Columbia Banking System, Inc.
Q3 2016 Earnings Call Transcript

Published: 27 Oct 2016

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking System’s Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Melanie Dressel, President and Chief Executive Officer of Columbia Banking System.

[Melanie Dressel:]

Thank you, Christina. Good afternoon, everyone, and thank you for joining us on today’s call as we review our third quarter 2016 results, which we released before the market opened this morning. And the release is available on our website at columbiabank.com. This was another quarter for us as we continue to build on the solid results from the second quarter that share. Our bankers achieved the highest loan production in our history with over 375 million in new originations. Along with the tracking production, our non-performing assets to period end assets ratio improved to the lowest it’s been eight years. In addition, our deposits grew 10% from the same period last year and we saw a modest expansion in our net interest margin forward. As we move forward our priorities continue to be growing quality loans, improving our operating leverage and effectively utilizing capital. Another priority is been prepare for going over the $10 billion in assets mark. Since we've been focused on this for nearly 3 years now, we feel confident that we've made the appropriate infrastructure investments to ensure we are well prepared for this eventuality. On the call with me today are, Clint Stein, Columbia's Chief Financial Officer, will begin our call by providing details of our earnings performance, Hadley Robbins, our Chief Operating Officer, who will cover our production areas, and Andy McDonald, our Chief Credit Officer who will review our credit quality information this afternoon. I'll conclude by providing a brief discussion about the economy here in the Northwest and then we'll be happy to answer your questions. Of course, I need to remind you that we will be making some forward-looking statements today which are subject to economic and other factors. And for a full discussion of the risk and uncertainties associated with the forward-looking statements, please refer to our securities filings and in particular Form-10K filed with the SEC for the year 2015. At this point, I'd like to turn the call over to Clint, to talk about our financial performance.

[Clint Stein:]

Good afternoon, everyone. Earlier today we reported earnings of $0.47 per diluted common share. Our reported net interest income of $85.6 million increased $3.4 million from the prior quarter. The linked quarter change was primarily driven by an increase of $260 million in average earning assets. Non-interest income before the change in the FDIC loss sharing asset was $23.3 million in the current quarter, up from $22.9 million in the prior quarter. The increase was due mostly to higher investment securities gains, which were up 343,000 from the prior quarter. Driven by the increase in net interest income, our operating revenue grew $3.6 million, so $104.3 million in the third quarter, up from $100.7 million in the prior quarter. Reported non-interest expense was $67.3 million for the current quarter, an increase of $3.5 million from the prior quarter. After removing the effect of Oreo activity and FDIC call back liability expense, our non-interest expense run rate for the quarter was $67.5 million. This is a $3.9 million increase from $63.6 million on the same basis during the prior quarter. I thought it might be helpful to provide you with the breakout of the main drivers of the linked quarter increase and expense. Compensation and benefits were up $1.2 million, driven by an increase of $1.1 million in incentive plan expense. Occupancy increased 567,000 due to 849,000 of expense recorded in conjunction with branch closures during the quarter. Advertising was up 950,000. We expensed 233,000 in the quarter for production of new commercials, the remaining amount is a result of seasonal broadcast expense. Legal and professional services increased 487,000, 250,000 of the increase is related to our annual regulatory exam fee assessed by the state of Washington. The remaining increase is attributed to the seasonality I had mentioned on previous calls. Excluding Oreo activity and FDIC claw back liability expense, our non-interest expense to average assets ratio of 2.84% hit the midpoint of the range that we have discussed in the past couple of quarters. Going forward, we still anticipate that 2.79 to 2.89% is a likely range for our expense ratio. The operating net interest margin increased 3 basis points to 4.03% during the quarter, as a result of the extra day of accruals. The additional day in the quarter increased the margin by 4 basis points. Now I'll turn the call over to Hadley to discuss our production results.

[Hadley Robbins:]

