Columbia Banking System, Inc.
Q2 2015 Earnings Call Transcript

Published: 23 Jul 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Columbia Banking System Second Quarter 2015 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 our host, Melanie Dressel, President and Chief Executive Officer of Columbia Banking System.

[Melanie Dressel:]

Thank you, [Askalane] [ph]. Good afternoon, everyone. And thank you for joining us on today's call to discuss our second quarter 2015 results, which we released this morning. The earnings release is available on our website, columbiabank.com. As we outlined, loan growth was very strong during the quarter, growing over $280 million. Our second highest quarterly total in our history than just under $500 million for the six months -- for the first six months of the year. This was the sixth consecutive quarter our bankers have achieved well over $200 million in new loan originations. Additionally, we increased our operating revenue from last quarter by $1.5 million and our credit quality continues to improve. We have $3.4 million of acquisition-related expenses during the quarter. These expenses should moderate significantly since we also completed the core operating system conversions of Intermountain during the second quarter. Clint Stein, Columbia’s Chief Financial Officer is on the call with me today. He will begin our call by providing details of our earnings performance. Hadley Robbins, our Chief Operating Officer will be covering our production areas this afternoon. And Andy McDonald, our Chief Credit Officer will review our credit quality information. I will conclude by giving you just a few thoughts on the Pacific Northwest economy, including Washington, Oregon and Idaho, and a brief outline of our priorities as we move forward in 2015 and beyond and then we will be happy to answer your questions. As always, I need to remind you that we will be making some forward-looking statements today, which are subject to economic and other factors. 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 2014. At this point, I'll turn the call over to Clint to talk about our financial performance.

[Clint Stein:]

Thank you, Melanie. Earlier today we reported second quarter earnings of $21.9 million or $0.38 per diluted common share. As expected, there was some noise in the quarter which influenced our reported results. To add clarity, I will take a moment to highlight these items for you. Our reported earnings per share were negatively impacted by $5.6 million in pretax acquisition-related expense. Partially offsetting the acquisition expenses was the net benefit from OREO of $563,000 and for the second consecutive quarter, the accounting impact of our acquired FDIC loan portfolios was the benefit, increasing pretax income $442,000. Combination of these items resulted in a reduction to reported EPS of $0.06. Our reported net interest income increased $646,000 over the prior quarter to $81 million. The increase was driven by additional interest income on loans of $1.1 million before factoring in the change in acquired loan accretion income. Non-interest income before the change in the FDIC loss sharing asset was $23 million in the current quarter, up from $22.6 million in the prior quarter. The growth was primarily due to increased service charges and merchant services income, which were up $1 million and $300,000, respectively, from the prior quarter. These increases were partially offset by lower securities gains and the decline in the gain on loan sales, which were $765,000 from -- which were down $765,000 from elevated levels in the prior quarter. Reported non-interest expense was $68.5 million for the current quarter, up $1.7 million from the first quarter. The increase was driven by acquisition expenses, which were $2.6 million higher in the second quarter. After taking into consideration the acquisition-related expenses and the net benefit of OREO, our core non-interest expense run rate for the quarter was $63.4 million, down from $65 million on the same basis during the first quarter. The $1.6 million linked quarter decline was entered in compensation and benefits, and resulted from the combination of seasonal expense spike in the first quarter and the realization of additional cost savings from the Intermountain transaction in the current quarter. The $5.6 million of acquisition-related expense is broken out as follows, compensation and benefit $3 million, occupancy $804,000, advertising and promotions $247,000, legal and professional services $632,000, data processing $180,000 and other expense of $745,000. As a result of the lower operating expense run rate, our core non-interest expense to asset ratio declined to 2.97% during the second quarter. We still expect this ratio to decline further as the Intermountain integration winds down. To date we have implemented roughly $5.3 million of the $8.6 million in cost savings we expected with the Intermountain acquisition. We anticipate implementing the remaining $3.3 million during the third quarter. Loan pricing remains very competitive, but near record loan production resulted in solid portfolio growth for the quarter. As a result, the operating net interest margin continued to show resiliency, compressing 1 basis point from the first quarter to 4.17%, which is unchanged from the fourth quarter of 2014. Our total cost of deposits remained steady at 4 basis points, while our average cost of interest-bearing deposits for the quarter ticked up 1 point to 8 basis points. The increase is a result of the migration of interest-bearing demand accounts, earning an average rate of 1 basis point moving to non-interest bearing demand, which is why interest expense on deposits declined even though average deposits were roughly $50 million higher for the second quarter. Last, tangible book value per common share ended the quarter at $14.29 declining from $14.40 at the end of the first quarter and our tangible common equity to tangible assets ratio was 10.3%. Now, I will turn the call over to Hadley to discuss our production results.

