipating a rebound. Could you frame that up again? I apologize for missing. I just wanted to get that straight.

Just - no, near term, my expectation is that we're probably going to see continued margin pressure just given where new asset yields are coming on both on the loan book and the investment securities portfolio. But with an anticipation of rising rates, that's when we would expect to see a rebound.

Okay. So we - yes, I guess the follow-up is maybe more specifically to spread income expectations. And I think you kind of touched on a little bit with what you think you do on liquidity. But what - if you do have broad NII expectations, could you share that?

We haven't given guidance on our NII expectations. But obviously, we had the benefit of PPP this quarter. That's going to go away. But now on a go-forward basis, of course, we'll have the Merchants Bank transaction that is going to benefit that number on a go-forward basis.

Okay. Great. Clint, I've got two questions on the - on Umpqua announcement and the first being look, you've had a couple of weeks to digest this and also get feedback from others. And the first question being, what do you think the most misunderstood piece of that combination that you - that you've heard that you've had to sort of dispel? And then the second thing is sort of the biggest risk that you see from the combination integration, etc. Thanks.

Yes. Well, I think the response to the first question, and we stated this on the investor call at the announcement, and I don't know that it necessarily resonated, and that was the statement that we made that we were more similar than what the market perception has been. And I realize that we've spent the past several months getting to know each other organizationally on a very, very detailed level. And so I guess as we progress towards the close and then through the integration, I think it will become more apparent to everybody on the outside looking in that we truly are much more alike than we are different. And so I do think that there's a bit of a perception issue there. I think the biggest challenge to pivot to the second part of that question, the biggest challenge going forward is as we go through the integration, maintaining our external focus, And that's something that I'm very confident in our ability to bring both our companies together into one. It's going to be a very powerful dynamic environment. But I do think that in some of these instances, really in any type of merger activity, there could be a tendency to become inwardly focused for a period of time. And so that's something we're very, very much aware of. And we spoke about the office of integration that we're setting up. That is very active. We have Steering Committee meetings going already on that. We have four of what I'll consider very, very bright mines and both companies, two executives from Umpqua, two from our executive team that are going to be fully dedicated to that office of integration. And I think a good way of thinking about it is how we went through the PPP process and the first round for the whole industry forced everybody to become inwardly focused, and it was an all-hands type activity. But then when we went through the second round of PPP, we had a very similar outcome, but many of our bankers, the vast majority of them were able to maintain their external focus, and that pivots back to David's question about the momentum and the growth opportunities that we've had. So that's at a high level, I think, our plan to combat that risk. And I feel really good about our prospects there.

Our next question comes from Jon Arfstrom from RBC Capital Markets. Your line is open.

Maybe for you, Chris, you kind of alluded to it in your comments, but what changes with your approach on expenses with the pending merger? And kind of what are you spending on now and where are you maybe pausing a bit?

I think when you look at our approach has always been one of consistency. We don't put out a big announcement of branch consolidations. It's just the normal course of business. I think with Clint as our CEO, we've always, in previous calls talked about offsets when we're making investments into technology and things of that nature. And I expect all of that to continue to move forward. Now as we come together, there's going to be opportunities. The investor deck is out and talks about some of those opportunities. And I wouldn't expect that we're not going to change culturally who we are with our approach to expenses. We'll run, and we'll use the office of integration to highlight things that where there's overlap, where there's locations that have overlap, and we'll work through our thoughtful process on when and how we institute those savings. But I would expect that to be a collaborative process that has very similar results to what we've done previously.

Okay. Thank you for that. And Aaron, can you review you - throughout a couple of puts and takes and expenses to kind of get back to a core. Can you give us those again?

Sure. So reported, we're about $90 million, right? About $2.2 million in merger-related costs. There was about $500 million in, I'm going to call them technology fees that were - we'll call them nonrecurring, I guess, but they were just unusual items. We also had about $500,000 in - did I say $500,000, sorry, in technology costs and then another $500,000 in kind of some outsized branch maintenance costs that just kind of happened to hit during the quarter. And then, of course, there's also the provision front funded commitments during the quarter, that obviously can bounce around depending on utilization and commitments, but that was also a factor in the quarter.

Okay. Good. Thank you for that. A couple of questions. The new loan production yields look like they're up quite a bit from the previous quarter. Is that simply mix? Or is there something else happening there?

It's mostly mix, Jon. In the second quarter, as you remember, may remember, we had a few larger high credit, very competitive deals that we have brought on. So it's really the mix.

Okay. Good. And then, Aaron, another question for you. I think you were talking about slide 10 earlier with some of the rate sensitivity updates. And I guess what's nuance here. I guess the way that I read it is with a 25 basis point hike, about $3 billion of your $4.2 billion in variable and floating rate reprices. Is that the message you're trying to get across with this?

Yes. I think in particular, the chart in the upper right gives you a sense. Previously, we weren't kind of disclosing what - kind of what happens at each hike in terms of how that influenced kind of what comes out from under the floor or off the floor, I guess, I should say. And so we're just giving a more granular level of detail there for you to kind of understand the pacing of how it's going to play out.

Yes. Okay. Good. That's very helpful. And then, Andy, I think you thought you're going to get away without a question. But how are you guys thinking about reserve and provision levels at this point? Obviously, things look very clean, but any thoughts on that?

Yes. I think it's going to continue to be the dynamic between the economic forecast, and I still continue to believe that the portfolio will continue to deal and then you got loan production. So those are the three things that I see as the drivers going forward. I mean, certainly the economy, I think GDP came out at 2% for the last quarter. So - so hopefully, loan production stays there. The pipeline, I think, is pretty good. So it's really going to be sort of that forecast, which is a huge CECL driver. But we continue to see healing in the portfolio, which is helping offset the declining forecast.

And our next question comes from Andrew Terrell from Stephens. Your line is open.

If I'm looking into the kind of growth by portfolio this quarter, I think a little over half of it came from residential real estate. Was this just from retaining more kind of mortgage production on balance sheet from your mortgage business? And just given kind of the really strong deposit flows, should we expect to see the residential portfolio continue to build from here as kind of a lever to deploy some excess liquidity? Or as I think about kind of the prepared remarks, it sounds like the gross outlook was pretty optimistic. So should we expect growth to shift back more towards commercial?

Yes. Yes, Andrew, I think if I understand it correctly, we did choose to retain some mortgage production during the quarter. We made a small purchase as well, about $30 million. The metrics were such that it made sense that we would do that. C&I is still a big part of what we're doing. And when I look at the pipeline and go forward, I would say that, yes, commercial is more of the driver of where we're going, but we saw an opportunity and it made sense during the quarter.

Understood. Thank you. And then, Aaron, I apologize if I missed this, but do you have the yield for the new securities purchased during the quarter?

The new purchases were - the average was 1.48%. And encouraging that, we've seen an upward trend in that not surprisingly given what we've seen in the rising slope of the curve. So hopefully, we'll see that trend higher from here.

Thank you. And I am showing no further questions at this time. I would now like to turn the conference back over to Mr. Stein for any closing remarks.

Thank you for attending our third quarter earnings call. And as always, please reach out if you'd like clarification or additional detail on anything we discussed this morning. This concludes our call. Have a great day. Goodbye.

This concludes today's conference call. Thank you for participating. You may now disconnect.