Umpqua Holdings Corporation
Q4 2014 Earnings Call Transcript

Published: 30 Jan 2015

[Operator:]

Good day, and welcome to the Umpqua Holdings Corporation yearend 2014 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Ron Farnsworth, Chief Financial Officer. Please go ahead, sir.

[Ronald Farnsworth:]

Thank you, Shanell. Good morning and thank you for joining us today on our yearend 2014 earnings call. With me this morning are Ray Davis, the President and CEO of Umpqua Holdings Corporation; Cort O'Haver, our President of Commercial Banking; Greg Seibly, our President of Consumer Banking; and Mark Wardlow, our Chief Credit Officer. Cort, Greg and Mark will join us, as we take your question after our prepared remarks. Yesterday afternoon we issued an earnings release discussing our full year 2014 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, under the Ask Us, 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 Law. For a list of factors that may cause actual results to differ materially from expectations. Please refer to Page 2 of our earnings call conference call presentation, as well as the disclosures contained within our SEC filing. I will now turn the call over to Ray Davis.

[Raymond Davis:]

Thanks, Ron. Welcome everybody. Ron and I this morning are going to focus our comments on three major areas. Providing details on the key drivers of our financial performance, updating you on our integration and cost synergy realization and timing, and discussing other initiatives to capitalize on the momentum we've build this year. After our remarks, of course, then we'll take your questions. As you know, 2014 was a very busy year for Umpqua and a highly successful one. We had many achievements and accomplished a great detail during the year. Those accomplishments range from delivering improved financial results to closing on a transformational acquisition, which doubled the size of the organization and positioned us for growth in our expanded footprint, to building out our product set and making technology investments to continue to enhance our customer experience. Looking first at our financial performance. For 2014, we generated full year operating earnings of $1.08 per share. This is up 15% from the $0.94 in 2013. Tangible book value per share increased by $0.31 or 4% from the prior year, ending 2014 at $8.80 per share. Our efficiency ratio, return on assets and return on average tangible common equity all improved on an operating basis for 2014. In the first nine months of the deal, we generated strong continued organic growth as well, with net loans and deposits growing by 4% and 6%, respectively. That's from the prior year. Gross loan growth before loan sales and unscheduled early payoffs was over $1 billion or 7%. Credit quality continued to improve with non-performing assets and total assets declining from 0.51% at December 2013 to 0.43% at the end of the year 2014. Capital and liquidity also remain strong and have improved following the acquisition. But of all our successes in 2014, the most important was closing on the transformational acquisition of Sterling Financial. It was the largest transaction in our company's history and made us the largest community bank in the West Coast. I am pleased to report that we have made significant progress integrating the two companies, and remain on track with all integration activities. Ron will discuss the financial impact of the synergies during his comments. As I said before, we measure the success of our acquisitions by whether they make us a stronger bank. I can confidently say that we are a much stronger bank today than we were a year ago. We are banking more customers, in a bigger footprint, with improved technology, products and services, all while continuing to provide the same local engagement and innovative customer experience Umpqua is known for. Going into this acquisition, we expected to see noise in our quarterly financial results, until integration was complete in 2015. This past quarter was no exception. We continued to invest in key areas of the company to make sure the conversions scheduled for the first quarter are completed successfully and on time. And I am pleased to report that we are ready, and that we expect our investments last quarter to payoff this year as well as over the long-term. For the fourth quarter, we reported operating earnings of $59.4 million or $0.27 per share. This is down compared to the $0.30 per share in the prior quarter, but higher than the $0.25 we earned in the same quarter a year ago. Again, Ron, will go through these results in detail, but our current quarter financial results were impacted by four key items. First, the provision for loan losses was lower, due to a higher level of loan payoffs and an improvement in the overall quality of our loan and lease portfolio. Second, we saw lower non-interest income. This was driven in part by a lower level of mortgage loan sales, as we chose to keep more of our originations on the balance sheet. We also experienced lower gain on sale margins and a larger loss on the fair value of the MSR, given the movement in rates. Third, we chose to sell less portfolio loans this quarter, which contributed to a decrease in other income. And finally, fourth, core non-interest expense was higher, driven primarily by an increase in net loss on REO and higher marketing expense to support the new brand and our growth initiatives. Turning to the balance sheet. Core deposit growth was again strong this quarter. We continue to believe that in a rising rate environment, one of these days, banks that compete with more than just price will benefit greatly. We have been successful with this strategy for more than 20 years and expect that to continue through any interest rate cycle going forward. Our loan production continued at a strong pace this quarter with commercial production over $600 million and consumer production, including home lending, of over $1 billion. Within this total number, we continue to realize strong loan growth in many of our smaller segments as well, primarily retail, small business, private banking, wealth management and dealer banking. During the fourth quarter, our commercial loan growth was partially offset by a significant outflow in loan balances of approximately $200 million above and beyond normal amortization. These outflows were driven by two primary factors