Thank you, Clint. Total deposits at September 30, 2016 were $8.06 billion, an increase of $385 million, $7.67 billion for June 30, 2016. On a year-to-date basis, total deposits have increased $619 million or about 8.3%, about $435 million of this increase was a non-interest-bearing DDA. Core deposits were $7.81 billion, which represents 97% of total deposits. The average rate on interest-bearing deposits remained low at 8 basis points which is the same as the prior quarter. The average rate on total deposits remained unchanged at 4 basis points. Loans were $6.26 billion at September 30, 2016, representing a net increase of about $153 million or 2.5% over the second quarter. Third quarter loan growth was largely driven by strong levels of new production in the amount of $375 million. New production was predominantly on NCI loans of $221 million and commercial real estate and construction loans of $112 million. Term loans accounted for $263 million of total loan to production, while new lines represented $112 million. The mix in new production was evenly balanced in terms of size, 35% of new production was over $5 million, 28% was in the range of $1 million to $5 million and 37% was under $1 million. In terms of geography 56% of new production was generated in Washington, 26% in Oregon and 18% in Idaho and a few other states. The average tax adjusted coupon rate for the third quarter production was 3.86% which is below the year-to-date average for new production of 4.05%. The difference is largely related to a higher proportion of LIBOR index loans booked in the third quarter. Following the pattern of new production, net loan growth in the third quarter was concentrated in C&I and commercial real estate. C&I loans end of the third quarter at $2.63 billion, up about a $111 million from the previous quarter. Industry segments with the highest loan growth in the third quarter include agriculture, forest and fishing, transportation and warehouse and professional services. Commercial real estate and construction loans into the second quarter at $2.88 billion, up $52 million from the prior quarter. The mix of asset types was well diversified, property segments with the most growth were healthcare facilities, owner-occupied warehouses and education facilities. Going into the fourth quarter, pipeline volumes are consistent with prior periods. However, we do have some headwinds for loan growth with payout activity associated with the sale of businesses and income properties and lower levels of line utilization, particularly associated with agricultural borrowers beginning to apply crop proceeds to operating lines. The decline in line utilization is a seasonal pattern seen we've seen it in prior years and it typically runs through the first quarter. That concludes my comments. I'll now turn the call over to Andy.

[Andy McDonald:]

Thank you. For the quarter, we had a provision for loan losses of $1.8 million, as always I like to give you a breakout by a provision. The originated portfolio had a provision of $2.8 million. The discounted portfolios had a release of 525,000 and the purchase credit impaired portfolio had a release of 433,000. The provisions were driven by charge-offs and loan growth in the originated portfolio, net recoveries and continued contraction of the discounted portfolio and a change in expected cash flows in the purchase credit impaired portfolio. For the quarter across all portfolios, loan growth was approximately $151 million. However, loan growth within the originated portfolio was $224 million as the discounted and PCI portfolios contracted by $65 million $9 million actively. We had net charge-offs of 906,000 for the quarter. The originated portfolio had net charge-offs of 1,433,000 million, while the discounted and PCI portfolios enjoyed net recoveries of 374,000 and 153,000 respectively. If you recall the last two quarters, the purchase credit impaired portfolio had net charge-offs of around $1.3 million reported, so it was the performance of the purchase credit impaired portfolio this last quarter that was responsible for the low level of net charge-offs which obviously help lower the aggregate provision for loan losses as well. So as of June 30, 2016 our allowance to total loans was 1.12% compared to 1.13% as of June 30, 2016. The modest decrease in the provision to total loans continues to reflect the overall credit quality of our loan portfolio. This quality can be seen in the impaired asset quality ratio which remains extremely low at 13.16%. Our reserves covered non-performing loans by a margin of 3.3 times and while our Oreo balance is now down to $8.9 million. For the quarter, non-performing assets decreased $3.2 million due to modest decreases in both non-performing loans and Oreo. As a result, NPAs were about $30 million or 32 basis points at period end assets. As we discussed previously, we anticipate to keep bouncing around the low level. At quarter end, loans 30 days or more past due and not on non-accrual were about 5.4 million or 9 basis points. In summary, we continue to be very pleased with how the portfolio is performing. So I'll turn the call over to Melanie.

[Melanie Dressel:]

