Columbia Banking System, Inc.
Q3 2014 Earnings Call Transcript

Published: 24 Oct 2014

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking System's Third Quarter 2014 Conference Call. [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 J. Dressel:]

Thank you, Stephanie. Good afternoon, everyone. Thank you for joining us on today's call to discuss our third quarter results. I hope you've all had a chance to review our earnings press release which we issued earlier this morning. The release is also available on our website columbiabank.com. As we outlined in our earnings release, our results reflect solid loan and deposit production during the third quarter as our bankers continue to be focused on developing new and deepening existing relationships. We also announced our merger agreement with Intermountain Community Bancorp during the quarter. Subject to customary closing conditions, we could close as early as November 1. We expect the integration to go smoothly as both teams have been working diligently to prepare for the closing. Clint Stein, Columbia's Chief Financial Officer, is on the call with me today. He'll begin our call by providing details of our earnings performance for the quarter. Andy McDonald, our Chief Credit Officer, will also be speaking this afternoon. He'll review our credit quality information, and Hadley Robbins, our Chief Operating Officer, will be covering our production areas. I'll conclude the call by giving you our thoughts on the economy here in the Pacific Northwest, including our new Idaho market and a brief outline of our priorities as we move forward. We'll then be happy to answer your questions. As always, I need to remind you that we'll be making some forward-looking statements today, which are such subject to economic and other factors. And for a full discussion of the risks and uncertainties associated with the forward-looking statements, please refer to our securities filings and in particular, our Form 10-K filed with the SEC for the year 2013. At this point, I'll turn the call over to Clint to talk about our financial performance.

[Clint E. Stein:]

Thank you, Melanie. We reported third quarter earnings of $21.6 million or $0.41 per diluted common share. We did have some noise during the quarter, so I'll spend a few moments going through the specifics. Our reported earnings per share were negatively impacted by roughly $0.04 due to $3.2 million in pretax acquisition-related expense and $117,000 of expense resulting from the accounting impact of our acquired FDIC loan portfolios. The impact of these 2 items was tempered by the $0.03 per share $2.6 million adjustment to net interest income discussed in our earnings release, along with another $0.005 per share stemming from the $565,000 gain recognized on the sale of 3 branches during the quarter. Our reported net interest income increased $1.1 million over the prior quarter to $76.2 million. After removing the effect of the $1.9 million linked quarter decline and incremental accretion income and the previously mentioned $2.6 million adjustment to securities income, net interest income increased roughly $400,000 over the prior quarter. Noninterest income before the change in FDIC loss-sharing asset was $20.7 million in the current quarter, up $1 million from the prior quarter. Noninterest income for the quarter was favorably impacted by the $565,000 gain on branch sales, with the remaining increase spread across many different line items. We've been evaluating best practices associated with our acquisitions and are now working to implement a number of those that we believe will improve efficiency, help generate incremental noninterest income and enhance our product set. After removing the noise created by the various items that impacted the quarter, total revenue was up just over $800,000 from the prior quarter. Total noninterest expense was $60 million for the current quarter, up $2.2 million from the second quarter due primarily to an increase in acquisition related expense of $2.6 million. After taking into consideration the clawback liability accrual, acquisition-related expense and the net benefit of OREO, our core noninterest expense run rate for the quarter was $57.8 million, up from $56.9 million on the same basis during the second quarter. The increase was mostly in compensation and benefits, which were up largely due to the payment of incentives related to our first half production results. With the pending Intermountain acquisition, we have spent considerable time during the quarter reviewing our post-integration expense run rate. A metric we utilize to measure our improved operating leverage is core noninterest expense to total assets. For the third quarter, this ratio was 3.1%, down from 3.12% in the second quarter. Our post-Intermountain integration goal is sub-3%. The previously mentioned $3.2 million of acquisition-related expense was split between West Coast and Intermountain, with $2.8 million and $459,000, respectively. The majority of the West Coast expense relates to the resolution of 2 large outstanding contracts. Transaction to-date, we have had $31.7 million in deal costs related to West Coast with an estimated $300,000 still pending. When compared to our pre-announcement estimate of $30 million, we're slightly over. While we are disappointed to have exceeded our deal cost estimate, we are pleased that we have delivered on our projected earnings accretion and model cost saves. The operating net interest margin contracted 5 basis points from the prior quarter to 4.22%. The NIM suffered in the third quarter from the robust deposit growth that occurred during the period. Average deposits grew at an annualized rate of 10% during the quarter in a significant -- resulting in a significant increase in short-term overnight funds, lowering the operating NIM by 3 basis points. Our average cost of interest-bearing deposits for the quarter declined to 7 basis points, while our cost of total deposits remained unchanged at 5 basis points. Now I'll turn the call over to Hadley to discuss our production results.