[Ronald Farnsworth:]

Thanks, Ray. Before I go through the financial results, let me start with the integration and cost synergy update. As Ray mentioned, the conversion and integration timeline remains on track with the core system conversion scheduled for later here in Q1. For past nine months, since the deal closed, we have been focused one thing, getting us up for a successful conversion and wrap up of integration. There is still work to do, but over the past quarter we've accomplished a lot, including the consolidation of 27 stores throughout the footprint, with no noticeable deposit run-off, and in many cases the newly combined stores continue to grow. We recently launched our new online and mobile banking platform, which is managed by our in-house technology and product teams. This is a major accomplishment with several enhancements over our previous core system vendor-based app, and it gives us control of the platform and the ability to drive future development that continually improves our customers' digital experience and supports future organic growth. We have completed several mock system conversions along with readiness reviews without significant issue. This is big, as we're upgrading not only the core bank processing system, but also upgrading to a new in-house mortgage loan servicing system; significantly upgrading our commercial loan processing and origination systems; and upgrading the classic Umpqua commercial online banking system, all incorporated through our enterprise services framework. And all of the training, additional equipment and temporary staffing is in place to support the conversions. After the conversions are complete, we will have some additional clean up on integration activities that will stretch into the summer. Needless to say, we are exactly where we had planned to be and we'll soon have upgraded systems in place to support future organic growth, while allowing us to achieve our cost synergy goals for the deal. I know there are a lot of questions about the timing of our targeted cost synergy, let me provide an update. As we guided to in October, we did not see much change in our overall level of synergy realization here in Q4, given how the store consolidations were spread throughout the quarter. To date, we have achieved approximately 45% of the targeted $87 million in annualized savings. Most of the synergies we'll see in Q1 will come from compensation. By the end of Q2, we expect the majority of the balance for synergies to be recognized following system conversions, noting that these will be mostly technology, occupancy and services costs. We are optimistic we will eventually exceed the total target of $87 million. Echoing Ray's comment, 2014 was an outstanding year for Umpqua and 2015 is setting up to be even stronger. Back in September 2013, when we announced the Sterling deal, we projected EPS accretion exceeding 12% following integration, tangible book value per share dilution of 4.6% with a two-and-a-half-year earn-back, a return on average tangible equity of 13% to 15% following the integration and cost synergies of $87 million on an annualized basis. We are on track for each of these. Noting the tangible book value per share dilution was negligible and earned back in the first quarter following the deal, with our overall level of tangible book value per share increasing 3% from $8.54 in Q1 to $8.80 here today. Now, let me turn back to current result. As I go through my detailed quarterly review comments, I will be referring to certain slide from the fourth quarter presentation deck, which we posted on the Investor Relations section of umpquabank.com yesterday afternoon. Also of note this quarter, we have combined our disclosures and the earnings release around non-covered and covered loan, noting the covered loan portfolio was small in relation to the total and the FDIC commercial loss share agreements are set to expire soon. We have provided the detailed split between non-covered and covered totals for higher profile items in the tables to the release. With that, please turn to the income statement on Slide 5 of the presentation. Full year operating earnings of $1.08 per share, was up 15% from the prior year. To summarize operating earnings for the fourth quarter, we saw a decline from $0.30 in operating earnings per share for the third quarter to $0.27 per share here in Q4. As a reminder, operating earnings are defined as earnings available to common shareholders before gains and losses on junior subordinate debentures carried at fair value and merger-related expenses, both net of tax. A few moving parts led to the $0.03 decline in operating earnings per share this past quarter. Our provision for loan loses declined due to the improved quality of the portfolio, helping the quarter by $0.03. Offsetting this was a decline of $0.03 from lower mortgage banking revenues in part due to a lower mix of conventional-for-sale loan production versus portfolio production, and in part due to $3.9 million higher loss on our mortgage servicing right valuation with the continued decline in interest rates. We saw an additional $0.03 decline from lower loan sale gains and other non-interest income and higher operating cost related mostly to additional marketing spend and the loss on a single OREO property. These are mostly temporary items, which will ebb and flow from quarter-to-quarter. Noting $0.02 of the overall decline resulted from the continued drop in the 10-year treasury yield this quarter. Although, operating expenses were up this quarter, we're positioned for a successful conversion and look forward to expense decline, as we progress through 2015. Towards the bottom of Page 5, you'll see that merger related expense net of tax was slightly higher this quarter related to store consolidation. We'll have additional merger related expense in Q1, related mainly to the system conversions with some cleanup carrying into Q2 and Q3 for excess facility consolidation. Turning to Slide 6. Net interest income increased by $2.3 million from the prior quarter level. For the fourth quarter $21.6 million of credit discount accretion was included in interest income, flat with the $21.7 million in the prior quarter, our total net interest margin declined by 6 basis points from the prior quarter. This