Umpqua Holdings Corporation
Q3 2017 Earnings Call Transcript

Published: 19 Oct 2017

[Operator:]

Good day and welcome to the Umpqua Holdings Corporation Third Quarter Earnings Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Mr. Ron Farnsworth, CFO. Please go ahead, sir.

[Ron Farnsworth:]

Alright, thank you, Matt. Good morning and thank you for joining us today on our third quarter 2017 earnings call. With me this morning are Cort O'Haver, the President and CEO of Umpqua Holdings Corporation; Dave Shotwell, our Chief Risk Officer; and Tory Nixon, our Head of Commercial and Wealth. After our prepared remarks, we will then take questions. Yesterday afternoon, we issued an earnings release discussing our third quarter 2017 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both of 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 laws. For a list of factors that may cause actual results to differ materially from expectations, please refer to page two of our earnings conference call presentation as well as the disclosures contained within our SEC filings. I will start the call by turning it over to Dave Shotwell, our Chief Risk Officer, to provide an update on the impact from the Northern California fires.

[Dave Shotwell:]

Good morning, Umpqua Bank has been actively engaged in the wake of the devastating wildfires that have taken place in Northern California over the past week. We have a long deep history in the area and will continue to be a resource for our customers, associates and communities impacted by the tragedy. Most importantly we're extremely grateful that all of our associates are safe. We've been holding daily fire situation meetings since the fire starts began on the evening of Sunday October 8th and we're very proud of the work our associates have done managing through the disaster. In terms of loss exposure, right now we are projecting no material financial impact. In the impacted zip codes, aggregate loan balances totaled just under 200 million which consist of commercial, agricultural, residential and consumer loans. We are aware of a very limited number of service residential properties that were damaged or lost and all were covered by insurance, we're also aware of three small commercial properties that were damaged also covered by insurance. Finally, we can report that none of our wine industry clients suffered losses and most of the vineyards had already completed harvest. In terms of operations we have 14 stores serving these counties, several were closed due to mandatory evacuation orders but as of Wednesday all stores are open and ready to serve our customers as a community resource. I will now turn the call over to Cort O'Haver.

[Cort O'Haver:]