[Hadley S. Robbins:]

Thank you, Clint. Total deposits at September 30, 2014, were $6.24 billion, an increase of $259 million or 4.3% from $5.99 billion at June 30, 2014. Compared to year-end 2013, total deposits have increased $285 million. Core deposits remained stable at 96% of total deposits and were $5.99 billion at quarter end. Noncovered loans were $4.58 billion at September 30, 2014, up $127 million or 2.8% from $4.45 billion at June 30, 2014. On a year-to-date basis, noncovered loans have increased $360 million, which is an annualized growth rate of 11.4%. The increase in noncovered loans was driven by another solid quarter of new loan production, which was $251 million during the third quarter. The mix of new loan production was predominantly centered in commercial business loans and commercial real estate loans. Term loans accounted for roughly $160 million of total loan production, and advances under new lines of credit represented about $91 million. New production was nicely distributed in terms of size. 18% of new production was over $5 million, 33% was in the range of $1 million to $5 million and 49% was under $1 million. In terms of geography, 61% of new production was generated in Washington and 39% in Oregon. In the third quarter, we also started a small specialty lending group that will focus on mezzanine finance opportunities in cases where the bank holds the senior debt position. During the third quarter, the average coupon rates for loans continue to decline. The current low interest rate environment coupled with competitive market conditions for good quality loans put pressure on pricing for both new and existing relationships. The bank's tax-adjusted weighted average coupon rate for loan portfolio was 4.73% at year-end 2013. The average coupon rate has declined each quarter since then and is now 4.52%. Commercial business loans ended the quarter at $1.83 billion, up $93 million or 5.3% from the second quarter. Line utilization on existing credit facilities was active. It held relatively constant at 56% of total commitments during the quarter. The increase in third quarter outstanding loans is largely due to new production, which occurred across a number of business sectors. Those sectors with the highest level of activity included finance and insurance, health care, agriculture and transportation. The commercial real estate portfolio including commercial construction was up about $19 million in the third quarter. However, this amount is small relative to the scale of the overall portfolio. Consequently, net commercial real estate loan remained essentially flat at $2.1 billion. The asset type with the most new loan activity during the quarter was term investor office, which increased $16 million. The underlying projects were mainly for state office space and medical/dental care facilities. The commercial real estate category with the largest decline was multifamily construction. Multifamily construction loans dropped about $14 million, primarily a result of stabilized properties moving to the secondary market for permanent funding. As we look to the end of the year, we expect seasonal borrowing activity to follow historic patterns in some of our industry sectors that will create headwinds for net loan growth in the fourth quarter. The 2 sectors with the most pronounced seasonal pattern are contractors and agricultural borrowers. These 2 sectors typically have quarterly increases to outstanding loans that occur in the first quarter through the third quarter followed by a decline in the fourth quarter. At this point in time, it's difficult to assess production volume through the year end. However, deal flow has been fairly steady, and our current C&I and commercial real estate pipeline is comparable to the amount and composition of loan types seen in prior quarters so far this year. That concludes my comments. I'll now turn the call over to Andy.

[Andrew L. McDonald:]