was driven by an increased average cash position during the quarter. Excluding the credit discount accretion, our pro forma margin was 4.22%, down 3 basis points from the 4.25% for Q3. Given the low interest rate environment, along with continued pressure from higher yielding loan payoffs, we, like all banks, expect this pro forma margin to continue to decline in 2015. On Slide 7, the provision for loan losses declined by $9.1 million from the third quarter level, as we continue to see an improvement in the overall credit quality of our loan and lease portfolio. This decrease was due to upgrades in the quality of the portfolio along with the higher level of loan payoffs during the quarter, freeing up some previous reserves. However, this was not a reserve release, as the provision exceeded net charge-off, and our overall level of allowance continued to increase, ending the year at $116 million. On Slide 8, total non-interest income decreased by $12.1 million as compared to the third quarter level. Of this decrease, approximately $3 million was related to lower gains from portfolio, multifamily and residential loan sales. The amount of portfolio loans we sell will fluctuate on market pricing and balance sheet capacity. The remainder of the decrease in non-interest income was related primarily to lower mortgage banking revenue, which includes gain on sale income, servicing income and changes to the fair value of the MSR asset. This is broken out on Slides 9 and 10. Overall, our home lending group had a great year, generating over $3.1 billion in total production, while we merged the two origination platforms this past summer. While the home lending contribution was lower in Q4, we have never been better positioned to capitalize on the market conditions we find ourselves in today. Typically, Q1 is a seasonally slower quarter for home lending, but not this year, given the recent aggressive decline in long-term interest rates. Our application and LOC pipeline have increased significantly here in January with refinance activity spiking, noting several $50 million days this past week. Assuming interest rates remain fairly static in Q1, we expect Q1 production volumes to exceed that of Q4, along with the gain on sale margin in the mid-to-high 3% range. That will be a nice change from 2.95% gain on sale margin this past quarter, driven in part by a lower LOC pipeline and market pressures. Now, please turn to Slide 11. Total non-interest expense increased by $8.3 million from the prior quarter. Excluding merger expense, our operating expenses increased $6.8 million to $180.7 million in the fourth quarter. Half of this increase was related to a loss in other real estate owned. This was driven by a lower appraisal on a single OREO property. An additional $1.9 million of the increase related to higher marketing expense to support brand and growth campaigns put in place in the fourth quarter. We expect the marketing cost to drop back down to Q3 level here in 2015. Turing to the balance sheet on Slide 12. Note that our interest bearing cash increased this quarter to $1.3 billion or just below 6% of total asset. As we said last quarter, we have been intentionally growing this balance to increase asset sensitivity, heading into a potentially higher interest rate environment. Obviously, the recent rally in bond prices has lead to lower long-term rates with many questioning the ability for interest rates to increase meaningfully in 2015. Regardless, we have let the bond portfolio decline to a floor, and we'll start to reinvest maturing cash flows monthly here in 2015, holding the bond portfolio around $2.4 billion for the near-term. Our cash position and loan to deposit ratio of 91% give us flexibility for loan growth to exceed deposit growth in 2015. Slides 13 and 14 further breakout our loan and deposit portfolios, and show how they've grown over the last several year. For a detailed presentation of the changes in the loan portfolio, please refer to Page 12 of the earnings release we issued yesterday afternoon. We saw good growth in our consumer loan portfolio this quarter, including 25% annualized growth in our mortgage loan portfolio, 24% annualized growth in the consumer loan portfolio and 8% annualized growth in our HELOC portfolio. Our leasing portfolio via FinPac had an incredible year of strong growth with leases and equipment finance loans increasing at a 25% annualized rate for the fourth quarter and up 45% year-over-year. Back to Slide 14 of the presentation, total deposits increased by $164.5 million from the prior quarter, with strong core deposit growth partially offset by the market preferred runoff of CDs. The cost of interest-bearing deposits was 23 basis points for the fourth quarter, about flat over the past few quarters. Please turn to Slide 15. Without going into detail, as you can see, all of our credit quality ratios remain strong for the fourth quarter. Now on Slide 16, our capital ratio has increased slightly based on net retained earnings. Basel III goes into effect March 31 and our capital ratio should be in line with prior guidance, noting we expect approximately $175 million of excess Tier 1 common above our internal floor of 9%. Also this past quarter, we saw the exit of private equity from the shareholder base, noting the slight outstanding share increase at quarter end related to a full exercise of the warrant we picked up in the Sterling acquisition. As we wrap up integration over the coming months, we are now allocating capital internally across business lines with the excess held in admin for reporting purposes. That excess will be used for allocation or return to shareholders. For the capital allocated to business lines, we are targeting the return on tangible equity in excess of 15%, noting several or above that level currently, given our current return on tangible equity of 12.6%. This goes above just looking at overall profitability in EPS terms on a quarterly basis, and will serve as a good framework for capital allocation in the future. We will present this additional information in quarters to come, following the integration. To recap, 2014 turned out to be a hallmark year for Umpqua bank and we are well-positioned heading into 2015. Now, I'll turn the call back to Ray to wrap up our prepared remarks.

