COLB
#Thank you, Jeanine.
Good afternoon, everyone, and thank you for joining us today on our call for our second quarter 2017 results.
The release is available via our website, columbiabank.com.
First, I want to take this opportunity to say that I'm deeply honored to have the privilege of serving as the next President and CEO of Columbia.
During my time at Columbia and especially through the past 5 months, I've witnessed the dedication, drive and pride of our employees.
Their resilience in the face of great difficulties and persistence in creating positive outcomes is truly inspiring.
As we approach the 25th anniversary of our company, it's important to acknowledge that, as in the past, our future is about placing the customer at the center of what we do.
I also want to take this opportunity to provide assurance that we'll continue to execute our existing strategy.
We'll continue to grow the bank by concentrating on building durable relationships with our customers, making the necessary investments in technology to ensure we have contemporary products and services and selectively look for acquisition partners that have good economic and cultural fit.
We'll also continue our ongoing efforts to reduce expenses and increase operating leverage while consistently holding to our credit disciplines across business cycles to best preserve our capacity to generate long-term, sustainable revenue streams.
During the second quarter, we achieved record net income for the period of $27 million.
Our bankers were successful in generating loan production of $316 million, which, along with higher levels of line utilization, resulted in net loan growth of $195 million or about 3.1% for the quarter.
We now have received shareholder and state regulatory approvals for the merger of Pacific Continental into Columbia.
Federal regulatory approvals are still pending.
Upon approval by the Federal Reserve and FDIC, we'll move quickly to close and commence integration and conversion activities.
Our system conversion date is now set for mid-November.
On the call with me today are <UNK> <UNK>, our Chief Financial Officer and recently announced Chief Operating Officer, who will provide details about our earnings performance; and Andy <UNK>, our Chief Credit Officer, who will review our credit quality information.
I will conclude by providing an update covering our deposit loan activity.
Following our prepared comments, we'll be happy to answer any of your questions.
It's important that I remind you that we'll be making forward-looking statements today, which are subject to economic and other factors.
For a full discussion of the risks and uncertainties associated with the forward-looking statements, please refer to our securities filings and, in particular, our 2016 SEC Form 10-K.
At this point, I'd like to turn the call over to <UNK> to talk about our financial performance.
Good afternoon, everyone.
As <UNK> mentioned, earlier today, we reported record second quarter earnings of $27.1 million or $0.47 per diluted common share, which is $0.03 higher than the second quarter of last year.
Expenses related to the termination of loss-share agreements with the FDIC and the pending acquisition of Pacific Continental Corporation reduced our reported earnings $2.2 million and lowered EPS by $0.04.
We recorded a pretax charge of $2.4 million in the second quarter to write off the remaining loss-sharing assets and relieve the FDIC call-back liability.
Acquisition-related expenses of $1 million in the quarter were in the following income statement line items: occupancy, $351,000; advertising, $11,000; legal and professional, $119,000; data processing, $473,000; taxes, licenses and fees, $3,000; and other, $66,000.
Our reported net interest income of $86.2 million was a decrease of $514,000 from the prior quarter.
The linked-quarter decline was primarily driven by additional mortgage-backed security premium amortization of $1.9 million, which was mostly offset by increased loan interest income of $1.5 million.
On the liability side, deposits were relatively flat, so loan growth drove additional borrowings, resulting in increased interest expense of $366,000.
Additionally, a slight shift from demand deposits to our commercial money market sweep product accounted for the remaining $118,000 of increased interest expense over the prior quarter.
Noninterest income of $24.1 million in the current quarter was a decrease from the prior quarter of $724,000.
The prior quarter included a $1.5 million bank-owned life insurance benefit as well as a $573,000 benefit from the release of the remaining mortgage repurchase reserve that was established in conjunction with our 2013 acquisition of West Coast Bancorp.
After removing the favorable effect of these 2 items on the prior quarter, growth in deposit and treasury management fees, card revenue, financial services revenues and merchant processing revenues led to a comparative linked-quarter increase of roughly $1 million.
Subsequent to the end of the second quarter, we outsourced our Merchant Services program to a third-party platform for a sales premium $14 million.
After an initial drop in the contribution from this business line, we expect the partnership will ultimately drive higher levels of merchant penetration within our existing customers, more robust account acquisition and a significantly higher level of income than we could achieve on our own.
During the first year, the pretax contribution is expected to decline from about $3 million to $1.5 million as we ramp up the capacity of the new platform.
Prior to outsourcing, merchant activities generated about $23 million in noninterest income and $20 million in noninterest expense on an annual basis.