Thanks Dave, I want to eco Dave's comments. This has been a terrible tragedy which has deeply impacted many people on our communities and our hearts go out to them all. We’re committed to helping our customers and communities rebuild today and in the days ahead. Today I'm going to focus a good portion of my comments on Umpqua NexGen. But let me first summarize the past quarter. Ron will talk about the financials in more detail and then we will take your questions. For the third quarter we reported $0.28 per share an increase of $0.02 per share from the $0.26 we earned in the prior quarter. The improvement this quarter was driven primarily by very strong loan and deposit growth which contributed to a 4% increase in net interest income over the prior quarter. Mortgage banking revenues also remained seasonally strong and we did a good job of managing core expenses, which declined slightly from the second quarter level. Two items negatively impacted our current quarter financial results. Number one, a loss from the change in fair value on the MSR asset and two, as we guided you on the last earnings call about final sterling merger related expenses. Our focus remains on creating stronger and more consistent financial performance, as such, we’re evaluating the profitability and risk adjusted returns on all of our business lines as we work towards reducing volatility and maximizing use of capital across the organization. Reflecting the early success of our balance growth initiatives, we had a very strong quarter in both loan and deposit growth. The loan and lease portfolio increased by just over 350 million from the second quarter level, which represents an annualize growth rate of 8%. Total deposits up to increase by close to 400 million or 8% annualized from the prior quarter level. Most of the three quarters of this growth came from commercial banking, with the biggest driver being non-interest-bearing demand accounts. The high single digit growth we’ve experienced so far, this year, has been largely attributable to the strength of the Umpqua branding culture, which has given us the opportunity to add talented bankers and to generate new multi-faceted banking relationships across our core growth markets, which are some of the strongest in the United States. A great example of this is our corporate banking group, which focuses on larger middle market customers. Most half of the commercial loan growth this quarter came from those teams. As we continue to invest in this space, we been able to better utilize our $25 billion balance sheet to drive stronger and more profitability growth. The early success of this initiative has also built brand awareness and name recognition, which has helped greatly in our recruiting efforts. Now let me turn to Umpqua NexGen. We provided a few additional slides in our earnings call presentation, summarizing permanent details about Umpqua NexGen, those can be found on Slides 4, 5 and 6 of the deck. Last quarter we introduced the NexGen initiative, we kicked off to modernize and evolve the bank. At the center of this is a new strategy we’re calling human digital banking; this strategy uses technology to build our Umpqua's customer centric brand and culture to differentiate us in a market place with a new competitive advantage. Through NexGen we'll activate our mission providing personalized banking for all anytime, anywhere. Our goal is to come out an even smarter, more customer centric and more profitability institution. We believe the benefits to our shareholders, customers and associates are significant. A big part of this strategy will include reducing and redeploying expenses across the organization and becoming more efficient in our delivery. But let me be clear on this, Umpqua NexGen is about more than just cost saves. Our focus will be on improving profitability across the organization and utilizing capital in a smarter and more efficient manner. This means investing in business lines was stronger risk adjusted capital returns, and in our high growth markets. We are redeploying capital and resources into new capabilities to deliver on our mission and provide a unique, human digital Umpqua experience that’s distinct in our markets. Our investment in digital and data will make it possible for our customers to bank in more convenient ways and empower our associates to be even more effective, accessible and efficient when serving our customers with financial solutions that meet their needs. Umpqua NexGen includes both operational efficiency initiatives and revenue enhancements, and while this is a three-year initiative, we believe we can achieve positive operating leverage in 2018. On our second quarter earnings call, we disclosed our 2020 return on average tangible common equity target north of 13% or 15%, depending on the rate environment. Ron will talk more about the financial targets and key assumptions in his comments, but let me provide some additional details on how we plan to get there. Starting with operational efficiency initiative, the biggest driver of expense ratings will be optimization of real estate. Today we have 300 stores across the west coast. We believe the opportunity exists to consolidate approximately one third of those stores by the end of 2020. At the same time, we will continue to invest in new ways to deliver retail banking that will increase our market share and sustain the strong deposit in consumer loan growth we have had historically. A few comments on our retail optimization strategy. Source identified for consolidation are considered giving market density and proximity to other Umpqua source, recent and future market growth potential, profitability and community impact. During the third quarter we consolidated six locations, including these six, we have now consolidated 70 stores since 2014. To date we have experienced no deposit attrition with those consolidations, and in fact we have been able to grow deposit balances at the remaining locations. Next round of consolidations begins with 30 locations which we completed during the first quarter of 2018. The remaining consolidations will be evaluated and phased in order to remainder of the three-year horizon based on lease contracts, digital adoption and the rollout of new ways to serve our customers. We estimate around $400,000 in average annual cost savings per store with some upfront cost that Ron will discuss. Approximately 25% to 35% of these savings will be reinvested into digital channels, higher growth markets and more profitable businesses. Now let me share some additional details. Smart profitable growth is the focus of our strategy and the planned investments in digital, data and marketing will accelerate our ability to differentiate in our markets, attract and serve customers and become less dependent on brick and mortar to serve, deliver, and serve the Umpqua experience. Together we believe these actions will provide significant financial benefits over time. The human digital experience we are building will help us grow market share even as we consolidate stores, and allow us to reap the benefits of a better customer experience, deeper relationships, greater fee opportunities and further operational efficiencies. A key part of our overall digital roadmap is leveraging the innovation and technology developed with Pivotus. Earlier this month we expanded our highly successful pilot of Pivotus' digital platform which provides customers with direct access to their own dedicated banker. We're using digital tools to democratize private banking and the scale and reach of our people. Our human digital strategy adds significant convenience and service for customers and affords us the ability to better leverage and scale the business going forward. In addition to the retail optimization there are a few other efficiency initiatives I want to highlight. We will be targeting $4 million in the annual expense savings by 2020 associated with some non-store facilities optimization. This will include reducing overall square footage by 20% which will be the bulk of the savings. We recently completed a reorganization of the commercial banking area focusing on standard control and relationships for bankers. That effort will drive 3 million in annual expense savings which will be realized in 2018. We are winding down our indirect auto business given its transactional nature and the well return on capital. The process begins in the current quarter and the runoff will take place over the next three years. This will free up approximately $40 million in capital, which will be redeployed at a higher return investment. In addition, we're evaluating several consultants to assist management in and identifying additional operational efficiency opportunities within the organization. This will focus on reducing non-interest expense in our back office and operations areas, which currently totals around $300 million per year. It is important to note that these savings associated with this initiative have not been included in the Umpqua Next Gen financial goals. Turning to revenue enhancements, we are targeting $30 million to $40 million in incremental annual core non-interest income by 2020. This initiative is directly tied to our success in entering the corporate banking space as we are able to generate more profitable banking relationships and create valuable reoccurring fee revenue to help mitigate some of the volatility in overall non-interest income. These revenues will come from a number of commercial and small business making products, including commercial cards, treasury services, trade and foreign exchange, brokers' revenue, merchant services and income from our capital markets teams. To help achieve this we have realigned incentive plans moving away from loan centric plans towards payout based on balanced growth in loans, deposits and fee revenue. We have also improved the speed of delivery to market on a number of the fee based services we offer. Given the lag, given the lag in timing associated with these types of fee based initiatives, I expect a nominal increase in fee revenue in 2018 with a larger ramp up occurring in 2019 and 2020. I will now hand the call over to Ron to discuss the financial impact of Umpqua Next Gen, and then go over the quarterly financials in more detail.