[Raymond Davis:]

So obviously, for the near-term we remain focused on completing the system conversion and integration, capturing the remaining cost synergies, continued strong organic loan and deposit growth and improving shareholder return, which means managing current capital and deploying excess capital in a prudent manner. Again, we believe, we are well-positioned to be successful in each of these areas in 2015, and we look forward to discussing our progress over the coming quarters. We'll now take your questions.

[Operator:]

[Operator Instructions] We'll take our first question from Steven Alexopoulos with JPMorgan.

[Steven Alexopoulos:]

Ron, can you help us better understand why the gain on sale margin was down so much in the fourth quarter? And then why you're expecting it to pick up to the mid-3s in 1Q?

[Ronald Farnsworth:]

So when we're talking about the held-for-sale gain margin, it was 2.95% and that was down from what we saw in the third quarter. Part of that is related to a drop in LOC pipeline, as I mentioned a bit ago. So given the way that that's accounted for, we recognized majority of the revenue, when the loan is LOC and the balance when it actually closes. And we saw a decline as you'd expect from the fourth quarter from September to December in the LOC pipeline. That was the majority of it. The other balance of that would be just related to overall market pressures here this quarter. Now, here in January with the continued decline in the 10 year, we've seen, as I mentioned, an incredible spike in our refinance volumes. And that provides more opportunity for pricing. We do fully expect that gain on sale margin for the for-sale piece to begin that mid-to-upper 3% range back here in Q1, similar to what you've seen several quarters over the last year or two.