Reported noninterest expense was $68.9 million for the current quarter, a decrease of $119,000 from the prior quarter.
After removing the effect of OREO activity, FDIC loss-share termination expense and acquisition-related expense, our noninterest expense run rate for the second quarter was $65.4 million.
Using the same basis, this is a $2.1 million decrease from the prior quarter and results in a noninterest expense to average assets ratio of 2.73%.
This ratio continues to remain within the range that we have discussed on prior earnings calls.
As such, we still believe, for modeling purposes, an expense ratio in the mid-2.7% range is reasonable.
The operating net interest margin remains unchanged from the prior quarter at 4.09%.
Higher loan yields added 7 basis points to the margin while the increased premium amortization in the investment portfolio lowered the margin by 6 basis points, and the additional Federal Home Loan Bank borrowings reduced the margin by 1 basis point.
Our effective tax rate for the second quarter was 29.1% compared to 26.6% in the prior quarter and 30% for the full year 2016.
The primary reason for the lower rate in the prior quarter was adoption of ASU 2016-09.
Excluding that impact, the effective tax rate would have been 29.8%.
As such, we continue to believe a reasonable assumption for the full year effective tax rate is 30%.
Now I'll turn the call over to Andy to talk about our credit performance.
Thanks, <UNK>.
For the quarter ended June 30, the company made a provision for loan losses of $3.2 million.
This was primarily driven by the originated portfolio, which had a provision of $4.4 million.
The discounted portfolios collectively released $440,000 for the second quarter, and the purchase credit impaired portfolio enjoyed a release of $738,000.
Loan growth, negative migration and net charge-offs drove the provision in the originated portfolio, while a continued contraction and relatively stable credit metrics in the other portfolios allowed the releases.
It's important to note that within the originated loan portfolio, we enjoyed over $260 million of loan growth during the quarter.
So as of June 30, 2017, our allowances to total loans was 1.14%, even with the first quarter, and essentially the same when compared to 1.13% as of December 31, 2016.
As we have discussed before, the weakness in the portfolio has been most notable in the agricultural sector, which drove both the provision and the increase in nonaccrual loans for the quarter.
At quarter-end, we had approximately $466 million in agricultural-related commercial business loans and another $258 million in commercial real estate farmland loans.
On a combined basis, the largest sector is [HOPs] at $97 million.
We have not experienced any credit issues within our [HOP] Portfolio.
Beef and cattle ranching is next at $96 million.
The cattle business showed weakness throughout 2016 but rebounded in the first half of 2017.
However, we continue to be diligent in this area as we are seeing increases in the U.<UNK> cattle herd, which could have a negative effect on pricing in the second half of 2017.
The next largest sector is wheat at $65 million.
Our wheat portfolio has been very stable, with over 97% of the credits rated pass.
Most of our wheat farmers continue to operate at around breakeven or better.
Fishing is our fourth largest exposure at around $50 million.
Similar to cattle, we have seen positive migration in the fishing portfolio year-to-date.
After fishing, comes grass seed, which is approximately $40 million, and 99% of this portfolio is pass rated and has also been stable throughout the year.
So as you can see from the numbers, our agricultural portfolio is very diversified, much like the rest of our loan portfolio.
With that said, the potato and onion portfolio has continued to deteriorate throughout 2017, and this particular area is what drove the provision and the increase in nonaccrual loans for the quarter.
Today, we have approximately $23 million in these commodities, almost all of which is rated substandard, and approximately $10.2 million was placed on nonaccrual during the quarter.
While we are disappointed in the performance of this portfolio, the bucket is small and very manageable.
For the quarter, nonperforming assets increased and, as discussed previously, was centered in the commercial business agricultural portfolio, specifically in the potato and onion area.
The nonperforming assets to total asset ratio thus increased to 42 basis points, up from 32 basis points last quarter and 35 basis points at year-end 2016.
In summary, outside of the issues discussed within our potato and onion farmers, the rest of the portfolio showed signs of improvement.
Net charge-offs remained modest, our impaired asset capital ratio improved from 24.3% to 21.1% and past dues came in around 31 basis points.
So I continue to be pleased with how the portfolio is performing in total.
And I will now turn the call back to <UNK>.
Thanks, Andy.
Total deposits at June 30, 2017, were $8.1 billion, relatively unchanged from the prior quarter.
Core deposits were $7.7 billion and are holding steady at 96% of total deposits.
The average rate on total deposits remained low at 5 basis points.