[Ron Farnsworth:]

Okay, thank you Cort. And for those on the call who want to follow on I'll be referring to certain page numbers from our earnings presentation. On page five, we lay out the 2020 financial goals we are driving to with Umpqua NexGen and the main financial assumptions to achieve the return on tangible common equity goals. Note we are framing the goals separately between a flat rate scenario and a moderately increasing rate scenario with those rate pasts noted in last two bullet points at the bottom of the page. Given that we are representing our 2020 financial goals, it is important to note the following. One, we're assuming no recessionary or lower rate environment here. If those were to occur over the next three years it is reasonable to expect that our financial results will differ. Two, the financial goals exclude fair value adjustments and exit disposal costs. I'll note later in the call that we are done with merger expense on a certain deal coming out at Q3. But suffice it to say these goals excludes future M&A as our focus is on exiting this strategy not on additional M&A. Three, these 2020 financial goals reflect declining credit discount accretion and no additional gain on portfolio loan sales, just recurring MBA activity. Additionally, we’re forecasting slight declines in overall conventional mortgage activity consistent with recent MBA forecast and reflecting housing price appreciation in the mini markets above conforming loan limits. Four, the NIM forecast incorporates deposit betas closer to historical norms. Moving that today, here in 2017 our deposit betas have been lower than expected. Five, our quarterly earnings release notes the GAAP return on tangible equity at 11% for the third quarter and 10% year to date. Excluding the fair value adjustments along with merger and exit disposal cost, our return on tangible equity is 13.3% for the third quarter and 11.9% year to date. On this internal measure, our efficiency ratio is 58.5% for the quarter and 61.6% year to date. Given we are forecasting no gain on portfolio loan sales and declining credit discount accretion, our comparable adjusted internal return on tangible equity measure is now 11% year to date and the efficiency ratio is 62%. This will help frame the starting point for the ramp we expect from today to achieving these financial goals for 2020. Notably achieving 13% or higher return on tangible equity in the flat rate scenario and exceeding 15% in the moderately increasing rate scenario. We expect the ramp to be more weighted towards 2019 and 2020 primarily given the repricing nature of the balance sheet and that will take some time, some of the revenues to time to mature. Six, the positive financial impact to our margin of a moderately increasing rate scenario over the coming three years is the main driver of the improved returns versus the flat rate scenario. Seven, with the exception of the additional operating expense opportunities that we are evaluating the consultant for, expense and revenue initiatives that Cort discuss earlier are presented on Page 6 and are incorporated in both scenarios. Eight, and finally, we assume no change in federal or state income tax rate. I have four final points, before we go over Q3 results. First, I want to reiterate that we are internally allocating capital and measuring profitability at the business unit level. That will continue over the coming quarters at the product and customer level. Second, we discuss these goals as excluding fair value adjustments and we are exporting strategies to reduce volatility to future earnings. More to come on this on future quarterly calls. Third, our excess capital is projected to decline over the coming three years to run half of current levels, prior to rebounding slightly in 2020 when [season] comes into place. Share repurchase is still expected to cover net share issuance with the generally flat common share count and dividends to shareholders are included in the 50% to 70% range of earnings. And finally given that we are laying out our three-year financial goals and major assumptions, we expect to focus quarterly calls on historical results and progress towards the 2020 goals. And with that let me spend a few minutes reviewing third quarter results. Turning to Page 8, of the slide presentation which contains our summary P&L. Third quarter earnings were $61 million or $0.28 per share, up from $57 million or $0.26 per share in the second quarter, and flat with the same period a year ago. At a high level the $0.02 increase from Q2 to Q3 resulted from $0.02 of continued improvement in net interest income and a $0.01 from higher gain on portfolio loan sales, offsetting the previously guided to $0.02 increase and merger expense this quarter. At the bottom of the first page of the earnings release we lay out the impact by quarter of our internal non-GAAP adjustments and total lease were a cost of $0.05 this quarter compared to a net cost of $0.04 last quarter and $0.03 back in Q1. EPS excluding these items will be $0.33 for Q3 up from $0.29 in Q2 and $0.24 in Q1. As per this group of items merger expense is now over as we guided to you last quarter. We will have continued exit disposal cost around future store consolidation and facility access as discussed earlier. The MSR and [fee gain] fair value adjustments generally move up and down with interest rates and as we discussed before we are exploring strategies to reduce this volatility. Turning to the net interest income and margin on Slide 9, and noted on Page 6, of the earnings release, net interest income increased by $8 million or 4% from Q2, this reflects the benefit of continued strong loan growth over the past few quarters and a small uptick in credit discount accretion this quarter from the increase in paid in full discounted loans. Also with a net interest income, our interest income on investments was down slightly as we use maturing cash to fund continued strong loan growth. And our interest expense on deposits increased $1.5 million or 3 basis points based in part on the growth this quarter and modest repricing based on the recent fed funds rate increase. Our deposit beta based on the fed rate increases over the past year has been in the 15% to 20% range driven primarily by higher cost public funds and broker deposits. For the third quarter, our net interest margin was up 3 basis points while the margin x credit discount was flat at 3.78%, slightly above our prior guidance range, given deposit betas are still relatively low. On Slide 10, the provision for loan and lease losses was $12 million, up from Q2 based primarily on continued strong loan growth. As shown later in the deck on Page 16, net charge offs were down at 20 basis points annualized, and our MPA ratio increased slightly to 30 basis points of assets based on two relationships. Overall credit quality remains very strong. Moving now to noninterest income on Slide 11. The increase in total non-interest income from Q2 to Q3 was driven primarily by higher gain on portfolio loan sales. On the home lending front as shown on Slide 12, and also in more detail on the last stage of our earnings release, for sale mortgage originations declined 3%, slightly under expectations for what is traditionally a seasonally stronger third quarter. Primarily given continued market wide housing price depreciation above conforming loan limits. Our gain on sale margin increased to 3.68% this quarter. Absent a decline in rates, we expect a normal seasonal decline in mortgage originations and gain on sale margins during the fourth quarter. Turning to slide 13. Non-interest expense was $188 million. The bridge we provide on the right-side details the major moving parts, they were in line with our expectations and prior guidance and included declines in operating expense of $1.5 million offset by the expected $5 million increase in merger expense, as we complete the cleanup work on a prior system conversion, a $900,000 of higher exit disposable cost. Exit disposable costs, for Q3, include the six stores just consolidated, along with 10 other non-store properties, combined the issue provide approximately $4 million of savings heading into 2018. Turning now to the balance sheet, beginning on slide 14. Our tangible book value per share is $9.83, which when you also account for the dividends to shareholders, of that 10% year-over-year and increased 12% annualize this past quarter. Lastly on slide 17, I want to highlight capital, knowing that all of our regulatory ratios remain in excess of well capitalized levels with our Tier 1 common at 11.1% and total risk based capital at 14.1%. We just increased our quarterly dividend from $0.16 to $0.18, and our total payout ratio was 65% this quarter. Our excess capital of approximately $260 million and as discussed earlier, we expect this to decline moderately over the coming three years. To conclude, our focus is on executing our Umpqua NexGen strategy, improving financial results, and generating solid returns for shareholders overtime, including a healthy dividend. And with that we will now take your questions.