[Steven Alexopoulos:]

Maybe this is for Ray. If we look at the loan growth slide since you've closed on the Sterling deal, this is Slide 13, it doesn't show a lot of traction. And I know you're saying you've had paydowns, but can you either give us what the gross originations have been or what the paydowns have been just to help us better understand what's going on behind the scenes on the loan side, because we're just not seeing it in the reported numbers.

[Raymond Davis:]

Yes. Overall loan production has been terrific this year approximately $9 billion across the whole footprint in all our different areas of the bank, so overall loan production has been good. Keep in mind, we're integrating two $10-plus billion companies making an incredible number of changes, upgrading systems, integrating policies. And I'm not going to say to you guys that that's not disruptive in some ways, in some ways it clearly as. And then the only surprise that we've had, that'd be for us, is the ones we reported this quarter, which were the companies that actually sold their businesses, which obviously we have no control over whatsoever. Those things are going to occur. The other aspect of it is, and I hope I say this right. Umpqua is in this for long-haul. We're not going to run the bank on our loan growth quarter-over-quarter-over-quarter. I mean we're in it for the long-haul and we're not going to be forced into or feel pressured, I should say, into originating transactions that don't meet either our underwriting standards or pricing requirements. I mean, we're just not going to do it. We're as competitive as the next guy when it comes to rates, where we need to be on good quality, relationships, but we're not going to step down into some of the terms, some of the conditions that we've seen come out of a lot of the other organizations. And quite frankly, it's product of the environment. And I think unfortunately some of our peers perhaps are either, if they are smaller are feeling the pressure and have to do something, and they feel they have to do something, which I think is pretty much selling their soul to the larger institutions where making very skinny deals doesn't really impact or move their needle.

[Steven Alexopoulos:]

Ray, well, you did lose these larger refinancings. Was that over price or structure?

[Raymond Davis:]

I would say that the vast majority of that was over structure without a doubt.

[Steven Alexopoulos:]

And then just finally on capital, you guys pointed out the $175 million of excess. At this valuation point do you prefer stock buybacks or increased dividends? And would you even consider M&A as an option given you are still very early with Sterling?

[Ronald Farnsworth:]

And as I mentioned in my prepared remarks, we are solely focused on integrating the two companies completing the conversions, completing the integration. Also, Basel III; we'll have certainty on Basel III here this spring and you will see us talk quite a bit more about allocation of excess capital once we have certainty on those levels. Right now, we've got pretty good estimates, but you will hear us talk more about that in April and July. And anything is on the table, as you've seen us talk about and actually execute on over the last three to four years, we've done a combination of dividend increase, buybacks and M&A. So you don't want to rule out anyone over the other.

[Operator:]

And we'll go next to Joe Morford with RBC Capital Market.

[JoeMorford:]

I guess, just first on expenses, recognized the higher OREO write-downs this quarter in the marketing spend, but just trying to clarify what's a good run rate that you are at starting into 2015? And then with that, you talked about the mix of the savings coming in the next two quarters, but what about the pace? How should we think about you realizing the balance of that $87 million over the first and the second quarters?

[Raymond Davis:]

Let met answer the question. The best I can by saying this. First of all, we will see, and I think in Ron's comments, he mentioned that we will see some reduction or capturing of synergies obviously in the first quarter. That's predominantly going to come we believe through conversation changes and reductions. I think that the second quarter, these conversions are scheduled at the end of February, so you're going to see the vast majority of this come in the second quarter where it should be running at full speed ahead. There will be some minor cleanup to do in Q3, Q4, but it's going to see overall run rate should be running pretty good here at towards the end of second quarter.

[JoeMorford:]

Ron, anything maybe on the run rate of expenses? Is it just if we back out those kind of outsized items this quarter that's as good a proxy as an air?

[Ronald Farnsworth:]

That's exactly what we said, we would be here for the quarter, expect for the OREO and marketing costs, which we talked about earlier for this quarter, that's right.

[JoeMorford:]

The other question was just on the provision. First, just trying to understand a little bit better the drop this quarter. How much influence did the improvement in credit have versus the loan payoffs? And can you sustain this lower run rate going into 2015 here? We'd like to see it bounce back up a little bit.