Thanks, Andy. The leading economic indicators in this part of the country are continuing to trend upward overall. We do see variation in the degree of economic growth because of the diverse region that we operate in, with our larger metropolitan areas driving the most growth. During the third quarter Washington's unemployment rate improved to 5.6% and 20,000 new jobs were added. This is in spite of the state labor force growing to 3.65 million in September, an increase above over 21,000 people from the prior amount, 70% or about 14,000 of these new jobs were added in the Puget Sound region. And that the Seattle-area jobless hit an eight year low at 3.9% during September. Thanks, to women economy with companies such as Amazon, Expedia, Stateburg [ph] and Zillow rapidly expanding their workforces in the region. For example, Amazon.com now in place over 25,000 people in Washington and it has reported 11,000 job openings in the Seattle Bellevue area. And last week Seattle Times reported that there are more construction cranes in Seattle than anywhere else in the country, twice as many as any other city other than Los Angeles. The Northwest Seaport Alliance, a consolidated container operation at the port of Seattle and Port of Tacoma, is the fourth largest container gateway in North America. Year-to-date imports are up 3% and Paul [ph] exports increased 12%. However total container volumes are essentially flat due to the weakened international market, as well as domestic volumes being down at the last struggles with decreasing oil and gas related activity due to low oil prices. You may be aware that Hanjin Shipping filed for receivership on August 31 and their alliance is still working to determine the impact of this situation and how to keep cargo moving. Oregon has been outpaced in the country in their job growth rate since 2013. The state posted a rate of 3.5% per job growth in September, compared to the nationwide average of 1.7%. Incomes have also appeared well with lower personal income growing by 1.3% during the last quarter or about $2.3 billion for Oregon workers. The unemployment rate in September was 5.5%. The Central Oregon city of Bend, Oregon where we have to branch locations with number one in the US for job growth last year at 6.6%. Idaho's unemployment rate held steady at 3.8% in September and the state rates third in the nation for year-over-year job growth. Total job had a net gain of 21,500 or 3.2% with all sectors except for natural resources experiencing growth during the last year. The population and labor force of all three states continues to grow. Overall we have an excellent job creation and strong GDP throughout the Northwest. Now let me talk for just a minute about dividend. Our financial performance and our optimism of better opportunities in the Northwest helped to support our decision to continue to pay both the regular and special cash dividend at the same levels as last year. Our quarterly regular cash dividend of $0.20 per common share will be paid on November 23, 2016 to shareholders of record as of the close of business on November 9, 2016. They will also pay a special cash dividend $0.19 per common share which will also be paid on November 23 to shareholders of record as of the close business on November 9. This is the 11th consecutive quarter that we have paid a special cash dividend. The regular dividend combines with special dividend accounts to payout ratio at 83% for the quarter and a dividend yield of 4.9% based on the closing price for stock on October 26. So with that, this concludes our prepared comments and as a reminder Clint Stein, Hadley Robbins, Andy McDonald are with me to answer your questions. And now Christina, we'll open the call for questions.

[Operator:]

[Operator Instructions] Your first question comes from Jeff Rulis from D.A. Davidson. Your line is open.

[Melanie Dressel:]

Hi, Jeff

[Jeff Rulis:]

Hi, Mealy. Good afternoon. Question I guess for – first one for Clint is just, on settlement [ph] expense run rate got the info on the, I guess the ratio there, I guess as that equates to – I thought you had stated a kind of run rate in the $63 million to $65 million a quarter, given that ratio maybe that's a little low maybe on a run rate range what does that equate to?

[Clint Stein:]

You are correct, in the prior quarter I stated at 63 to 65 range for the run rate. Its probably more like 64 to 66 and there's variability we saw that this quarter you know, we always talk about there's a potential for timing differences and you know in the second quarter, for example, our data processing expense was a little lower than what would typically anticipate. We saw that kind of rebound in the third quarter. Advertising is something that you have a bit of seasonality and lumpiness to it. So that's why you know it's hard to just give you a specific number. But you know, Melanie mentioned in her prepared remarks about the robust economy in the Northwest and I'm sure you're well aware what's going on in the Portland market as well that you know that’s creating pressure in terms of just hiring and retaining talent. So we have expense pressure, I don't think that it's lessened any and we continue to reinvest in our systems and in our franchise. And you know, we've done a pretty good job I think of trying to find efficiencies and our existing run rate, so that it's not just an incremental and to expense. If we look at you know, operating - our operating expense, so take out noise from Oreo the FDIC claw back liability in any acquisition expense, we look at the first nine months of 2015 and compare that to the first nine months of this year. And I think expenses are up 1%. So we're very mindful of that, but there is pressure there and we do you know, we do continue to reinvest in technology and different things. So I think that it's probably at 64 to 66 range for the immediate future.

[Jeff Rulis:]

Got it. Okay. And a question on the - on just the loan yields, higher loan yields and this environment is pretty rare sequentially and I hardly refer to a higher percentage of LIBOR-based. But is it just mix that was put on in the quarter that led to that or are you seeing anything else in the market that would suggest that loan yields are firming up?

[Hadley Robbins:]

The coupon rate as I mentioned was 3.86 and that was below really what was on the margin and I think most that's attributed to an extra day in this particular month. The created that difference, was that right Clint?

[Clint Stein:]

Yes, and we had some - we had some higher yields in the PCI book in the quarter that popped that number a little bit as well.

[Jeff Rulis:]

All right. So I guess the environment is still as is pressure on loan yields…

[Clint Stein:]

That's right. I would say that from a competitive perspective when you're in the marketplace there still is the pressure on coupon and that trend has been pretty consistent over past two years. I haven't seen really update. The difference was getting lost, but its still there.