[Hadley Robbins:]

Thank you, Clint. Total deposits at June 30, 2015 were $7.04 billion, a decrease of $30.6 million from $7.07 billion at March 31, 2015. On a year-to-date basis, total deposits have increased to $120 million or about 1.7%. Core deposits were $6.74 billion, holding steady at 96% of total deposits. As Clint mentioned, the average rate on interest-bearing deposits remain low at 8 basis points compared to 7 basis points in the previous quarter. Loans were $5.61 billion at June 30th, representing an increase of about $161 million or 2.95% over the first quarter. The increase was largely driven by new loan production of $282 million and more active line utilization. Line utilization increased from 51.1% in Q1 to 52.9% in the second quarter. Higher levels of line utilization contributed about $58 million to the total change in loans for Q2. Draws under ag lines of credit represent a significant component of this increase. Historically, ag activity builds in the second and third quarter and recedes in the fourth and first quarter. New production was predominately centered in C&I in commercial real estate loans. Term loans accounted for roughly $207 million in total production, while lines represented about $75 million. The mix in new production was fairly granular in terms of size. 21% of new production was over $5 million, 14% was in the range of $1 million to $5 million and 65% was under $1 million. In terms of geography, 68% of new production was generated by lending teams in Washington, 30% in Oregon and 2% in Idaho. As seen with new production, second quarter net loan growth was concentrated in C&I in commercial real estate. C&I loans ended the second quarter at $2.3 billion, up about $116 million. Industry segments with the highest loan growth include agriculture, finance and insurance, and healthcare. Likewise commercial real estate loans ended the first quarter at $2.6 billion, up $40 million. Commercial real estate asset types with the largest increase were farmland, warehouse and hotel motel. Aggressive competition for earning assets continues to create pressure on pricing across all of our markets. The tax adjusted average coupon rate on second quarter new production declined to 4.08% as compared to 4.39% in the first quarter. The average tax adjusted coupon rate for the overall loan portfolio trended down as well from 4.50% at March 31st to 4.44% at June 30th. Competitive environment makes predicting outcomes for net loan growth difficult to estimate with confidence in position however. Deal flow remains active and I expect to see positive net loan growth in the third quarter. Concludes my comments, I'll turn the call over to Andy.

[Andy McDonald:]

Thanks, Hadley. For the quarter, the company had a provision of $2.2 million driven by the originated portfolio which required a provision of $4 million. The provision was driven by $312 million in loan growth in the originated portfolio along with modest migration trend experience during the quarter. We also had a small provision of $477,000 for the purchase credit impaired loans. Offsetting the provision for originated and purchase credited impaired loan was a release in provision from our discounted portfolios of $2.3 million. The release was due to declining loan balances, given the liquating nature of these portfolios and positive migration trends experienced in the quarter. To some extent, as loans migrate from the discounted portfolio to the originated portfolio, we’re simply moving dollars from one bucket to another. We had net charge-offs of $3.2 million for the quarter centered in the originated portfolio which had $1.8 million and a purchase credit impaired portfolio which had $834,000. That equates to about 9 basis points for the quarter, so while up from prior quarter, it's still a very modest number. As of June 30th, our allowance to total loans was 1.23%, down from 1.29% at March 31st and 1.28% at year-end 2014. Our allowance to nonperforming loans as of June 30th is 269%, up from 221% last year. For the quarter, non-performing assets declined $8.7 million or 16%, thanks to declines in both nonperforming loans and OREO. Nonperforming loans now represent just 46 basis points of period in loans. As of the end of the quarter, we also had approximately $8.6 million in recorded investment in TDRs, of which $200,000 is included in the NPA category, needing $8.4 million in performing TDR. Past due loans at quarter end were 23 basis points compared to last quarter when they were 39 basis points. With that, I will turn the call back over to Melanie.

