Columbia Banking System, Inc. (COLB) Q3 2022 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to the Umpqua Holdings Corporation Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Jacque Bohlen, Investor Relations Director. Please go ahead.

Thank you, Shannon. Good morning, and good afternoon, everyone. Thank you for joining us today on our third quarter 2022 earnings call. With me this morning are Cort O'Haver, the President and CEO of Umpqua Holdings Corporation; Tory Nixon, President of Umpqua Bank; Ron Farnsworth, our Chief Financial Officer; and Frank Namdar, our Chief Credit Officer. After our prepared remarks, we will take your questions. Yesterday afternoon, we issued an earnings release discussing our third quarter 2022 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both these materials can be found on our website at umpquabank.com in the Investor Relations section. During today’s call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the Safe Harbor provisions of federal securities. For a list of factors that may cause actual results to differ materially from expectations, please refer to slides two and three of our earnings presentation, as well as the disclosures contained within our SEC filings. We will also reference non-GAAP financial measures alongside our discussion of GAAP results. We encourage you to review the GAAP to non-GAAP reconciliation provided in the earnings presentation appendix. I will now turn the call over to Cort.

Okay. Thank you, Jacque. I will provide a brief recap of our performance and then pass to Ron to discuss financials. Frank will discuss credit. Then we will take your questions. For the third quarter, we reported earnings available to shareholders of $84 million, which represents EPS of $0.39 per share, compared to the $0.36 reported last quarter and the $0.49 reported in the third quarter of last year. On an operating basis, which excludes a number of interest rate driven items and merger expenses that Ron will review, EPS of $0.47, compared to $0.37 last quarter and $0.49 in the third quarter of last year. Return of a provision for credit losses compared to 2021’s recapture was a driver of the annual variance. Operating pre-provision net revenue was up 30% on the quarter and $0.31 for the year -- 31% for the year at higher interest rates and loan growth have substantially offset declines in mortgage banking revenue and PPP related fees. Loan balances grew $1.1 billion in the third quarter, representing a quarterly growth rate of 4.4% as new generation was diversified across portfolios, business lines and geographies. Deposit balances increased $685 million, representing a quarterly rate of 2.6%, while growth once again outpaced deposit balances -- increases. Our growth rates were far balanced than in the prior quarter and we continue to target a balanced growth profile. Turning to other initiatives at the Bank, we continue to add new digital and payment solutions to meet the evolving needs of our customers. And in the third quarter, our teams implemented enhancements to product offerings and service capabilities. These include a new integrated receivable solution for businesses and commercial clients launched in partnership with a fintech best-in-class provider, as well as a digital healthcare payments and practice management solution that we will market to doctors, dentists, hospitals and all healthcare providers. We have a robust road map planned for Q4 and into 2023 for continuous digital innovation and payments technology deployment. And just this week, we successfully launched real-time payments. Umpqua Bank is now registered with the Clearing House and the real-time payments network enables our customer’s access to funds and the ability to review balanced information within seconds 24 hours a day, 365 days a year. Our ongoing advancements in payments technology continue to accelerate revenue growth in our core commercial fee categories, including 43% growth in commercial card revenue during the third quarter compared to the prior year. Our pipelines across all fee-based solutions, which includes treasury management, cards, merchant and international remain very strong. As discussed on last quarter’s call, we continue to take necessary steps within the mortgage banking segment to manage our expenses and efficiently deploy capital in light of significant headwinds in the home lending industry. To that end, we further reduced headcount during the quarter and implemented additional business model adjustments to shift production towards salable volume, which is generally more profitable. We have put on $3 billion in net loan portfolio growth through September and $953 million of it, which is one-third of the growth is from portfolio mortgages. Going forward, we expect our recent actions to result in lower growth in portfolio mortgages as we continue to target balanced growth profile for the balance -- for our balance sheet. These actions take time to work their way through the financial statements and we will continue to update you on our progress. We remain committed to serving our customers and we will continue to invest resources in our low to moderate income communities. We are making investments to build and expand relationships in historically underserved markets with products and through services provided by our retail, small business and home lending teams. Regarding capital, earlier this month, we declared a $0.21 per share dividend sellable -- payable October 28 to our shareholders of record as of October 14th. We once again accelerated our dividend declaration timing compared to our usual post earnings cadence, as we continue to plan for our pending combination with Columbia Banking System. As we detail on slides six and seven of our deck, we continue to make headway with our integration planning and our scheduled Q1 of 2023 core system conversion date, remains achievable at this point given our ability to separate conversion planning activities from legal close date. Since we last spoke in July, we have signed a letter of agreement with the Department of Justice and we have received required regulatory approval from the State of Oregon. We are pleased to have passed two additional milestones and we are prepared to close the transaction after obtaining the remaining regulatory approvals and after Columbia executes purchase agreements to divest the 10 Columbia State Bank branches identified by the DOJ. Before I pass to Ron, I would like to commend our teams. Umpqua’s loan portfolio is up 13% through September and while favorable market conditions contributed to that growth, it is primarily reflective of the diligent focus of our associates and our ongoing investments in talent, talent that has joined the Bank since we announced our pending combination with Colombia. Our operating markets, pipelines and top-tier banking teams support my expectations for continued net portfolio growth into 2023 outside significant economic deterioration, which we have not seen today. We remain acutely focused on the health of our new and existing borrowers and our new loan production mirrors, the high quality metrics exhibited by our overall loan portfolio. I am excited about the activity at Umpqua and I am excited about our forthcoming combination with Colombia. And with that, Ron, take it away.