[Ronald Farnsworth:]

In terms of the overall provision it is, sad to say, very formula based. We saw an improvement in our credit quality of the portfolio. We saw continued recoveries from that recovery pool we've been talking about for the last couple of years. There's been high level of recoveries on a quarterly basis, so all that goes into the mix, including growth, and I did talk it earlier. Now, with the overall improvement in quality of the portfolio, if that continues, then yes, you'll see it on the lower end. But also with some of those larger payoffs or paydowns late in the quarter did free up a bit of a reserve.

[Operator:]

We'll go next to Jared Shaw with Wells Fargo Securities.

[Jared Shaw:]

I guess just following up on a few questions here. When you are talking about the competitive pressure and the pressure on rates and structure, are you seeing that more from larger competitors in the market or is that more on the regional and maybe even smaller size banks in your areas?

[Raymond Davis:]

Well, I would say it's both.

[Jared Shaw:]

So it's really spread around both sides. And then in terms of looking at loan growth, once you get through the integration, you have both companies on that single credit policy and you are not distracted with the system's integration. What could we be seeing in terms of loan growth? Are you pretty optimistic about the second half of the year in terms of being able to turn on that net new loan growth?

[Raymond Davis:]

First of all, we have been on a single-credit policy [technical difficulty] in April. That's done obviously, so systems side is [technical difficulty].

[Jared Shaw:]

I'm Sorry, I think I lost you at the end there.

[Raymond Davis:]

Did you not hear us?

[Jared Shaw:]

No, there was, it seems a little distant.

[Raymond Davis:]

This is Ray. I think the bottomline is, yes, we feel about loan growth for 2015. No question about it.

[Operator:]

And we'll go next to Aaron Deer with Sandler O'Neill & Partners.

[Aaron Deer:]

I guess following up on the loan growth expectations, can you talk a little bit about what your thoughts are on sales out of the portfolio? For one thing, I thought that there was going to be more coming out of the multifamily and commercial real estates books, but it seem like there was more out of the residential mortgage side. So what kind of repositioning should we expect going forward and recognizing that some of that is price market related, all else equal, what would you expect?

[Raymond Davis:]

Aaron, let me answer it this way. I can't predict the future or be too specific, but what I can tell you is that balancing the portfolio is not a, and I don't mean to sound flippant when I say this, because I know you guys understand it. But it's not a two week or three month project, it takes a long time. And I think we had mentioned in, I think it was the second quarter of 2014, there would be ups and downs on different sectors of our portfolio. For example, commercial real estate might go up and then it might go down for two or three quarters and that might go back up again. But overall, the game plan is to get an overall balance of the portfolio. But it's not going to be a straight line to a specific number, its going to be a jagged March, if you will, to where we feel we are a little bit more balanced.

[Aaron Deer:]

Would you just say that the portfolio sales this quarter were at the lower end or at the higher? Obviously, last quarters were higher, so are we at a lower end and expect it to come back up, or could it go lower still in terms of the volume of sales?

[Raymond Davis:]

I think this is in the ballpark.

[Aaron Deer:]

And then, lastly, on the run on the margin, I'm just curious. Obviously, you guys have been building up a big cushion of cash that can be redeployed back into loans. How big of an impact would you say that the excess cash, the impact that that had on the margin this quarter that we might get back here in the quarters ahead?

[Ronald Farnsworth:]

Yes. So in terms of the overall margin it dropped 6 basis points and I reference in my prepared remarks that was mostly related to the increased in average balance cash. I talked about also to we're going to be redeploying maturing cash flows out of the bond book, keeping it roughly $2.4 billion. So I would expect to see still a larger level of cash. We're talking about $50 million to $100 million a month of maturing cash flow and reinvestment in bond portfolio, which will be still around that 2% range. So that 6 basis points dropped, it was mostly driven by the rise in cash, I wouldn't expect to see another increase of that level here in near-term. No, but I expect to see a significant drop in the cash balance. It will be the governor basically with loan or deposit growth and you heard us early, we expect strong loan growth in 2015.