[Melanie Dressel:]

Thanks Andy. Improvement continues in most of the leading economic indicators here in the Pacific Northwest. In fact, now the end of June, the Seattle Times suggested that even with relatively modest growth in rural and higher urban areas, the report for the second quarter is likely to be stronger than the first quarter of this year. Our large metropolitan areas such as Seattle, Tacoma, Bellevue in Washington, Portland, Oregon, and Vancouver, Washington, NYC, Idaho had been expanding significantly. The Bureau of Labor Statistics reported that Washington, Idaho and Oregon have all placed in the top 10 nationally for job growth over the past year. Washington’s growth was second in the nation after Utah. Idaho and Oregon were close behind ranking fourth and sixth best in the nation respectively in percentage of job growth year-over-year as of May. Last month, Washington experienced modest job growth resulting in 5.3% unemployment rate, a 7-year low which tracks with the national rate of 5.3%. The Seattle area, unemployment in June was just 3.9%. In the past year, state gained almost 115,000 jobs with just under 19% of those jobs in the private sector. An interesting note from the Seattle Times is that the states’ unemployment rate has gone down in inverse proportion to the number of construction trends going up. As I mentioned earlier, Washington nearly leads the nation in job growth over the past year much driven by growth in the construction sector with almost 18,000 jobs added in the past year. One of the challenges now facing the industry is the lack of enough skilled workers to fill the job. Home prices and sales volume especially in the Seattle metropolitan area showed healthy gains that have outpaced the nations. The Tri County area of Kings, the Snohomish, Pierce Counties in Washington posted a 7.5% in average gain over the year. We are also pleased to report that Seattle has formed the Northwest Seaport Alliance, which is now awaiting federal maritime commission approval and this will unify the two ports, strengthening the Puget Sound gateway and attracting more marine cargo for the region. Oregon’s unemployment rate kicked up just slightly in June to 5.5%, up from 5.3% in May, but significantly lower than the 7% just a year ago. Payroll employment grew by over 52,000 jobs since June of 2014. The resulting year-over-year growth was 3.05%, which is much faster than the national growth rate of 2.1%. Oregon’s job growth has consistently outpaced the nation since 2013. The fastest growing sectors are those encompassing white collar firms and healthcare providers and are primarily clustered in the Portland, Oregon, Vancouver, Washington metro area. It’s been almost six years that Idaho’s jobless rate has been below the national rate, an increase in the number of people choosing to entering the job market bumped up Idaho’s unemployment rate from 3.9% in May to 4% in June. The Idaho Department of Labor set an additional 2,300 potential workers reentered the labor force just last month. The lowest unemployment rate in the state was in Boise, with 2.7% in June. Although there are concerns about the dry weather, Idaho still expects the agricultural exports to top a $1 billion as they did in 2014. And during the year, farm income increased 45% compared to a decrease of 22% for the rest of the country. Agriculture is Idaho’s fastest growing sector, tripled that as the number two growth industry, which is healthcare. On a regular basis, we survey our business customers throughout our market area to better hundred their challenges and opportunities. Our most recent survey in June shows that our customers remain optimistic about the economy and about the general business conditions. About 93% of our customers are confident about the future of their own business. This was carried among all industry’s surveys. However, our customers agreed that government regulation and taxes continued to be their top issues and we saw additional concern for wholesale costs and the draught conditions. Over half say they are not yet ready to invest in capital expenditures. Overall, the Pacific Northwest economy continues to perform better than the country as a whole in just about every economic indicator. Our priorities going forward continue to be growing loans, improving operating leverage and effect of utilization of capital. We continue to feel very optimistic about our opportunities in the Pacific Northwest, which helps us support our decisions to pay another special dividend at $0.16 in addition to regular dividend of $0.18. Those will be paid on August 19 to shareholders of record as of August 5th of this year. We are pleased to pay a special cash dividend for the sixth consecutive quarter. Both dividends totaling $0.34 constitute to payout ratio of 89% for the quarter and in dividend yield of 4.1% based on our closing price yesterday. And lastly, I will add just a couple of comments. We are very gratified that we are recently named one of Washington’s best places to work for 2015 by the Puget Sound business generals for the ninth consecutive year. We are also very pleased to be awarded the best large business by the readers of South Sound Magazine. And I know that Clint had not mentioned this, but he was recently named the CFO of the year by Puget Sound business general and he is very deserving of this honor and we are all really proud of him. With that, this concludes our prepared comments this afternoon and as a reminder, we have Clint Stein, Andy McDonald and Hadley Robbins here to answer your questions. And now we will open the call for questions.