[Jeff Rulis:]

Okay. And maybe one last one for Melanie. I missed the very initial comment on that, something about the $10 billion mark. And I had a just any preliminary thought on for '17 barring say M&A is non-existent in '17 is the idea that you'd probably try to manage below that mark for '17 if you could or maybe that's not even a good way to think about it. Anything on that $10 billion mark, you could add to it?

[Melanie Dressel:]

I think that we're going to go over $10 million next year on and you know we just elected organic growth and in its reasonable assumption. We have talked a lot over the years about whether or not you manage under $10 billion and we've reached the conclusion that you know we're going to go over it at some point in time, we've been preparing for three years. We [indiscernible] feathered in a lot of the investment that needs to go into. There is something that we can do about the impact at Durbin amendment, so again, that’s going to be a reality. But we're just going to continue to grow and we got comfortable in doing that.

[Jeff Rulis:]

Great. Thank you.

[Operator:]

Your next question comes from Aaron Deer from Sandler O’Neill and Partners. Your line is open.

[Melanie Dressel:]

Hi, Aaron.

[Aaron Deer:]

Hi. Good afternoon, everybody. I guess Hadley, maybe you could just give some of your thoughts on what you’ve scene over the past years in terms of seasonality in the Ag and other seasonal books and how we might expect to see that play out here in the first quarter, I am sorry in the fourth quarter with overall balances?

[Hadley Robbins:]

What we have seen and this is the general trajectory of activity, particularly online, is that it starts to trend down in the fourth quarter and continues through the first quarter and then picks up in the second and third quarter. And in the third quarter, we have seen it start to trend down slightly. But I expect that to accelerate in the fourth quarter. Taking Ag as an example and it's not the only segments that we have with the seasonal pattern, they harvest their crops, they grade the cash and the cash then is applied to the operating lines and we see that going on. Many on a cash basis and expensing things now prior to year-end as well. And so it impacts our deposit side too, but I don't anticipate the kinds of pressures there that I would see on our operating lines.

[Aaron Deer:]

In terms of dollar balances what's kind of the low to high peak that you would expect to see over the course of the year amongst those customers that recognize in that obviously the volume of those customers is been growing over time?

[Hadley Robbins:]

It has and we've been successful in booking new client, so it's kind of a mixed bag. But the swings are in the range of $50 million and those are net loan balances. And I really - I don't have a field that I'm confident of in predicting what will happen in this particular year.

[Aaron Deer:]

Okay…

[Melanie Dressel:]

I'll say that we will share as that our bankers are not taking their foot off the accelerator you know, they are still committed to record quality loan production. So on some respect that certainly helped us last year, even though we saw the seasonal decline online.

[Aaron Deer:]

Sure. I guess, sort of kind of plays into my next question which is more kind of big picture, Melanie you touched on some of the many strengths in the [indiscernible] robust economy right now, as what was as the volume of claims in the area. Given that level of construction, what are kind of your thoughts in terms of the – when you look absorption rates and new product coming online, what are your thoughts for the overall real estate markets and over the next 12 to 24 months?

[Melanie Dressel:]

Well, you know, it’s really hard to see a crack and that part of the economy and just because the job growth has been so strong. And I think this yesterday it was announced with a multifamily on project in Federal Way, which is halfway between Seattle and Oklahoma [ph] that was the highest price per unit on sale at any multifamily project, in anybodies history and that wasn't just a little bit over, it was I think $40,000 per unit higher and you know so that a little bit scary only from the standpoint that you know, that’s so incredibly strong that gets the job growth that – just the in migration and I think that the [indiscernible] will be if we see the number of jobs not meeting the expectations of all the people that are moving into the area. And I am just not seeing where that would be right now.

[Aaron Deer:]

Sure. Okay. Well, thank you very much. I appreciate you taking my questions.

[Melanie Dressel:]

Thank you.

[Operator:]

Your next question comes from Matthew Clark from Piper Jaffray. Your line is open.

[Matthew Clark:]

Good afternoon. How are you doing? I may have missed it Hadley, but you mentioned the new coupon rate this quarter on production was 386 and I think last quarter was 420?

[Hadley Robbins:]

Right.

[Matthew Clark:]

And can you just give us the portfolio of coupon as well?

[Hadley Robbins:]

I think its 432.

[Matthew Clark:]

Okay. Thank you. And then line utilization, you may have mentioned it, I may have missed it this quarter, the percentage wise?