[Operator:]

We'll take our next question from Jeff Rulis with D.A. Davidson.

[Jeff Rulis:]

Ray, you outlined the production of commercial and consumer at $600 million and $1 billion. How do those numbers compare to Q3?

[Raymond Davis:]

A pretty much, and actually on the residential side a little bit lower, but consumer side seems to be moving up, so in the ballpark, yes.

[Jeff Rulis:]

And then a little more granular on, the non-interest income on the service charges were down sequentially. Was there some seasonal impact occurring there? Or maybe Q3 was abnormally high?

[Raymond Davis:]

You there?

[Jeff Rulis:]

It just completely cut out. I didn't hear the response after the service charge.

[Gregory Seibly:]

[technical difficulty]

[Jeff Rulis:]

The line is cutting out again. I can't hear, Greg.

[Raymond Davis:]

Can you hear me?

[Jeff Rulis:]

I can. Yes, its better, thanks.

[Raymond Davis:]

Well, basically what we're saying is, I think what Greg was saying is that there has been this natural drift in the OD NSF over the last several years in virtually most every institution, quite frankly, because of the pressures that have been applied to that. So I don't think there is anything more significant to it than that. And we expect that to continue and hopefully be replaced with new product revenue opportunities, with the conversion, with the new product offerings that will be rolled out here in the March 1.

[Jeff Rulis:]

If I were to track your trend, however, I guess in the Q2 to Q3 grew, is that a product of capitalizing on fees on the combined entity? And then from here you are just going to try to hold the line, when you say you expect it to continue declines from here?

[Raymond Davis:]

No. I think you're going to see some pressure on, depending on the growth of our accounts you will see some pressure in the NSF OD. I think you're going to see that everywhere. But I think overall interest or non-interest income -- again, in that there is a lot that gets factored in there, as you well know, not just fees. I mean there is sale on some of our loans. There is all kinds of different things that factor into that. It just depends on what those volumes are. But I don't expect to see any significant drops, no.

[Operator:]

We'll take our next question from Matthew Clark with Sterne, Agee.

[Matthew Clark:]

Maybe first just on loan yields and pricing. Your reported loan yield was up 5 basis points despite the unexpected payoffs. Just can you tell us what the core yield is, excluding purchase accounting in third quarter and fourth quarter? And then also, give us what the weighted average rate on new money is in the fourth.

[Ronald Farnsworth:]

I'll take the first and then turn it over to Cort for the second. So if you look at the P&L interest income on loans, it was up just under $3 million for the quarter. If we look at the average balance that was roughly $1 million of the $3 million, and the balance would have come mostly from fee income. Again, we talked about the significant payoffs. So that was the main driver of the blip there, given credit discount accretion was relatively flat at $21.6 million. And with that I'll turn it over to Cort talk about new volume yields.

[Cort OHaver:]

Matt on new loans, on a C&I loan, we generally get somewhere to 3%, 3.25%, so prime to prime minus 0.5 on a new C&I loan. On a terms loan, our average term loan is somewhere between three to five years. Over five years are usually go to float, and we try to hold the floor somewhere in that range. Obviously, if you're up three years, you might be slightly under four. If you're closer to five years, you're probably at 4. And then other thing I'd throw in our FinPac portfolio, which is growing and it's growing double than size, since we closed on that July of 2013, the average weighted on that portfolio is about 14.5%.

[Matthew Clark:]

And then was there any covered loan accretion this quarter in the number that we didn't see in the release?

[Raymond Davis:]

Yes. And again, when I talked about we've combined those just given the balance. There was covered accretion. It was small. It was less than last quarter. If you recall Q3 it was a little over $2 million. This quarter it was little under $2 million, overall covered loan interest income was down right around $1 million for the quarter.

[Matthew Clark:]

And then just on expenses, it would suggest, based on what you guys have realized to date, you've got $12 million that still left to come out of the run rate. Can you talk about the underlying, though, expense growth that may or may not eat into that $12 million. Just trying to get a sense for the moving parts on kind of legacy Umpqua and STSA baseline expense growth this year?