Okay. Thank you, Cort. And for those on the call, I am going to follow along. I will be referring to certain page numbers from our earnings presentation. Starting on page 11 of the slide presentation, which contains our performance ratios both on a GAAP and operating basis. The adjustments for our internal operating measures include various fair value changes from interest rate volatility along with merger and asset disposal costs, which are detailed in the appendix on slide 32. Our NIM continued to strengthen, up 47 basis points in Q3 to 3.88%. This drove improvement in our efficiency ratio and a continued increase in our PPNR and return metrics, both on a GAAP and operating basis. Our GAAP PPNR ROAA increased to 1.8%, while our operating PPNR ROAA increased to 2.1% and operating ROE increased to 15.9%. Turning now to page 12, which contains our summary quarterly P&L, our GAAP earnings for Q3 were $84 million or $0.39 per share. On an operating basis, we earned $103 million or $0.47 per share. For the moving parts as compared to Q2, net interest income increased $39.4 million or 16%, representing the power of our interest-bearing cash, skipping bonds and water falling down in the loans in the last few quarters, combined with the recent Fed rate increases. We added a provision for credit loss of $27.6 million, driven primarily by the continued strong loan growth and a slight deterioration in the consensus economic forecast. Non-interest income declined $25.8 million, reflecting lower home lending gain on sale revenue, along with the fair value adjustments driven by the significant bond market sell-off and higher yields. Namely rate-driven fair value losses on bonds and loans held at fair value, partially offset by net MSR and swap CVA gains, as detailed later on the right side of slide 32. And non-interest expense declined $1.6 million or 1%, mainly from lower mortgage banking and payroll tax expense. As for the balance sheet on slide 13, loans were up $1.1 billion and deposits increased $0.7 billion. This difference along with a targeted increase in interest-bearing cash was funded with short-term borrowings that mature by year end. The decline in investments AFS related primarily to the unrealized loss resulting from higher market yields this quarter. Our total available liquidity, including off-balance sheet sources ended the quarter at $14.4 billion, representing 46% to total assets and 54% of total deposits. As noted on the bottom of slide 13, our tangible book value declined due to the AOCI rate mark on AFS investments. But we also present measures for this and the TCE ratio, both including and excluding AOCI for reference. Slide 15 highlights net interest income, noting the increase to $288 million in Q3 resulted from the recent rate increases, along with continued strong loan growth. From a rate volume standpoint, increase in rates led a $29 million of the $39 million increase, with volume and mix making up the $10 million difference. Following that on slide 16, the trends for our net interest margin, noting again, our NIM increased 47 basis points in total to 3.88% in Q3. We represent a waterfall on the margin change on the right side of the page, knowing our loan and cash yields more than offset rising deposit costs. Key for me here is following the 150-basis-point increase to the federal funds rate during Q3. Our NIM for the month of September was 3.94% and another 6 basis points higher than the full Q3 amount, which bodes well for the remainder of the year. The next two slides include information which investors may find helpful on continued rate sensitivity. First, on slide 17, we provide the re-pricing and maturity characteristics of our loan portfolio. The first table on the upper left breaks down the pricing drivers on loans. Turning now to the quarter end, 34% of the portfolio is fixed, 30% is in floating rate and 36% are adjustable rates over time. The lower left table shows the maturity schedule by category. The upper right table shows the loan rate floor buckets for floating and adjustable rate loans, noting this has declined to less than 1% of the book. The lower right table breaks down the balances by rate change band along with the weighted average rate change required for these loans to move above their floor. Hopefully, investors and analysts will find this information useful in assessing the beneficial impact on net interest income of future potential rate hikes. And next on slide 18, on the left, we have included our projected net interest income sensitivity for future rate changes, in both ramp and shock scenarios over two years. This is a simulation we run in back test quarterly and assumes a static balance sheet. The deposit beta used in this simulation is 51% on interest-bearing deposits and it applies to future re-pricing, assuming future rate changes. The table on the right shows our deposit beta from the last rising rate cycle, starting Q3 2015 and running through Q3 2019 to catch the lag effect. Our beta then was 42% on interest-bearing deposits. Our cost of interest-bearing deposits increased from 11 basis points in Q2 to 23 basis points in Q3 or a net increase of 12 basis points and an implied re-pricing beta of 8% based on quarterly averages. The spot rate at September 30 was 38 basis points versus 10 