Loans were $6.4 billion at June 30, 2017, a net increase of $195 million or 3.1% over March 31.
The second quarter increase was largely driven by loan production, as mentioned previously, of $316 million.
Line utilization also increased from 49% at March 31 to 51.7% at June 30.
Line activity in our C&I portfolio typically rises in the second quarter, which reflects seasonal borrowing patterns of a few industries in our portfolio, most notably agriculture.
Assuming historical patterns hold, we're likely to see line utilization continue to increase in the third quarter.
New production for the second quarter was mostly centered in C&I and commercial real estate and construction loans.
Term loans accounted for roughly $190 million of total new production, while new lines represented about $126 million.
The mix of new production remained granular in terms of size.
19% of new production was over $5 million, 28% was in the range of $1 million to $5 million and 53% was under $1 million.
In terms of geography, 57% of new production was generated in Washington, 33% in Oregon and 10% in Idaho and a few other states.
C&I loans ended the quarter at $2.7 billion, up about $145 million from the previous quarter or 5.7%.
Industry segments with the highest net loan growth in the quarter included agriculture, finance and insurance and manufacturing.
Commercial real estate and construction loans ended the quarter at $3 billion, up $27 million from the prior quarter.
The mix of asset types associated with new production was broadly diversified.
The largest net increases occurred in multifamily and healthcare construction loans.
The quarterly average tax adjusted coupon rate for new production of 4.58% exceeded the portfolio rate of 4.52%.
There was a modest uptick in coupon rates for new production this quarter, primarily due to repricing commercial loans following the December and March changes in the Fed funds rate.
The Feds funds move in June was too late in the quarter to have a material impact on our loan yields.
We continue to believe that the Northwest will grow faster than the national economy during the rest of 2017.
The growth rate is likely to be less than last year as labor supply tightens.
The tighter labor supply is developing in a number of industries, accompanied by upward pressure on wages.
Farmers and contractors, in particular, have found it progressively more difficult to find workers.
The region does benefit from population growth at a rate that exceeds the national average.
However, the availability and cost of housing may slow future growth rates.
Overall, business confidence continues to be optimistic, yet business owners are hesitant about committing resources or taking on additional debt to fund significant expansion plans.
Most can look ---+ continue to look for more certainty regarding Trump administration policy changes before committing to action.
The bank's pipeline at the end of the second quarter is below levels seen at the same time last year.
However, deal flows remain steady.
New loans, coupled with seasonal line utilization, should help create positive net loan growth in the third quarter.
In closing, our quarterly dividend of $0.22 per common share will be paid on August 23, 2017, to shareholders of record as of the close of business on August 9.
This dividend constitutes a payout ratio of 47% for the quarter and a dividend yield of 2.22% based on the closing price of our stock on July 26.
This concludes our prepared comments this afternoon.
As a reminder, <UNK> and Andy are here with me to answer your questions.
And now Jeanine, we'll open the call for questions.
Let's see, I guess, just start with maybe a question for <UNK>.
Given the kind of updated timeline on the PCBK close, could you sort of reengage the cost saving assumptions, assuming a kind of a mid- Q3 closing with conversion in mid-Q4.
If you could just broadly kind of roll through that again.
Sure.
I believe that we had originally stated ---+ we didn't really tie it to a specific quarter, if you will, because of the uncertainty around when we would close.
I think it's reasonable that we'll have 50% of the cost savings realized in the first year, 85% in the second year and then 100% thereafter.
And in terms of why I say 85% realized in the second year is that there's always a bit of a trail.
It could be month 10 after close that we have all the cost saves in place.
It could extend on just a few of them until month 13 or something like that.
But even if it's later in that first year, the realization rate goes down.
And so I would think that ---+ I mean, we've got pretty much everything tracking towards the model still.
Feel really good about that.
I don't think that sliding the conversion really changes the economics of what we put out in the slide deck in January because I think that our time from close to conversion is still going to be about what we've always anticipated it to be.
Okay.
So that ---+ just to confirm, you're saying 1 year from, call it, early August or early to mid, you get half the cost saves by August of '18 and then 85% by August of '19.
Yes.
And I think that's a fairly realistic but biased ---+ a little bit biased towards a conservative estimate.
Got it.
And then another question for Andy.
On the kind of potato and onion deterioration, I guess ---+ and I hadn't heard much on that front, if you could just itemize what in that industry is causing pressure.
Is it pricing.
And then, I guess, thoughts on any kind of recovery or resolution down the road.
Yes, so potatoes have been in a slump, pricewise, for, oh, gosh, almost 4 years now.