[Operator:]

[Operator Instructions] And your first question comes from the line of Joe Morford with RBC Capital.

[Melanie Dressel:]

Hi, Joe.

[Joe Morford:]

Thanks. Good afternoon, everyone. I guess this quarter’s securities investment portfolio declined as the cash flows were used to fund loans. Do you see more of that going forward and just in general how should we think about the relationship between loan growth and earning asset growth over the next few quarters?

[Clint Stein:]

We would love to have more of the cash flows from the investment portfolio flow into loans. I think that there is a lot of different variables that could drive that as you know and one of them is deposit growth. And we have some seasonality with our deposits if we look at year-over-year comparisons. Second quarter of last year, deposits were down a little bit. Second quarter, this year they ended down a little bit but on average they were up. So, I guess it’s a long way of saying all things being equal, we would love to shift those cash flows into the loan portfolio but we won’t necessarily know how successful we are at that until we get there.

[Joe Morford:]

Okay. Fair enough. I guess the other question would just be on the expenses. With the system's conversion now completed, what are your expectations for the core expense run rate in the third quarter and should that reflect most of the targeted savings?

[Clint Stein:]

Yeah. We would expect to hit the targeted savings of $8.6 million. We have $3.3 million to go and our best estimate is that we will achieve those during this third quarter. Some of that will be phased in, so we won’t get the full benefit and that’s an annualized amount. So it’s about $825,000, off of the quarterly run rate. This quarter, we were $63.4 million on an operating or core expense run rate basis. But there is always variability from quarter-to-quarter in terms of expenses. And so, I think that, that $63 million to $64 million range is a pretty good range in terms of what we are shooting for long-term.

[Joe Morford:]

Perfect. Thanks so much, Clint.

[Clint Stein:]

You bet.

[Melanie Dressel:]

Thanks, Joe.

[Operator:]

And our next question comes from the line of Jeff Rulis with D.A. Davidson.

[Melanie Dressel:]

Hi, Jeff.

[Jeff Rulis:]

Hi. Just to clarify on that Clint, on the expense. When you say long-term, I guess are you referring to, we’re not going to get to that 63 and change number in Q3, or is there some puts and takes there?

[Clint Stein:]

Q4 is kind of where we’ve always felt like we would have the first clean post-integration run rate from for a full quarter. There were a lot of things that had already been put in place, already this quarter just because the core system conversion was mid May. So we worked through all of the post-conversion items, and that’s usually where we really start to get the cost savings. But Q4 would be where we’ve always targeted to have that good clean look at what our new run rate is going forward.

[Jeff Rulis:]

Okay. And then a question on the loan front, I guess maybe relative payoff activity in Q2 versus Q1 overall?

[Clint Stein:]

There was less payoff activity in Q2, as compared to Q1. I think that’s probably approaching $70 million in terms of the swing.

[Jeff Rulis:]

Okay. Do you view that as abnormally low? And I guess expectations for Q2, it’s tough number to gauge, but did you feel like that was light and that Q3 may - that might be tougher to match Q2?