basis points at June 30, for a net increase of 28 basis points during the quarter. We used the spot rates to help gauge movement and potential trajectory heading into the next quarter. This 28 basis points of spot rate increase is a deposit beta of 19% on the 150 basis points in Fed funds rate increases during Q3 and on a cumulative basis we were at 9%. For comparison, the loan coupon, though, increased by 59 basis points between June 30 and September 30. Tying everything together, we expect our interest-bearing deposit costs to increase again in Q4, but stay well below our model level, which will bode well for our NIM assuming additional Fed moves in November and potentially December. Okay, now to our segment disclosures, starting with the core banking segment on slide 21 of the presentation. Net interest income increased $39.5 million over Q2, given the higher rates and loan growth discussed previously. I will talk about CECL in the provision in detail here in a few minutes, but you will see here, we had a $27.6 million provision this quarter, again related to continued loan growth and slight deterioration in economic forecast variables. The next few rows show the fair value changes due to rising interest rates. I mean, as a Group, we are a $25 million loss in Q3, compared to a $10 million fair value loss in Q2. Non-interest income of $36.8 million increased from Q2 due to continued growth in commercial fees. And in the non-interest expense section, you will see the merger expense recognized to-date on the combination, along with exit and disposal costs related to lease exits on recent store consolidations. The direct non-interest expense for the Core Banking segment was up slightly this quarter primarily related to higher deferred loan costs back in Q2 not repeating in Q3. The efficiency ratio for the segment improved to 52%, meaning this would be 48% ex the non-operating fair value changes in merger exit costs. And the operator disclosure for the core banking segment back on page 34 in the appendix and also on page 24 of the release, it’s great to see the operating PPNR increased 45% year-over-year and 31% from Q2, which is good to see the beneficial -- benefit of continued loan growth and rate increases. This is significant and again bodes well for future core banking revenue with additional forecasted Fed funds rate increases. Turning now to slide 22 of the presentation, we show the mortgage banking segment five quarter trends. To start, the continued increase in longer term yields further depressed volumes and pipelines. We have $397 million in total held-for-sale volume this quarter, down 31% from Q2 due entirely to lower activity with higher rates. The gain on sale margin was 2.65%, up slightly from Q2. These two items resulted in the $10.5 million in origination and sale revenue noted towards the top left of the page. Our servicing revenue was stable and for the change in MSR fair value, the passage of time piece was stable, while the change due to valuation inputs was a gain of $16.4 million, due again to the increase in long-term rates during the quarter. We implemented the MSR hedge in August, offsetting $14 million of the MSR gain in line with expectations. Non-interest expense totaled $21.5 million for the quarter. Again, this represents held-for-sale origination costs, servicing costs along with administrative and allocated costs. The direct expense component of this was $10.5 million as noted on the right side of the page. As noted towards the bottom of the page, the MSRs at a record high valuation of 1.51% as of quarter end. A couple of final items before I turn it over to Frank, on slide 24, we have included the quarterly loan balance roll forward. Quarterly loan growth was driven by $1.9 billion in new originations and net advances, offset by $0.8 million of payoffs. Slides 25 and 26 provide additional stats and composition of the portfolio. And next, let me take your attention to slide 27 on CECL and our allowance for credit loss. As a reminder, our CECL process incorporates a life of loan reasonable and supportable period for the economic forecast for all portfolios, with the exception of C&I, which uses a 12-month reasonable and supportable period, reverting gradually to the output mean thereafter. We use the consensus economic forecast this quarter updated in August. Overall, the forecast reflected higher expected inflation and interest rates and a slight uptick in peak unemployment rates. With this, we recognized a $27.6 million provision for credit loss, with $12 million of that for the quarter’s strong loan growth and $15 million for slightly deteriorating economic variables. This page shows the commercial and leasing portfolio is driving the majority of the increase, as they are the most sensitive to the unemployment rate forecast, which increased slightly on peak from 3.7% to 4.1% over the horizon. The ACL increased to 1.16% at quarter end, up from 1.12% in Q2. And lastly, I want to highlight capital, on page 29, noting that all of our regulatory ratios remain in excess of well-capitalized levels. Our Tier 1 common ratio was 10.7%, and our total risk-based capital ratio was 13.2%. The Bank level total risk-based capital ratio was 12.4%. And with that, I will now turn the call over to Frank Namdar to discuss credit.