So it's been long in the cycle.
The surprising thing is the most current pricing on potatoes has ---+ actually has shown fairly strong improvement.
But most of the folks that are in potatoes are also in onions, so the onion market really just fell out, and prices now are half of what they were a year ago.
And that's obviously a significant impact relative to just ---+ you're looking at $14.
It drifted down, and now you're looking at $6, so a significant change in the economics for onions.
So it's really been driven by price.
And obviously, the price is a function of supply.
And I guess, as it triggers through your ---+ where that goes into nonaccrual it's just been a ---+ is it that onion piece that pulled the whole kind of group down to get to this stage.
Yes, I mean, what we do is we forecast out.
We're monitoring these credits on a budget on a monthly basis.
And there's always carryover from 2016 because the farmers never sell 100% of what they grow in any given year in the year they grow it.
And so we are now looking at farmers who will have a difficult time paying off their 2016 crop, so there will be a carryover from that.
And then when we look at what their costs are going into 2017, at the current pricing for both potatoes and onions, it's unlikely that they will make any money.
So given the period of time in which the potato industry has been down, those guys were kind of somewhat benefiting from a little bit better of an onion market.
That's gone away, so there's really no support for them.
And thus, we've placed them on nonaccrual.
Yes, we've seen the repricing in the loan portfolio has been really favorable for the margin.
If you take the investment portfolio and the premium amortization out, we would've seen a nice expansion in the operating margin for the quarter.
We're seeing new stuff come on at higher-than-portfolio rates.
We didn't really get any benefit of the last rate increase in the quarter, so we'll see that flow through in the third quarter.
I think that ---+ also, we typically ---+ we've had, just like we do in the loan book, we have some seasonality with our deposits.
And it's not uncommon for us to have stronger deposit growth in the second half of the year than the first year.
So I feel really good about the margin.
I'm as optimistic as I've ever been that it'll continue to expand from here.
On a side note, we just missed it ---+ for the quarter, we now round up to 5 basis points for our cost of funds.
We were rounding down, but I think if you carry it out a few decimal places, it's just a touch over 4.5 basis points for our funding cost.
And that's a product of the ---+ as I mentioned in my prepared remarks, we had some additional interest expense with the increase in overnight borrowings, but we also saw, during the quarter, just some funds ---+ it was about a little over $50 million increase that went into our commercial money market sweep product and the combination of ---+ that's really what drove that increase and the cost of deposits to go up ever so slightly.
On an annualized basis, the revenue is about $23 million.
The expense components are right at $20 million.
So it's ---+ there's variability from quarter to quarter, but as you're adjusting your model, if you use those amounts and break them into quarterly increments, you'll be pretty close.
We think that it's going to drop, as I said, to about $1.5 million the first year, net contribution.
From here on out, it'll all flow through noninterest income.
There won't be the noninterest expense component.
And we see that building back to the level that we're currently at with a net contribution, that $3 million level.
We see it building in the 24- to 36-month horizon.
And then from there, we really think that we're going to be able to leverage the expertise of this third party and the technology they bring to the table and increase it further from there than what we could do on our own.
Yes, so what we're doing to mitigate our loss content within that portfolio is we're working with the farmers, and we're either taking the farm ground as collateral to bolster our position from a collateral standpoint so that we're not reliant on the commodities that they're growing but rather the farm ground itself.
Or we're working with the farmers who are getting loans from primarily government-sponsored agencies in which they're then able to inject additional cash proceeds, essentially allowing us to pay our loans down and give us a better margin between where our loan value is versus what the current market value of the collateral would be.
So in both cases, real estate is the avenue of resolution.
We do have certain specific allocations within the allowance.
That's a little over $3 million.
I have not broken out the number specific to the other credits and what they're drawing, but I would say that, in aggregate, we're probably somewhere between $5 million to $5.5 million in allowance.
So it's fairly well covered.
That's a good point of clarification.
It is a transition that we're working through in the third quarter.
So we've ---+ we executed the agreement early in the quarter.
We've sold the portfolio, but we're servicing the existing portfolio and transitioning to that new platform, really, throughout the majority of this third quarter.
So I think that you're probably not going to see ---+ there's going to be some noise in terms of ---+ we'll still have some expense associated with that in our financials in the third quarter.
By the fourth quarter, we should be pretty clean with what the new go-forward run rate is going to look like in terms of not having the noninterest expense but then also having the lower noninterest income.
Not directly, but certainly, it's related.