[Hadley Robbins:]

The existing 3% - 53.1%.

[Matthew Clark:]

Got it. Okay. And then maybe Andy I think a couple of quarters ago, we talked about charge off kind of normalizing in that 20, 25 basis point ranges where they had been, I know you guys have higher recoveries and lower gross charges this quarter. So I would assume you kind of get back to that level. But just curious what you are seeing?

[Andy McDonald:]

Yeah, like Clint mentioned before, the uptick in the NIM was related to the purchase credit impaired portfolio to some degree, a lot of the charge-offs or I should say a lot of the recovery this quarter were actually the purchase credit impaired portfolio and about $1.8 million of that was really associated with pools of loans in the purchase credit impaired portfolio that received interest payments, but have no remaining discount. So the net charge-offs number because of the crazy raise accounting for purchase credit impaired loans made to look like we recovered a lot on loans that we charged offs, but that's not really the case. And that's why I try to highlight the difference between the purchase credit impaired portfolio in prior quarters to this quarter. So, yes, I would anticipate that they were normalized back, the credit impaired loan is hardest one to kind of predict, but the activity in the originated portfolio is the one should focus on.

[Matthew Clark:]

Okay. Thank you.

[Operator:]

[Operator Instructions] Your next question comes from Jackie Boland from KBW. Your line is open.

[Melanie Dressel:]

Hi, Jackie.

[Jackie Boland:]

Hey, Melanie. A question followed to Clint on occupancy, so normalized for the branch closure expense that highlighted in your prepared remark, that brings the balance down a bit lower than where we've seen in past quarters, is that a good normalized number or whether - are there some other factors that play in there?

[Clint Stein:]

Well, there is – its a good baseline, I think if you look at where we were last quarter, where we're at in the third quarter, backing out the branch closures expense, that's a good range of what I would expect going forward.

[Jackie Boland:]

Okay. And then you – I am not sure if it was you, but somebody had mentioned, just the difficulty with the strong economy and in some cases retention, and I know that a lot of the quarter on quarter change was incentive, but how much overall has retention costs kind of elevated compensation over the past year?

[Melanie Dressel:]

We don have that number readily available Jackie.

[Jackie Boland:]

Just your general sense? Is it a noticeable amount or is it just kind of the normal cost of doing business?

[Melanie Dressel:]

Well, for instance in some of the - even in the non-procedure areas, there are certain areas that the cost of employees is going out, just because there's specialty area and so its kind of hard to indicate overall percent as increase in that. We just really pride ourselves in negotiating on really hard to get the best talent in the market and that generally comes with maybe a slightly higher salary.

[Jackie Boland:]

Okay. So can we expect based on production and to the extent that you might advantageously hire you know, a new person - the salary line would trend up over time? Maybe not at the same level that we've seen this year.

[Clint Stein:]

We're always recruiting and a lot of it is situational and I would just say that it appears that the trend line is up for recruiting the high quality talent.

[Jackie Boland:]

Okay. Fair enough. And then just one last one, kind of housekeeping, I know that 3Q always had seasonal strength and deposit. But was there anything in particular of notice this quarter since it was a little bit stronger than we've seen in past 3Qs?

[Clint Stein:]

With regard to the production, I would say that we had some loans that actually closed this quarter, that closed faster than we thought, which elevated the level of overall production this quarter. But I would say that the loan officers have bee as Melanie said very active in the marketplace and continue to be we had a number of successes, a few within large on the loans and than on the deposit side, what is been taking place there is that the deposits have been driven by and large by our own production, those clients have brought to us very good deposit balances and we've been successful in acquiring deposit balances of customers that typical bring us more then $1 million, which is really kind of [indiscernible] behind the large increase.

[Melanie Dressel:]

And I think a piece of it is that we're not transaction bankers, we really work to make sure that everybody trying to gain the entire relationship, so you’ve got both sides of the balance sheet and it will probably be a little different if we were more transactionally ended you probably aren’t going to get the same level of deposit growth.

[Jackie Boland:]

Okay. Thanks for all the color, guys. I appreciate it.

[Melanie Dressel:]

Thanks, Jackie.

[Operator:]

There are no further questions at this time. I will turn the call back over to the presenters.

[Melanie Dressel:]

All right. Well, we appreciate you being with us this afternoon. And the next time we talk to you, I guess that it will be after the first of the year. So happy holidays to everyone and we will be back talking with you next quarter. Thank you.

[Clint Stein:]

Thank you.

[Operator:]

This concludes today’s conference call. You may now disconnect.