Thank you, Ron. Turning back to slide 28, our non-performing assets to total assets ratio of 0.16% was relatively steady with the prior quarter’s level and our classified loans to total loans ratio of 0.74% was similar lease stable. Our annualized net charge-off percentage to average loans and leases was 11 basis points in the quarter, reflective of the continued below average net charge-off activity in the FinPac portfolio. FinPac’s ratio came in at 1.36%, still well below its historical 3% to 3.5% range, displaying the resiliency of its customer base and the impact of strategic credit adjustments continually and consistently being applied within that portfolio. My expectation continues to be for a gradual migration to historical norms over the coming quarters in this space. As expected, essentially all of the quarter’s charge-off activity was in the FinPac portfolio as the Bank’s activity was again nearly de minimis. We continue to be very pleased with our credit quality metrics, charge-off activity is minimal, non-performing and classified loan ratios are low and delinquency migration is satisfactory. We remain confident in the quality of our loan book and look forward to high quality growth balanced with effective and active risk management practices. Back to you, Cort.

Okay. Thank you, Frank and Ron, for your comments and we will now take your questions.

Thank you. [Operator Instructions] Our first question comes from the line of Jared Shaw with Wells Fargo. Your line is now open.

Hi. Good morning.

Hi, Jared.

Maybe just and more broadly, if you could share with us sort of the -- what you are hearing from your customers in terms of broader commercial sentiment with the economic backdrop that we are seeing and does that change any of the longer-term assumptions with the COLB deal? And I guess, how should we be thinking about that as we look at 2023 growth, maybe just the Umpqua part of growth going into 2023?

Hi, Jared. This is Tory Nixon. Just I think from the customer’s perspective, today we are continuing to see very active customers, certainly, on the borrowing side. Our C&I portfolio continues to grow, a lot of activity. I think changes in interest rates and the economic cycle. It’s just a little too early to see anything material from their perspective, yet. I think there is a somewhat of a slowdown in the pipeline on the real estate side of the house. So in our multifamily and our commercial real estate division, they are a little more interest rate sensitive in a little bit of a slowdown there. But, overall, some really still good activity from our existing customer base and our prospect community. We continue to prospect throughout the footprint and continue to have success in bringing new relationships into the bank.