[Operator:]

[Operator Instructions] We’ll now hear from Michael Young, with SunTrust.

[Michael Young:]

Wanted to obviously start with the NexGen cost saves expectation. If I can’t take everything that you have laid out thus far ignoring the potential back office cost saves, and assume sort of a normal level of just expense inflation, it seems like we are kind of more flat on expenses for three years, is that the right characterization at least for now, until we get more clarity on the back-office piece?

[Cort O'Haver:]

I pointed out, that also -- that be fair that of also though incorporate reinvestment of portion of the store saves.

[Michael Young:]

Right, okay. And then secondly, I guess moving to that back-office piece, I guess too early to tell now, but any sort of order of magnitude expectation of what that could be or a timing when you would have more clarity on that piece?

[Cort O'Haver:]

I really don’t have any more guidance to provide on that, other than here is the [indiscernible] and this is something we definitely want to look at as part of the initiative. I’d expect given the ramp up required in connection with a review like this, you will definitely hear us talk more about this most likely in the spring and summer next year. But we are targeting items to positively impact second half of 2018 and then to obviously '19 and ;20 our full run rate.

[Michael Young:]

And just lastly maybe on just one-time cost associated with exiting all of these locations and/or any other sort of restructuring cost you name re-incur, do you have any sort of magnitude of that?

[Cort O'Haver:]

yes, in terms of the exit disposal cost, we noted that on Page 5 of the presentation, at this point we are estimating in the range of 8 million to 12 million a year over the next three years annually over the next three years, we will provide more updates as we get them over time but that’s a fair assumption at this point.

[Michael Young:]

But that will include other cost for, personnel or employees etcetera, not just the physical branch locations.

[Cort O'Haver:]

That includes the exit full cost around locations, there will be severance over the same period, obviously the 2020 goals we're referencing here are straight up for 2020, not at the end of the 2020, but I will provide more updates on that but there will be additional for severance over the end of period, if there were some.

[Operator:]

We will now go to Jared Shaw with Wells Fargo Securities.

[Jared Shaw:]

Just following up on that, as you look at the total cost of NexGen over that time period and you're saying, you're going to roughly reinvest 25% of the cost savings. Should we assume that those -- that the expenses or the investments are being made more front loaded in that timeframe, and that over the life of it will be offset by 25% or will you be layering those in as you realize those cost savings.

[Cort O'Haver:]

They would be front loaded, so you will see that surge in 2018, which would be on the front end of the obviously the full benefit of the physical reduction but then we will see the leverage of that in 2020 and beyond.

[Jared Shaw:]

Okay thanks and then as you look at other business lines or focused on more profitability business lines, what are your thoughts on the longer terms strategy of staying with the mortgage business?

[Cort O'Haver:]

It is the core, you know we're looking at that, I think in addition to that what we’ve done with other fee initiatives is kind balance out the lumpiness, to be have two approaches, right we're creating other fee opportunities inside the company with what we been able to deliver over the past four, five quarters and then looking at mortgage on a long-term basis including a cyclicality and its impact to the lumpiness on revenue. And we're all looking at it.

[Jared Shaw:]

And then just finally for me as you look at the commercial loan growth that you saw, can you give us a view, I guess how big are those corporate banking loans and what's the potential as you continue to add larger loans, should we continue to see that accelerated pace of growth staying with us for a little while.

[Tory Nixon:]

Hi Jared this is Tory Nixon, the act that typically the average deal size is somewhere in the $15 million to $25 million range and we’ve now kind of deployed a corporate banking group in each of our major metropolitan markets, so from Seattle to Portland, San Francisco, Sacramento, Los Angeles, Vegas and San Diego with the kind of the last leadership addition on Monday in Orange County. So, we now have a core team in the corporate banking space throughout the franchise. So, I would see that we will continue to build upon the leadership and continue to grow the business throughout the foot print and not just on the lending side but including deposits in core fee income.