Thanks, Hadley. For the quarter, the company had a provision of $1.5 million for noncovered loans. The originated portfolio provision was $1,250,000 and was primarily due to the strong origination and subsequent loan growth activity we had been enjoying. For the quarter, originated loans grew about $200 million, thus necessitating most of the provision. We also had a small provision related to the Bank of Whitman portfolio. The remaining loan balance in the Bank of Whitman portfolio is a bit over $30 million, and we now carry a reserve of $824,000 for these loans. So you can see it's not a large part of our balance sheet. In total, our allowance for loan and lease losses for both originated and discounted loans is 1.09%. As we had discussed before, this ratio is skewed due to the West Coast loan portfolio which due to day 1 accounting treatments continues to carry a $45 million discount as of September 30. This discount, of course, provides a shield for loan losses as well. Excluding acquired loans, the ALL coverage ratio is 1.27%. So we remain comfortable with our provision levels, especially in light of our coverage ratio for nonperforming loans, which is 178%. Nonperforming assets continued their decline and now represent 0.53% of our noncovered assets. Most of the reduction came this quarter thanks to the sale of OREO properties as well as a modest reduction in nonperforming loans. As of the end of the quarter, we also had approximately $14.7 million in recorded investment in TDRs, of which about $2.7 million is included in the NPA category, leaving $12 million in performing TDRs. Past due loans at quarter end were 32 basis points compared to last quarter when they were 23 basis points. Including covered loans, past due loans stood at around 37 basis points as of September 30. One thing to keep in mind with respect to the pending Intermountain transaction, similar to our last 2 acquisitions, we will likely have a provision related to the acquired portfolio in the first full quarter after closing. The timing and amount depend on many different factors, so I can't give you any specifics other than to remind you that it has occurred in previous transactions. With that, I will turn the call back over to Melanie.

[Melanie J. Dressel:]

Thanks, Andy. I'd like to briefly give you an update about the economy here in the Pacific Northwest and I'll also touch on Idaho. As we've come to expect during this gradual, often uneven economic recovery, we continue to see mixed results in the leading economic indicators we look to. On the whole, however, trends are positive. This is certainly the case in Washington. September's unemployment rate edged up slightly to 5.7% from 5.6% in August. So it was down from 6.9% a year ago. After 8 straight months of job growth, the number of jobs decreased slightly from August due largely to a decline in private sector jobs. The Seattle metro area unemployment rate remains steady at 4.8% compared to a national rate of 5.9%. The state has gained almost 76,000 jobs during the past year with almost 60,000 of those jobs added since the beginning of 2014. Most of those jobs, about 90% of them, were added in the private sector. Seattle recently ranked fifth in the nation in home price appreciation with an 8% annual increase in August compared to an average annual decrease of 7% a year ago. After 3 months of gains, Boeing recently announced that it will shift about 2,000 jobs, mostly in engineering, out of the region by 2017. This is a relatively small concern, however, since sales continue to be brisk. As of June, the most recent month available, more than 95,000 people in Washington worked in the aerospace products and parts manufacturing and about 90% of those worked for Boeing. Some good news for Washington -- or some other good news for Washington. The ports of Tacoma and Seattle just announced that they are ending their long-standing rivalry and are forming an alliance to manage the marine cargo business of both ports. This is expected to help the state counter the very strong competition from other West Coast rivals, including British Columbia. Other good news is that the biotech sector is growing with a real impact on the economy. The life science industry is one of the largest economic sectors in the state. In fact, transactions in the industry recently exceeded $1 billion, and the industry is attracting partnerships and dollars from both inside and outside Washington. Moving on to Oregon. The Oregonian recently reported that the economic growth in 4 of 5 major Oregon metropolitan areas had been expanding at or above average rates. Unemployment remains a concern as the unemployment rate in September was 7.1%, which was above the national average of 5.9%. Manufacturing continues to be strong, adding about 1,000 new jobs. And in 2013, Oregon's manufacturing output, primarily high tech, was over $65 billion, the 10th highest in the nation. Oregon is about 19,000 jobs away from regaining all the jobs lost during the recession. In 2013, Oregon's rate of personal income grew at 3.5%, the fifth highest growth rate in the country. Idaho is one of the 10 states that Moody's Analytics expects to have the highest employment growth rates in the country. And in fact, Idaho's 4.5% unemployment rate in September was the lowest in the state since May 2008, down from 4.7% in August. The Boise metro area is a shining example that a strong economy is possible despite modest national economic growth. Jobs are up nearly 3% from a year ago, and the unemployment rate is very low. The total value of goods and services produced in Idaho grew just under 7% in 2013 to $62 billion, the third highest growth rate nationally. Even during the worst of the recession, Idaho's agriculture thrives with almost every important crop seeing higher prices year-over-year. One sector that's rebounding is construction, especially in the Boise market. In short, the economy is continuing its steady improvement here in the Pacific Northwest. As I mentioned earlier, I'm very pleased with the progress we've made preparing for the closing of the Intermountain transaction. I want to acknowledge our teams of bankers as well as everyone from the Intermountain group working on the project. They're just doing a great job, and we're right on track with the process. Despite what might be a distraction with the upcoming acquisition, our bankers continue to be externally focused on calling on both prospective and existing customers. And although growth through acquisition has been prominent in our expansion over the last several years, we're equally committed to growing organically. In addition to quality loan growth, our concentrated efforts are around growing noninterest income and further examination of expenses for reduction opportunities. Before I open the call for questions, I want to note that we are pleased that we've achieved our projected earnings accretion related to our acquisition of West Coast Bancorp. As a result, we announced an increased in our regular cash dividend to $0.16 per common share and per common share equivalent for holders of preferred stock. The dividend is a 14% increase from the regular dividend paid for the second quarter and 33% from the first quarter in 2014. In addition, we announced a special cash dividend of $0.14. Both dividends, totaling $0.30 will be paid on November 19 to shareholders of record as of October 31, 2014. Together, the dividends represent a payout ratio of 73% for the quarter and a dividend yield of 4.8% based on the October 22 closing price. With that, this concludes our prepared comments for the afternoon. As a reminder, we have Clint Stein, Andy McDonald and Hadley Robbins here to answer questions. And now Stephanie, will you open the call for questions, please?