And Jared, here Cort, one last thing relative to the product sets of both companies like you heard Clint and I say a year ago now, our respective Banks independently are very complementary of one another. We each have products and services potentially the other one does not have and there’s a tremendous opportunity to leverage those opportunities. So as it relates to the combination, I am extremely excited with the momentum that we have created. But the opportunity to combine products and services, portfolios and markets both and teams together is a huge, huge opportunity that we have before us.

Okay. So when we look at like the sort of the $1 billion of growth this quarter, I mean, do you feel that that sort of a sustainable rate as we go through the next few quarters barring any major economic change from these levels?

Yeah. This is Tory.

Tory, just a clarification, Jared, you mean relative to just us or the combination.

Yeah. Yeah. No. No. Just -- right, just looking at the Umpqua side of it?

Okay, Tory.

Yeah. No. I think that based on pipeline and activity, the Q4 and into Q1 will be less from a loan growth perspective than we saw in Q3. Pipelines are still healthy, but they are down from their peak about 15% to 20%. So and that’s mostly in the real estate space, as I mentioned, a little more sensitivity on the interest rate side. So we will just see less growth on the real estate piece here for the next couple of quarters and I think good -- some continued decent growth on the C&I side. So expect less in Q4 and Q1 at this point but still healthy.

Okay. Okay. That’s good color. Thanks. And then, on the RTP, real-time payments rollout, how do you see that sort of playing with the broader FedNow rollout expected in 2023? Is that complementary or do you expect to see more of a shift over to FedNow from that volume as we look out into 2023?

Yeah. This is Tory, again. I think complementary at this point. I mean, for us, the products that Cort mentioned, our integrated receivables are our healthcare product and then real-time payments is about us creating and partnering on the technology front for working capital solutions for our customers. And those essentially bring money into companies through a faster, easier, more efficiently. And I think that it serves the customer well and it serves the Bank really well. So I think we are well-positioned to be provider, a significant provider on the payment side and excited about that for the company going forward.

Okay. Great. And then just finally for me, as we look at, again, just more of the Umpqua balance sheet, you have done a great job of growing DDA as a percentage of overall deposit funding over during COVID. Do you think -- has that been a systemic or a structural change in your relationship with those depositors where we should expect to see that stay closer to this 40% level or should it start dipping back and reverting closer to the 30% as we move through the cycle?

Well, this is Tory, again. I think there absolutely has been a shift over the last couple of years, two years to three years in relationship banking within the company, and our desire and requirement to make sure that we are getting the deposits and the operating accounts of the companies that we Bank if we are going to make loans to them. So that shift is very purposeful and my expectation, I think, all of our expectation is that absolutely continues into the future that we are a full service company, a full service Bank. And we will continue to pursue non-interest-bearing deposits very strong and very forceful in the company as we move forward. So I expect it to be similar to what it is today going forward.

Great. Thanks a lot for the color.

Thank you. Our next question comes from the line of Brandon King with Truist. Your line is now open.

Thank you. Good morning.

Good morning, Brandon.

Yeah. So I wanted to touch on deposit growth. It was -- it’s pretty solid, and Cort, a lot of your competitors are seeing deposit decline. So I wanted to get more color on the deposit growth outlook near-term and within the context of any seasonality that you are expecting?

Well, this is Tory, Brandon. The -- certainly, we feel very confident in our ability to generate deposits in the company. We have -- as I said earlier, big emphasis on relationship banking, full service banking that will continue into Q4 and beyond. The market is shifting. There’s certainly liquidity leaving the system and our customers are -- some of them are more rate sensitive than others and we just have to pay really close attention to the customers we have and the prospects that we are looking to Bank. And we will continue to work hard to bring deposits into the company at the lowest cost possible and I feel very confident in the commercial banking teams and all the teams in retail and our ability to do that.