[Operator:]

We will now move to Steven Alexopoulos with JPMorgan.

[Steven Alexopoulos:]

I want to start on the NexGen assumptions on Slide 5, looking at the net interest margin assumptions under the two scenarios, would it be correct for us to assume that, that’s reported NIM and not the adjusted margin?

[Cort O'Haver:]

That’s correct, so that is the 2020 goal for fiscal 2020 again by each com by rate scenario. And it's also safe to assume that if rate centered at somewhere between the two columns that the margin will also be seen between those two ranges. [Multiple speakers]. We will have the credit discount accretion obviously toward 2020 it's not there.

[Steven Alexopoulos:]

So, the margin has been relatively steady or the reported margin, as we look at three years basically what you are telling us you need a very significant increase in rates to hold that margin flat. Otherwise will just keep heading down every quarter, and it’s a credit accretion.

[Cort O'Haver:]

Yes, I mean that’s just math of the credit discount accretion. That will continue to decline. And the overall margin credit we have been a little bit above it, above this range here just because the betas haven’t kicked in so basic course assume betas kick in more in line with historical norms. If that were to continue the recent trends and not kick in then as you would expect from outside of these [indiscernible].

[Steven Alexopoulos:]

And then on the cost saves, it’s a bit confusing to me with all those talk about reinvesting some of the cost saves of what you will actually see in terms of a net cost save benefit in 2018, 2019. Can you just quantify what you are expecting in each of those years?

[Cort O'Haver:]

On the store side we talked about 30 stores being consolidated in 2018 and this is of course absent the exit disposal cost. I would expect when you look at the impact of that, we will take a third over three years, we can dollarize that at approximately $40 million. What we are trying to get out there is that we see a quarter to a third of that being reinvested in the digital initiatives in 2018, granted that will front load though a portion of the phase because there will be phased in over the three years. I hope that helps.

[Steven Alexopoulos:]

So, you only plan to close 30 stores in all of 2018 and it will be in the first quarter there is no other branch that’s being consolidated?

[Cort O'Haver:]

So, what we are going to do and we have announced the closure of 30, those will start in early January and complete, hopefully by the end of the quarter most certainly not any later than first couple of weeks in April. And then based upon on our deposit growth, net those with the 270 we will have left, we'll evaluate. The remainder of the stores that we have looked at consolidating, we will make a decision in '18 based on what we see with the residual stores and our ability to generate deposit growth to fund our loan growth. And if we can pull some of the '18 we will, otherwise we have got it scheduled out through the balance of the 2020 plan. So, I guess what I'm saying is based on how we perform with the remaining stores but all the initiatives we have got we will look at that probably midyear or maybe by third quarter and if we can move some up we will if not, we feel like we need to prolong and we will stick to the original plan that we got to continue with the balance of the closure by 2020.

[Steven Alexopoulos:]

And then on the fee revenue targets. I noticed that you are changing the incentive structure there. Are you making any other changes to drive these improvements in fee revenue? What else are you doing there?

[Tory Nixon:]

Steven this is Tory Nixon again. So, we have I think very little need of investment for process or product, it's really more about behavior and the emphasis and focus accountability coupled with the alignment of compensation certainly. There is a lot of opportunity within our existing customer base, but as we continue to go up market and corporate banking and you see the deposit generation and the C&I growth that comes with this continued fee opportunities, so there is a real opportunity for us as we continue to be in the mid-market space.

[Steven Alexopoulos:]

Maybe just one final one, what are your thoughts upon exiting the indirect auto business more likely to that conclusion.

[Cort O'Haver:]

It just doesn’t carry the returns on capital we can get, and with all that Tory is doing in other parts of the bank, its transactional in nature, they have done a great job, they have done exactly we have ask them to do, but we can find higher returns and other more core business opportunities that provide not only loan opportunities but deposit in fees, so it was a decision we made and we will be winding it down in this quarter and it will take couple of years for those loans roll off the books, but that was a decision.

[Operator:]

We’ll now move to Jeff Rulis of D. A. Davidson.

[Jeff Rulis:]

Thanks, good morning. Ron a question on maybe more of a near term margin, appreciate the guidance out to 2020. But with the I guess the stickiness of deposit betas and kind of exceeding core on your guidance, how do you look at in kind of the short term to medium term on margin outlook for 6 to 12 months out?

[Ron Farnsworth:]

Sure, so I guess first on the total margin, we were up three bps, just given the increase in -- the $2 million increase in credit discount accretion this quarter. I expect that will reverse and head back the other way here short term Q4, Q1. Over the back in Q2 I think it was around $6 million of credit discount accretion, this quarter it was $8 million, so it will be somewhere ballpark in that 4.5 to 6 range Q4 and then declining quarterly on a [probably ratable] basis, over the following two years. In terms of the margin ex the credit discount, you are right, we don’t see the betas kicking in, I think that’s industry wide phenomena, so best guess at this point, the best estimate at this point would be just in range with where we have been in the last two quarters ex-credit discount. I mean you also saw some other moving parts this quarter in terms of bond yields, they were off with 10-12 bps Q2 and Q3 that tends to bounce around, ideally, we will see a little slower prepay in Q4 maybe that will pick back up but all in it should be in the range of the last two quarters near term.