[Clint Stein:]

Well, I think I referenced some seasonality of our ag portfolio. And I do believe that we will continue to have positive activity in the third quarter, but it will start trending down towards the end of the third quarter and will continue into the fourth quarter. But to some degree that may be offset by construction commitments that we’ve been booking this year and drought will be occurring. And so it’s a difficult thing to forecast and handicap for you, but those are the forces in motion.

[Jeff Rulis:]

So your ag and construction comments were more production related versus - you’re just sort of stepping aside from the payoff activity that could become [indiscernible] number?

[Clint Stein:]

We will have payoff activity, but the payoff activity and part of it’s planned, as we sell down certain positions we have, as well as unplanned which relate to loans that get paid off by our borrowers. But the more predictable movements within the portfolio related to draws and paydowns on ag and we do have a fairly significant volume of mortgage related activity in our warehouse lines. And those are pretty active as well, but they tend to slow down as we go into the fourth quarter and people stop buying homes at the same velocity that they have. So bottomline is that I don’t see any payoff activity at this point that is out of pattern in a significant way.

[Jeff Rulis:]

Okay. Maybe last one on just timing of production of loans that - was that carried throughout the quarter front-end or backend loaded?

[Clint Stein:]

Pretty steady throughout the quarter.

[Jeff Rulis:]

Okay. Thanks.

[Clint Stein:]

You bet.

[Melanie Dressel:]

Thank you, Jeff.

[Operator:]

And our next question comes from the line of Jacquie Chimera with KBW.

[Melanie Dressel:]

Hi, Jacquie.

[Jacquie Chimera:]

Hi, good afternoon, everyone. The increase in service charges in the quarter, was that purely seasonal or was something else going on there?

[Hadley Robbins:]

Service charges on our deposit counts is -- I think will be sustained. We’ve looked pretty carefully at how we’ve structured our service charges and evaluated how our accounts and services related to them are bundled and made changes. And I think that we will see those numbers improve over the coming year. And so I think that those are built in.

[Jacquie Chimera:]

And does that relate to the change you’re talking about earlier with the movement of the demand deposits and the non-interest-bearing, would that impact charge service charges at all?

[Hadley Robbins:]

Yes. Some of that caused the change in where money flowed, and so you are exactly right.

[Jacquie Chimera:]

Okay. And then I have one for you, Clint. The amortization in the quarter, I know that most of the change in the FDIC loss share asset was driven by that amortization. Are the Columbia and American River transactions, are they still having an impact this quarter even though the loss share has expired already?

[Clint Stein:]

Well, there is each, both Columbia River and American Marine [indiscernible]. So each have two loss share agreements. And so it’s only the commercial side that expired. Now the residential side goes on for a while, but it’s a much smaller amount in terms of what we expect for amortization just in general I got that numbers here. We’ve had about $1.3 million year-to-date for four of the banks. We would expect that level that we had in the second quarter to continue. It will decline slightly for the remainder of this year so figure a $1.5 million to $1.4 million each quarter. And then when we look at 2016, we would expect roughly $3 million of total amortization on the loss share assets for the entire year.

[Jacquie Chimera:]

Okay. And will that be front-loaded given the May expirations?

[Clint Stein:]

Yes. Out of that $3 million, about $2.3 million we would expect in the first half of the year.

[Jacquie Chimera:]

Okay. That’s really helpful. Thank you. And then just one last one Melanie so I don’t bore everyone with my technical questions. If you could just give us an update on M&A chatter in the market, how maybe conversations have changed over the last three months and just kind of what you’re hearing?

[Melanie Dressel:]

Well, I have been saying for a long time, but I think that there is a lot more discussion around M&A. And I don’t think that we saw a decline in the quarter versus say the last several quarters.

[Jacquie Chimera:]

You, sorry, you did or you did not see a decline?

[Melanie Dressel:]

Did not, it’s been differences, yes.

[Jacquie Chimera:]

Okay. Has that piece of M&A this year -- has it surprised you that it’s been a little slower than in years past just in the Pacific.