[Ronald Farnsworth:]

So obviously, as the deal was structured, it was based on projected earning in IBIS estimates, which should include growth in underlying expense. And so when you expect from the underlying company, aside from synergies, and synergies are separate from this, would be just your typical annual inflation merit type increases, which typically hit towards the end of Q1 or early Q2 in that 2% to 3% range.

[Operator:]

We will go next to Jacque Chimera with KBW.

[Jacque Chimera:]

Just a quick follow-up, I want to make sure I understood you on the covered loan accretion. I didn't realize that it is small. That was not in part of the 21 point, I can't remember its $21.3 billion or $21.6 billion. That was just purely legacy Sterling, correct?

[Ronald Farnsworth:]

The $21.6 million was Sterling credit discount accretion. On the covered side, again it was a little under $2 million, down from last quarter. But keep in mind anything that happens there, 80% of it goes back to the FDIC, down in that non-interest income line. So we're just talking about really small numbers here, as we've completed or get close to the end of commercial loss share agreement time period. So pretty small in what you expect for the quarter.

[Jacque Chimera:]

So the 4.22% margin that you reported in the slide deck, it excludes the credit discount, but it includes that small amount of accretion. Is that correct?

[Ronald Farnsworth:]

Right. Very small and it's offset down in other incomes in most part.

[Jacque Chimera:]

And then it looks like we've surpassed $80 million in M&A expenses that are stripped out for the quarter. Can you give an update on any future costs that you are expecting in the next quarters, as you do system conversions and what the total cost might be?

[Raymond Davis:]

You bet, you bet. I'd expect a little bit more here in the first quarter than what we saw in Q4. First quarter may also be solely related to the system conversions, and then just small tail pieces in Q2 and Q3 related to facility consolidation. And we did talk about this a couple of quarters back, where we expected the total all-in would be right around $100 million. And that compared to the original September announcement, as we progressed through and closed the deal back in Q2 last year. A little bit higher in merger expense and we had an offset with a little bit lower liability fair value adjustments at the date of acquisition.

[Jacque Chimera:]

And then the share increase in the quarter, was that compensation related?

[Raymond Davis:]

No. The outstanding share increase in the quarter was primarily driven by the warrant exercise from the private equity exit. That's an outstanding and on diluted it was a very modest impact, just given it was under the treasury stock method in quarters past.

[Jacque Chimera:]

And then just one last quick one. The security sales in the quarter, is that still repositioning the balance sheet post the merger or are we back to more just normal ebbs and flows?

[Raymond Davis:]

Normal ebbs and flows on that.

[Operator:]

We will go next to Matthew Keating with Barclays.

[Matthew Keating:]

Ron, could you please refresh our memory in terms of the 12% accretion guidance following the integration, whether or not that includes benefit from the Sterling-related accretion of the credit discount?

[Ronald Farnsworth:]

Right. And we've been talking about this for last couple of quarters. So it's much higher than 12%, including the credit discount accretion, and it's still above 12% here over the last several quarters. That will only go larger here in 2015, as we complete the integration and gain the synergy.

[Matthew Keating:]

And as it relates to the pro forma financial return metrics, I'm referring to the 1.2% to 1.3% ROA, 13% to 15% return on tangible common equity. Do those encompass accretion or are those standalone?

[Raymond Davis:]

Those are standalone. It's really reflective of the combined synergies of the company following the integration.

[Matthew Keating:]

And the scheduled accretion, I think you had mentioned that the first year following the transaction, it's around $14.5 million in scheduled accretion. Where does that go to, I guess, in year two?

[Raymond Davis:]

You bet, and that was a quarterly amount scheduled. We've been a bit above that just with additional paydowns in this rate environment, and that number will slowly phase down over the course of roughly five years. So it's not a cliff. It would be like what you'd expect from a premium bond amortization over the life of bond.

[Operator:]

And there are no further questions in the queue at this time. End of Q&A

[Ronald Farnsworth:]

Well, thanks, Shanell. I want to thank everybody for their interest in Umpqua Holdings and their attendance on the call today. This will conclude the call. Good bye.

[Operator:]

That does conclude today's conference. Thank you for your participation.