[Jeff Rulis:]

Okay, got you, thanks. And then maybe any detail on the maybe it's for Dave, the two properties put on non-accrual, any detail that you could offer and if thoughts on any more systemic deterioration there?

[Dave Shotwell:]

Sure, yeah Dave Shotwell here. It's not systemic. Again, this is two loans out of a very large portfolio, one loan is a shared national credit and one is a residential land loan, both of which are being actively worked out and we expect that we will these down and out of bank in the next couple of quarters and we don’t anticipate any impairments on these loans.

[Jeff Rulis:]

Okay, maybe one last one, just on the branch closures, any detail on the balance of this where it is perhaps regionally and then if you have a thought on the mix of owned versus leased properties here?

[Cort O'Haver:]

Hey Jeff, Cort, so I mean, it's about 50-50 owned and lease relative to locations, I’ll tell you that more than half are in our urban, more dense markets, so we view those as through consolidations and like I mentioned in my comments, we’ve not seen any positive attrition at all in consolidation markets where we have stores close by so, we view that, it's just an opportunity to consolidate safe share and discontinue to grow with digital and mobile. We do have some that will be consolidations in more urban markets and the distance between those stores is greater than what you would call on urban markets and we have plans to work with both communities and our customers to make sure that we're serving those communities well as we consolidate into other urban markets. So, it's about 50-50 there and about 50-50 owned and leased.

[Jeff Rulis:]

Thanks, and I guess just, the conduit to unload that amount of branches, have you reached out you got a buyer for that, is that a case by case any preliminary thought.

[Ron Farnsworth:]

I just want to reiterate Jeff, we're not talking about selling off the branches inclusive of the deposits, so a lot of these are timed in connection with leased exits, with the leased facilities in terms of the owned facilities, we’re constantly doing that as you saw, you're right, mentioned earlier that they are roughly 10 months to our properties, that we had, that we exited this past quarter, again they are about half of those around. So, we’re constantly in that market and we got targets for where those are going to go.

[Operator:]

We will now move to Jacque Bohlen with KBW.

[Jacque Bohlen:]

I wonder if you could just touch on the organizational and cultural impact of everything that you have announced and kind of the preliminary feedback you may have gotten from some of the staff that you have.

[Cort O'Haver:]

It’s a great question Jacque of course so we spend the better part of probably the last four, five months developing NexGen that's why we mentioned it to you all a quarter ago. We have spent a considerable amount of time out in the field talking about this, both physically and then through the use of video and all the things that we do internally in the organization. I think we view this also as an opportunity to better meet the needs of our customers, our customers preference on how they buy and consume financial products and services has certainly changed, you all know that. They have migrated to more mobile digital, I don’t think it's anything you don’t know that we were found at around a very physical delivery, which has been revolutionizing the way people bank for many, many years it's time to do that again. So I will tell you through a lot of hard work of the executives that providing this transformational vision of where our customers are wanting us to go and being out with our associates saying we're going to transform this company again, we're going to go from physical to more mobile digital and come along for the journey has really rallied the troops from my perspective and it's been very, very well received, it doesn’t come without some like we talked about some tough decisions we're going to have to make but this company has always shown a desire propensity to take on tough challenges and I couldn't be more pleased with all of the associates at this company that they have embraced that.

[Jacque Bohlen:]

So, might you see a realignment or shuffling of some job duties as certain positions become eliminated, perhaps they move into some of the expansion opportunities you mentioned?

[Cort O'Haver:]

Yes, we do an exceptional job communicating tough decisions and providing opportunities to associates. This technology that we’ve developed or Pivotus has developed with us provides a very unique opportunity for associates to really up their game, to provide a more advisory type level of service then we've done before. So, there is really kind of cool things that we're doing with how we're repositioning the company that provides associates a lot of opportunities. So, there is no question, there will be some jobs eliminated. I'm not going to lie to anybody. There will be some things eliminated but we have shown just through the ways we have operated this company for 25 years. We generally find opportunities for people if they exist and there is a great opportunity for a lot of associates and lot of managers to just completely retool again.

[Jacque Bohlen:]

And switching gears over to the quarter just two quick questions. The sale income in the quarter, does that come primarily -- I know that the balances were smaller but most of the income generated from the sales of the leases.

[Ron Farnsworth:]

It's actually the majority of that was on the residential side, there was small piece from the leases, and so they were discounted transactional acquired loans, driven majority of that. There is probably 0.5, 0.55 of the par just in terms of sale gain the balance would have been discounted.

[Jacque Bohlen:]

And is there any particular reason why none of these additional sales, given that -- they have been ongoing now for the recent quarters why they weren’t included in the NexGen calculations? Is it just to remain conservative or should we infer that sales are going to be more muted going forward?

[Cort O'Haver:]

I want to infer that sales will be muted going forward. We will still be opportunistic where conditions warrant but as we look at building out these three-year goals and plans, the goal here is sustainable earnings and reduced volatility. And when to look at portfolio sales from time the time is only adding to that.

[Jacque Bohlen:]

And then also just if you had the dollar value of the indirect auto portfolio.

[Cort O'Haver:]

About $400 million in outstanding, and the 40 million in capital of course is based off the roughly 10% of this base capital allocation.