[Operator:]

[Operator Instructions] Our first question comes from Joe Morford.

[Joe Morford:]

I guess first question was just on the deposit growth this quarter, which was very strong. Just kind of curious what kind of drove that activity. And then similarly, saw nice increase in deposit service fees and is that mostly due to the higher balances? Or is there anything different going on in terms of fee structures and stuff?

[Melanie J. Dressel:]

Hadley?

[Hadley S. Robbins:]

Sure. We do have kind of a seasonal pattern to our deposits, and we're in the peak season right now. So a lot of that is, is just the seasonal push that we get, plus we brought on a fair number of new clients that have increased our commercial deposit base. With regard to the service fees, we haven't gone in and changed any fees. It's just related to more activity.

[Joe Morford:]

Okay. Great. And then I guess just if you could just talk a little bit more about the new mezzanine lending division. What are some of the opportunities you see there? What part of the business you're going to be going after, and did you bring on a team that has some expertise in that area to start that?

[Hadley S. Robbins:]

Yes. It's a small team. I mentioned it because it's new to our lineup, and we're looking forward to future contributions. It's a team that's pointed at primarily providing recapitalizations and leverage buyouts but only to clients that we currently do business with. And those clients would be commercial clients with -- we have the first position on assets, and this adds additional dollars in cases where we typically exceed loan to values that we're comfortable with. So it's a way for us to participate in helping our existing clients through transitions, and we're looking forward to having some good activity as the economy returns to strength. And we do have an individual that brings with them a fair amount of expertise in the area. So we're confident of that and we'll manage the growth carefully going forward.

[Operator:]

Our next question comes from Jeff Rulis with D.A. Davidson.

[Jeffrey Rulis:]

Melanie, it seems like the Intermountain transaction may be, I guess, expedited on a closing. Any sense on -- and again, not to speak -- if I had to turn I guess before closing, but what would be the targeted conversion rate if -- have you guys put thought on that?

[Melanie J. Dressel:]

I'm sorry. The conversion rate or date?

[Jeffrey Rulis:]

Date.

[Melanie J. Dressel:]

It's going to be in May of next year.

[Jeffrey Rulis:]

And then I had another one on, maybe for Clint, on the expiration of the loss share agreements. I guess broadly speaking, I don't really want to get into the nitty-gritty, but are there some broad final marks that will occur when those expire? In other words, is the indemnification asset go away? And what happens on the margin front? Or any other impact that you can see.