Got it. And then on the balance sheet side of things, I am curious, I know the merger kind of is pending. So I am not sure if this can be an actionable item as of now. But are there any thoughts to any sort of hedging against the downside of rates potentially in the future? Is that kind of a strategy that’s being contemplated?

Hey, Brandon. This is Ron. We just talked about. We did implement the hedge on the MSR. We have also got a pretty negative debit impact this quarter from the fair value of loans held at fair value for that mark. So, obviously, when we think about down rates in the future, which is always a possibility, of those two will take care of themselves. In terms of the overall balance sheet in the NIM, it’s something we do consider, we do contemplate. I think key on that is going to be opportunities we will have on, as you mentioned, on a post combination basis, but nothing definitive at this point in terms of hedging strategies for NIM, but something we always evaluate before. Try to keep ourselves relatively asset sensitive, so not overly on the upside, not overly also on the downside. So part of that is just going to be the natural flow of the balance sheet, right? That is a risk long-term if rates were to drop for bank industry in general for margins to come back under pressure.

Got it. Thanks. And then, lastly, on loan growth, I appreciate the comments on having more balanced growth going forward, but considering the economic slowdown that a lot of people are expecting, are there any loan categories that your kind of shying away from now relative to a couple -- last couple of quarters?

This is Tory again. I think there’s -- we have been cautious in places like on the CRE side in office and hospitality for a while, so that hasn’t changed. Really at this point, we continue to do, I think, a very respectable job in the way we underwrite and the way we manage risk in the company and we will be opportunistic and looking at loan opportunities and relationships for the Bank, for our existing customer base and for prospecting and feel that we should and will lend throughout the cycle and feel good about that. So there’s really nothing that we are staying away from other than what we have been very -- I think I have already talked about previously on the hospitality and the office and some in the retail space. Frank…

Yeah. Brandon…

… do you want to add to that?

Yeah. Yeah. Brandon, this is Frank Namdar. Yeah. I mean, we have and we will continue to be an institution that really practices underwriting through the credit cycles. Our portfolio is kind of built for that and we will continue to do that. So I think that is in support of exactly what Tory was referencing.

Thanks for taking my questions.

Thanks.

Thank you. [Operator Instructions] Our next question comes from Adam Butler with Piper Sandler. Your line is now open.

Hey. Good morning. This is Adam calling in for Matthew Clark.

Good morning.

Good morning. I believe I heard earlier in the call that you plan on reducing headcount within the mortgage business. Is that fully reflected in that decrease in the salary line?

Yeah. In our comments, well, we reduced in the quarter 60 headcount in our mortgage group in the third quarter and year-to-date that’s 100 in the mortgage group.

No. It’s not -- this is Ron. No. It’s not fully reflected because that occurred throughout the quarter.

Yes. Yeah.

Okay. Thanks. And is there any plan -- plans for future reduction in headcount or is that to be determined at a future of time?

Yeah. We will continue to assess that segment of the business. Like, I have said on previous calls, mortgage first finance is an important product for our customer base, but we will continue to evaluate it as rates move around.

Great. And with regard to hiring opportunities, I recall you guys expanding some teams in Phoenix and Denver. Are you seeing opportunities there and are you seeing opportunities in other markets too?

Yeah. This is Tory again. Definitely seeing opportunities of people that want to work for the Bank, we have hired some folks in Phoenix and in the Denver market that you talked about. We continue to look at other places in our footprint, kind of infill if you will and throughout the footprint. So still always looking for really strong banker talent and we are having a lot of success and feel very confident we will continue.

Okay. Great. Those are all my questions. Thank you.

Thank you.

Thank you. And I am currently showing no further questions at this time. I’d like to turn the call back over to Jacque Bohlen for closing remarks.

Thank you, Shannon. We would like to thank you for your interest in Umpqua Holdings Corporation and participation on our third quarter 2022 earnings call. Please contact me if you would like clarification on any of the items discussed today or provided in our presentation materials. This will conclude our call. Bye.

This concludes today’s conference call. Thank you for your participation. You may now disconnect.