[Operator:]

We will hear from Matthew Clark with Piper Jaffray.

[Matthew Clark:]

Curious on your commentary around the expense run rate, you talked about assuming a flattish run rate over the next few years as being reasonable, does that consider the volatility of the mortgage business just obviously as it ebbs and flows and the variable piece of that expense base or not?

[Cort O'Haver:]

It does, and again I made the comment in terms of we do expect slight reductions in overall mortgage volume just given where conforming loans are compared to housing price depreciation. So that is incorporated. But again, as we talk about the savings from the reduction of the physical, the reinvestment being almost front loaded in on the digital side I think when you look, basically run rate today to three years out I think it's safe to say it's going to be in the range of generally flattish versus the annual inflationary merit increase plus digital not offsetting the other pay. So along with a way of saying when we look at the efficiency ratio improvements, driving this high return on tangible equity there is little over half in connection with on the expense side and the balance will be less than half on the revenue side. But I do expect that it will be -- I talked about the ramp on that return on tangible over three years I think in 2018 it will be closer to where we are today on a core basis, just given the investments we are making.

[Matthew Clark:]

And then for the branch consolidation you mentioned half of them are going to be in real markets. Can you talk to what attrition you might be assuming, if at all?

[Cort O'Haver:]

Yes, again we are assuming a moderate attrition, we also assume any connection with the 70 plus stores we have consolidated over the last three years, we have been fortunate to actually grow in those receiving stores. So, while these strategies are going to be around ahead of reduce that attrition and that is of course incorporated into the assumptions where they have on page five in terms of overall targeted deposit growth over the three years.

[Matthew Clark:]

Okay. And then you mentioned the snick non-performer, just curious what the overall snick portfolio size is today?

[Ron Farnsworth:]

Yeah in terms of the snick portfolio [indiscernible] here.

[Matthew Clark:]

Yeah, just the size of the portfolio.

[Ron Farnsworth:]

Yeah, we have outstanding balances of about a $1.50 billion commitment.

[Matthew Clark:]

And outstandings?

[Ron Farnsworth:]

Roughly the 550 to 600 range.

[Matthew Clark:]

Okay. And then just a couple of housekeeping items, curious of the mortgage expense this quarter, I guess the question I ask every quarter, roughly $32 million of mortgage expense, how much of that was variable?

[Cort O'Haver:]

Consistent with past several quarters, discussion on that front, so two-thirds roughly two-thirds will be variable, going up and down with production volume.

[Matthew Clark:]

Yeah, okay. And then share repurchase this quarter, it's any worth pricing how much?

[Cort O'Haver:]

We didn’t have any this past quarter and so it wasn’t disclosed in the release. Generally, its Q1, Q2 is where you see more net share issuance through equity plans, so that’s where you will see the higher level of repurchase, just to hold the share gain flat.

[Matthew Clark:]

Okay. And then of the decline in the MSR this quarter, how much of that was just amortization expense versus actual impairment?

[Cort O'Haver:]

Yeah, the ballpark right around $5 million.

[Operator:]

We’ll now move to [Tyler Stephen] with Stevens.

[Unidentified Analyst:]

Hey nice quarter and thanks for all the details on NexGen. I wanted to start on the fee income side. You talked about 3Q being a base case or a starting point for NexGen and hitting the profitability target. So, should we think about 3Q fee income as a base case and then essentially adding $30 million to $40 million of incremental core of non-interest fee income to that, is that the starting point?

[Cort O'Haver:]

That is.

[Unidentified Analyst:]

Okay, got it and you mentioned capital efficiency a few times around the auto exodus, are there any other lending types that you have on the drawing board from a return on capital standpoint?

[Cort O'Haver:]

I would say there is all sorts of types that we’re reviewing from that standpoint. Nothing we are announcing at this point in time though. I did mention we’re looking at reducing volatility around some of the fair value adjustments. But yeah that’s taken them [indiscernible] but nothing to announce at this point.

[Unidentified Analyst:]

Okay, I am sorry. Back there on the fee income, did I hear in your prepared remarks correctly that you’re assuming basically in terms of the 2020, the fee income piece of this that from a mortgage standpoint you’re just essentially using MBA for the next couple of years, no other change from the mortgage contribution?

[Cort O'Haver:]

That is correct.

[Unidentified Analyst:]

And then just lastly for me, I appreciate.

[Cort O'Haver:]

Tyler real quickly just want to follow up on that, so again I mentioned, we’re seeing pressure on the conventional mix, over the total production volume, just given continued housing price appreciation, so we also incorporate a forecast for that over the three years, just continued pressure on that front.

[Unidentified Analyst:]

Okay alright and then last for me, I appreciate your laying out a little bit about, how the initiatives plans are realigned and I assume that it sounded like at least it was at the line of business level and I'm just wondering, if there were any initiative realignments at the executive level and so what does might me be in order to achieve these targets?

[Cort O'Haver:]

Its core, we're process right now, we're doing all incentive plans and so we're looking at everything [soup to nuts].

[Operator:]

We will now move to Michael Young with SunTrust.