[Clint E. Stein:]

Well, in terms of the margin impact with the operating NIM, what we attempt to do there is to really remove the accounting noise and give you an idea of what our NIM would be without the acquisition entries. And so I think looking at the operating NIM, I don't really see the expiration of our first 2 loss-sharing agreements having an impact on that. Obviously, as the covered portfolio continues to wind down, the reported NIM starts to more closely approximate the operating NIM. Relative to, I guess, just overall accretion income and asset -- loss-share asset amortization, we'll see a pretty significant reduction in both of those. We just have -- technically, we have 8 loss-sharing agreements. There's just 2 of them that will expire at the end of the first quarter, but they were also the 2 largest agreements that we had the commercial side for Columbia River and American Marine. Just for context, our best model estimate right now for projected accretion income is that we'll be roughly $38 million for this year compared to $53 million last year. That drops to roughly $24 million for 2015. When we compare the loss-share asset amortization on where we'll be, we're thinking $19 million for this year. That drops to a little over $8 million in 2015. The majority of that, not quite half, hits in the first quarter. So you can see that the impact of those 2 largest agreements expiring, the loss-share asset amortization trails off significantly. So roughly $4 million in the first quarter to a little under $2 million is what we're projecting for the second quarter. Of course, we re-yield each quarter and so these numbers will move around a little bit, but just to give you some context on what we're looking at right now.

[Operator:]

[Operator Instructions] Our next question comes from Jackie Chimera with KBW.

[Jacquelynne Chimera:]

Sorry if I missed this in the prepared remarks. I noticed that occupancy expense was down on a linked quarter basis. Was there anything unusual that drove that?

[Melanie J. Dressel:]

Clint?

[Clint E. Stein:]

Well, we've consolidated or closed some branches over the year, so that's helping our run rate. We've just been really busy with working through some of the excess space that we had as a result of West Coast. In terms of specific things, on the second quarter, we had some higher repairs and maintenance in some of our retail branches that hit expense. So that resulted, I guess, on a quarter-over-quarter decline of about $340,000. So I think that it's a combination of just we're more effectively using our space and eliminating excess space, but also combined with some of its timing related as to when we have repairs that hit some of our areas on the Oregon Coast, for example. There's only a certain window of time when you can really affect exterior repairs of facilities, and that's a pretty harsh climate. So that's why it'd be centered in the summer months.

[Jacquelynne Chimera:]

So is the 3Q level a fairly good run rate going forward absent the acquisition then and seasonal patterns of repairs?

[Clint E. Stein:]

Yes, yes, I think so. There's less -- I mean, third quarter seemed pretty clean from an occupancy standpoint. There wasn't as much noise with the -- the other thing that impacted the second quarter run rate was we had $547,000 of acquisition-related expense in there for the third quarter. That number was $10,000. So I think we've got a much cleaner run rate in the third quarter.

[Jacquelynne Chimera:]

Okay. That's really good color. And turning to the premium amortization, not the premium [indiscernible] but the reversal that occurred in the quarter. Is there any impact on what I'm guessing is a revision and how it's going to be calculated on a go-forward basis?

[Clint E. Stein:]

Yes, it's really -- the adjustment's really a timing issue as to when we recognize the premium on those securities. So what I think you'll see as an impact is the -- we'll have additional premium to amortize over the life of the bonds that are in there right now in the portfolio with the premium. And so it's going to lower the yield on the portfolio. It's -- if we look at just the impact today -- and the number changes because as each month rolls by then there's less and less premium associated with those bonds. But it's about a 10 basis point impact on the yield on the investment portfolio.

[Jacquelynne Chimera:]

Okay. And that's the security yield, not the NIM impact, right?

[Clint E. Stein:]

Right, right.

[Jacquelynne Chimera:]

Okay. And then just lastly, looking back to the deposit growth that you talked about, Hadley, was any of that temporary in nature outside of seasonal fluctuations, some large deposit that came in that you expect to leave? Or is it all just natural timing of ebbs and flows?

[Hadley S. Robbins:]

I think it's more in the ebbs and flows. There is a pattern. Again, we're kind of at the peak, and it will probably move down in the following months, particularly in December. And you'll see another kind of period of buildup, and then it typically goes down in April. And so those are kind of the waves that we ride on the deposit growth. But again, underlying it is a level of new client growth too in terms of deposit levels.

[Operator:]

[Operator Instructions] And there are no further questions in queue at this time. I'll turn the call back over to the presenters.

[Melanie J. Dressel:]

Thanks so much everyone. We're happy you joined us this afternoon, and we'll talk to you next quarter.

[Operator:]

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