[Melanie Dressel:]

It has.

[Jacquie Chimera:]

Flat.

[Melanie Dressel:]

Yeah. Yeah. And my guess is that it still related to price, just getting both sides, feeling good that -- about the pricing on it.

[Jacquie Chimera:]

Do you think better earnings are impacting some of these discussions or some of the collar banks just doing better and so it’s raising their valuation desires?

[Melanie Dressel:]

It could be. And it certainly make sense that that would be the case. And there probably some that are thinking that they’re going to see bump in the rising interest rate environment whenever that occurs and some wanting to hold off and see what happens there.

[Jacquie Chimera:]

Okay. Thank you for the color. Appreciate it.

[Melanie Dressel:]

Thanks, Jackie.

[Operator:]

[Operator Instructions] Your last question comes from the line of Aaron Deer with Sandler O'Neill.

[Melanie Dressel:]

Hi, Aaron.

[Aaron Deer:]

Good afternoon, everyone. I had a couple of questions, one is, the -- I was looking at the seasonal flows, Clint, that you kind of outlined and in fact you’ve had that kind of dress down in each of the second quarter. I guess notwithstanding those flows that we saw this quarter you guys still have a really spectacular base of non-interest bearing deposits. As we approach the day one rates might go higher, how do you guys think about the impact of higher rates on those particular deposits in terms of the beta or migration trend when rates rise?

[Clint Stein:]

Well, we’ve said -- we’ve been asked that question actually quite a bit recently. And we don’t expect in a normal rate environment that we’re going to be at 96% to 97% core deposits. And so, we do think there will be a bit of a shift and the core deposits would drift back to what we consider are more historical levels of the mid 80s. Where I see that occurring is probably more with money market, accounts and going back into CDs when rates are meaningful, I don’t think that the first couple of movements in rates are going to cost people to jump out and extend into CD, because they’re going to expect rates to continue to go up and they won’t want to jump into soon. One of the things that I look at and as Melanie can jump in, they feel differently or going to add anything to what it is composition of our deposit base. From quarter-to-quarter it bounces between 51 to 49, 51 commercial to 49 consumer to 50-50. And so just by the nature of the relationships that we have and having that higher percentage of business-related deposits, there is less sensitivity to rates than if we had a higher percentage of consumer deposits.

[Melanie Dressel:]

We’ve as always been pretty consistent in the composition of our deposits over a long period of time and we’ve just never been a high CD bank even in the higher interest rate time. And I just can’t think that our deposit customer base has changed that much over the last several years. So I agree with plans that we’re probably looking more for a core deposits in maybe 80% to 85% and that we should be able to just go back to more a normal composition in the overall deposit mix.

[Clint Stein:]

One of the other things just to add to that that we’ll have a new investor slide deck on our website next week. And we’ll have a chart in there that shows our historical lag to rates in the market -- to the market these rates have increased. So I think that underscores what Melanie was saying about the long-term nature of our deposits in the relationships and how we build those based on service revenue and price.

[Aaron Deer:]

That’s better. Keep an eye out for that. And Hadley you mentioned the benefit from unfunded construction commitments coming on the books. Where do unfunded commitments on the construction books stands today and how does that compare to where it was say a year ago?

[Hadley Robbins:]

Well, proportionally, the utilization of the construction commitments that came on in second quarter, I think they’re funded about 24% overall. And so we’ve got a fair amount that will be grind down over the construction periods which range from 24 to 36 months usually. And so the amount of the construction commitments, let’s see if I can get that. It’s 370.

[Clint Stein:]

Yes. Okay.

[Aaron Deer:]

370.

[Hadley Robbins:]

Yes, exactly.

[Aaron Deer:]

All right. Thanks guys.

[Clint Stein:]

You bet.

[Melanie Dressel:]

Thank you, Aaron.

[Operator:]

And there are no further questions.

[Melanie Dressel:]

All right. Well, thank you very much. Everyone enjoy the rest of this summer. And we’ll talk to you after third quarter.

[Operator:]

Thank you. And this does conclude today’s call. You may now disconnect.