[Michael Young:]

Just wanted to kind of go back to this and zoom out may be the 50,000-foot view, we kind of move forward and you are executing on all the individual items within this plan. If there were to be either kind of worse macro environment or maybe you didn’t get some of the revenue pick up that you had forecasted or expected. Would you take a second look at expenses to try to get to sort of the high-level numbers that you originally laid out?

[Ron Farnsworth:]

This is Ron, of course that will depend on scenario and situation what's going on in overall economy but like I said, we should say yes and we will be reporting on progress towards these goals on a quarter basis. We will talk about this quarterly going out.

[Operator:]

We will now move to David Chiaverini with Wedbush Securities.

[David Chiaverini:]

Question on provisioning, we have a few more years, before [seasol] kicks in, the [sensitive] overlaps with the tail end of your forecast the time horizon of them going NexGen. Could you talk about what impact [seasol] could have on you provisioning levels and the reserve to loan ratio?

[Ron Farnsworth:]

This is Ron, I think overall for the industry role, assuming an increase in overall levels of reserves, I did reference on the discussion on excess capital earlier, I expect the excess capital to decline over the coming three years but then, take up slightly in connection with [seasol] and that’s of course just in connection with how we measure excess capital or just based on our lowest amount of excess across the four regulatory ratios bank comparing, have to bank level total risk based capital. Today we're little over 13% and our house floor is 12% that delta is 260 million. So, you would see conceptually a slight increase from period to period, there years out in connection with [seasol] on that front. Still too early to say though where we see the overall increase in reserves but it's got great estimates, we plan on parallel run around in 2019, they are not adopting till 2020 on that front. So, we will provide more intel on that as we get out closer to that but I made a modest slightly conservative assumption on these 2020 goals around next capital for [seasol] beginning in 2020.

[David Chiaverini:]

Great thanks and then shifting question on the human plus digital banking strategy, is this the unveiling of what Pivotus has been working on or is that a separate endeavor?

[Cort O'Haver:]

So yes, I mean, certainly what Pivotus is doing is key and instrumental to our human digital concept which is really using digital to enhance our associates relationships with our customers, is a little different than what some banks are doing. Some banks are using technology as a way to interface only with customers and reusing technology to enhance our associates relationship with their customers, a little difference there. So yes, it is basically coming a kind of coming to market with all about hard work that Pivotus has been putting in over the last couple of years.

[David Chiaverini:]

Can you maybe just give an example of how that would differ from the typical digital banking strategy at other banks?

[Cort O'Haver:]

Yes, so we are talking about is having a technology experience with a customer that links a customer directly with a bank associate. So, it's not an application for sake of an application where you would log in and whether its AI or machine learning whatever it is, there is non-human behind the scenes. I'm not saying some of that we won't use but what we are talking about is having an application where you have a connection and I mean any customer of the bank, I don’t care if you have $10 in a DDA or $10 million in the money market you have access to a human being through a digital application at all times. And the building of that solid core relationship which is really a foundation of this company 25 years ago and using any mobile digital sense is really where we are taking this company.

[Operator:]

You will now hear from Aaron Deer with Sandler O'Neill & Partners.

[Aaron Deer:]

Just a few quick questions. One is with respect to the efforts reduced MSR volatility there. Would that include the potential of selling that book or are you just talking about hedging or something along those lines?

[Cort O'Haver:]

We are going to look at all options.

[Aaron Deer:]

And then you mentioned a reduction in gains on portfolio loan sales, except for perhaps SBA what if -- if it's just the SBA loans have been sold at this point what's kind of a run rate that we should think about for what you typically do?

[Cort O'Haver:]

That’s been in anywhere from the 0.5 million, 1.5 million range on a quarterly basis here for the past year.

[Aaron Deer:]

And then lastly just on those -- as snick balances provided earlier and the commitments and outstanding fee. Does that include just loans where you have participated in another bank as the lead or would that also include loans where you guys were the lead but just happened to participate out some and I guess caught up in the snick characterization.

[Tory Nixon:]

Aaron this is Tory Nixon. Most of those are purchased as syndication, so we are not the lead, we are participant in the facility. We have several -- few where we actually lead smaller syndications but part of the design here with building out the corporate banking space is to have the expertise and the ability to participate in the lead left strategy and as we move up market to be able to lead larger syndications in the 150 to 300, 350 range.

[Operator:]

We will go to Matthew Clark with Piper Jaffray.

[Matthew Clark:]

Just on the loan growth guidance I think your mid to high single digit is the guide I think previously I think we have kind of assumed high single digit. Obviously, you got the indirect auto portfolio running off over the next few years. But can you just talk to what else we should think about in terms of what your underlying assumptions are for that guidance?

[Cort O'Haver:]

I think in connection with that too, again I talked earlier about the change in the mortgage market and the portfolio for a jumbo product just given appreciation has been a bigger piece, I’d expect that to slowdown going on balance sheet as well, over the coming three years, so that’s probably a bigger moving part.

[Operator:]

It seems there is no further questions in the queue, I’ll turn it back over to our host for additional or closing remarks.

[Cort O'Haver:]

Okay, alright well, thank you all for your interest in Umpqua Holdings and your attendance today. This will conclude the call. Good bye.

[Operator:]

This does conclude today’s conference call. Thank you all for your participation.