We've looked at the merchant program that we had over the years and came to the conclusion that with this arrangement and the ability to essentially double a dedicated sales force, get an improved product set, remove some of the operating risk that we have and be able to redirect capital that we were going to deploy that into the other areas of the bank, on the whole, provided a better net contribution to the bank.
I'll have to follow up with you on ---+ off-line on exactly which line items.
I don't have that committed to memory, sorry.
Well, so I'll give kind of a backlog and then ask <UNK> to weigh in.
We routinely look at where our marketplace is.
And [keen in part of] the changes in our competitors, but we believe that we've been able to lag our deposit costs, at least historically, understanding, of course, it's been a long time, and there's new technologies out.
So we've been able to lag our deposit costs fairly substantially on a historical basis, as I indicated.
And so it's a process that we're going to follow.
We have a number of strategies on the shelf that we can pull off in the case that we see the market start to move.
And the idea behind those strategies is to contain the range of increases to where we think that we have the most competitive pressure with new product types.
<UNK>.
Yes, and I think that also gets into the ---+ some of the things that drove deposit growth or a slight decrease in deposits during the quarter is that we're really looking at ---+ in particular, with some of our public fund customers, where we have operating accounts, and we have their excess funds, and we've worked with a lot of them to send funds back to the local government pool, because it's just too expensive and, quite honestly, we could fund it in other ways.
And so just ---+ we really take, I guess, a holistic view of the deposit base.
We try to be rational and smart about pricing, and I do think rates are becoming ---+ starting to become meaningful.
And so that will create some upward pressure.
I think that's a little bit of what we saw with the money markets going into that reciprocal sweep product we have is that people are looking at it and thinking now it's worth their effort to look at other alternatives.
So I do think there will be some pressure, but I ---+ consistent with my earlier comment about the margin, I think that we're seeing in terms of pricing in the new production and repricing in the existing parts of the loan portfolio, I still think that it bodes well for the margin and net interest income.
Well, it's probably a number of things, and I'll kind of highlight a few that I think about.
First of all, comparing to last year, that was the peak of production during the second quarter.
And we are, collectively, year-to-date, a bit below where our production was last year, and our pipelines are moving in the same way.
The things that we're seeing out in the marketplace a bit are that the pricing and the structure is more competitive.
And it seems to be a bit more each quarter.
And as a consequence, we adhere to our disciplines, and that's disciplines both on pricing and credit structure and have made decisions that we can compete to a point but not to the point where we're going to compromise.
So that has an impact.
We're also managing exposure levels in our portfolio, and that changes from quarter to quarter.
And that also has an impact as compared to where we were last year.
Things to think about going into the third quarter are that the payoff and prepayment activity was pretty high going into the third quarter and in the third quarter last year.
We don't have that visibility that we did last year into that kind of activity, but our expectation is that we may see less of payoff or prepayment activity.
We also had some undrawn construction lines that have the ability to help us in the third quarter as well.
So although that pipeline may be less than it was last year for some of the competitive reasons, the activity that drives net loan growth may be adequate to keep us pointed the direction that would be consistent with prior year.
About a little over 25%.
Yes, we still have some leftovers from the Great Recession in the real estate area.
We got a couple of contractors.
The other stuff is pretty spread out across the portfolio.
Well, I think that part of is the seasonality.
Obviously, the growth in the loan portfolio, our ---+ we had a lot of great activity in our lending teams.
And we had, I think, a good quarter when it came to swap activity and swap fees.
Obviously those help.
But in general, I think it's just a product of first quarter is typically our toughest quarter, and then it builds through middle part of the year.
You know as well as we do that the Portland metro area was shut down for most of January with snow and ice.
And then just in terms of line utilization and some of those things, people were slower getting going in the spring in our ag book.
And so intuitively, we believe that there was some impact there.
If you ask us to put a number to it, I don't know that we can do that, but we just know that it did slow things down, and activity was slow, especially during the winter storm times.
I want to follow up on Aaron's question regarding the geography of the income and expense items for Merchant Services.
So I was a little bit off when I was speaking of expense.
In our financial statements, we actually net the processing expense associated with the merchant program out of that merchant processing revenue line item that you see in noninterest income.
If we look back over the last 4 or 5 quarters, that number is anywhere from $3.6 million to $4 million a quarter.
So on an annual basis, roughly about $15 million, $16 million of that $20 million of noninterest expense or expense impact, I guess, is going to come out of that noninterest income line item, that net merchant revenue services.
The remainder is primarily going to come out of comp and benefits for the most part.
Well, if there are no further questions, thank you for attending.
Bye-bye.
