Banner Corporation (NASDAQ:BANR) Q3 2023 Earnings Call Transcript

Banner Corporation (NASDAQ:BANR) Q3 2023 Earnings Call Transcript October 19, 2023

Operator: Hello, and welcome to the Banner Corporation’s third quarter 2023 conference call and webcast. [Operator Instructions]. I would now like to turn the conference call over to our host, Mark Grescovich, President and CEO of Banner Corporation. Please go ahead.

Mark Grescovich: Thank you, Bannick [Ph], and good morning, everyone. I would also like to welcome you to the third quarter 2023 earnings call for Banner Corporation. Joining me on the call today is Rob Butterfield, Banner Corporation’s Chief Financial Officer, Jill Rice, our Chief Credit Officer, and Rich Arnold, our Head of Investor Relations. Rich, would you please read our forward-looking Safe Harbor Statement?

Rich Arnold: Sure, Mark. Good morning. Our presentation today discusses Banner’s business outlook and will include forward looking statements. Those statements include descriptions of management’s plans, objectives, or goals for future operations, products, or services, forecasts of financial or other performance measures and statements about Banner’s general outlook for economic and other conditions. We also may make other forward looking statements in the question-and-answer period following management’s discussion. These forward looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and the most recently filed Form 10-Q for the quarter ended June 30, 2023.

Forward looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations. Mark?

Mark Grescovich: Thank you, Rich. As is customary, today, we will cover four primary items with you. First, I will provide you high level comments on Banner’s third quarter 2023 performance. Second, the actions banner continued to take to support all of our stakeholders including our Banner team, our clients, our communities and our shareholders. Third, Jill Rice will provide comments on the current status of our loan portfolio; and finally, Rob Butterfield will provide more detail on our operating performance for the quarter as well as comments on our balance sheet. Before I get started, I want to again thank all of my 2000 colleagues in our company who are working extremely hard to assist our clients and communities. Banner has lived our core values, summed up as doing the right thing for the past 133 years.

Our overarching goal continues to be to do the right thing for our clients, our communities, our colleagues, our company and our shareholders and to provide a consistent and reliable source of commerce and capital through all economic cycles and change events. I am pleased to report again to you that is exactly what we continue to do. I am very proud of the entire Banner team that are living our core values. Now let me turn to an overview of our performance. As announced, Banner Corporation reported a net profit available to common shareholders of $45.9 million or $1.33 per diluted share for the quarter ended September 30, 2023. This compares to a net profit to common shareholders of $1.15 per share for the second quarter of 2023 and $1.43 per share for the third quarter of 2022.

The earnings comparison is primarily impacted by the provision for credit losses and the increase in funding cost. Our strategy to maintain a moderate risk profile and the investments we have made during our Banner Forward program to improve our operating performance have positioned the company well to weather recent market headwinds. Rob will discuss these items in more detail shortly. To illustrate the core earnings power of banner, I would direct your attention to pre-tax, pre-provision earnings, excluding gains and losses on the sale of securities, Banner Forward expenses and changes in fair value of financial instruments. Our third quarter core earnings were $62.8 million compared to $63.4 million for the second quarter of 2023. Banner’s third quarter 2023 revenue from core operations was $157.7 million compared to a $158.6 for the second quarter of 2023.

We continue to benefit from a strong core deposit base that has proved to be resilient and loyal to Banner in the wake of a highly competitive environment, a very good net interest margin and core expense control. Overall, this resulted in a return on average assets of 1.17% for the third quarter of 2023. Once again, our core performance reflects continued execution on our super community bank strategy that is growing new client relationships, maintaining our core funding position, promoting client loyalty and advocacy through our responsive service model, and demonstrating our safety and soundness through all economic cycles and change events. To that point, our core deposits represent 89% of total deposits. Further, we continued our strong organic generation of new relationships and our loans increased 8% over the same period last year.

Reflective of the solid performance coupled with our strong regulatory capital ratios, and the fact that we increased our tangible common equity per share by 11% from the same period last year, we announced a core dividend of $0.48 per common share. As I have mentioned on previous calls, Banner published our environmental, social, and governance highlights report last December and published our inaugural 2022 ESG report earlier this summer. Both of these documents reflect the ways in which we continually strive to do the right thing in support of our clients, our communities and our colleagues and provides an outline of the level of commitment Banner has to the many communities we serve. Finally, I am pleased to say that we continue to receive marketplace recognition and validation of our business model and our value proposition.

Banner was again named one of America’s 100 Best Companies and Banks and one of the best banks in the world by Forbes. Newsweek named Banner, one of the most trustworthy companies in America, S&P Global Market Intelligence ranked Banner’s financial performance among the top 50 public banks with more than $10 billion in assets, and the digital banking provider Q2 Holdings awarded Banner their Bank of the Year for Excellence. Additionally, we have noted previously, Banner Bank received an outstanding CRA rating in our most recent CRA examination. Let me now turn the call over to Jill to discuss trends in our loan portfolio and her comments on Banner’s credit quality. Jill?

Jill Rice: Thank you, Mark, and good morning, everyone. Banner’s credit metrics continue to be strong and our super community bank model continues to serve our clients well. Delinquent loans as of September 30 were 0.27% of total loans compared to 0.28% of total loans reported as of June 30 and 0.22% of total loans as of September 30, 2022. Adversely classified loans represent 1.17% of total loans down from 1.38% as of the linked quarter and compared to 1.39% as of September 30, 2022. Net loan losses continue to be moderate at $663,000 for the quarter and $1.8 million year to date. And Banner’s nonperforming assets remain low at 0.17% of total assets. Our reserve for loan losses continues to be a source of strength. We posted a provision for loan losses of $2.9 this quarter covering the moderate level of net charge off taken in the quarter as well as providing for loan growth.

In addition, we provided $346,000 to the reserve for unfunded loan commitments for a total provision for loan losses of $3.3 million. Due to an improvement in market valuation, we released $1.3 million of the provision recorded last quarter that was related to financial institutions subordinated debt held within the investment portfolio. In total, the net provision for credit losses for the quarter was $2 million. After the provision for credit losses, our ACL reserve totaled to $147 million or 1.38% of total loans as of September 30. This coverage level is identical to that reported in the linked quarter as well as that reported as of September 30, 2022, and currently provides 560% coverage of our non-performing loans. As reflected in the release, loan originations declined modestly quarter-over-quarter.

Still, loan outstandings grew by $139 or 5.3% on an annualized basis and are up 8% year-over-year. C&I-line utilization decreased 1% in the quarter and balances were down $49 million in the quarter due to a combination of loan payoffs and decreased line utilization. This was partially offset by a 2% increase in small business scored loans. Compared to September 30, 2022, commercial and small business scored loans are up 5.4%. We also saw an increase of $17 million in owner-occupied CRE or 7.4% on an annualized basis. Excluding multifamily, our commercial real estate balances decreased 1% in the quarter driven primarily by the payoff of a substandard assisted living facility as well as an underperforming self storage property and are down 3% when compared to September 30, 2022.

Given the expectation of a sustained interest rate in increased rate environment and the impact of overall market dynamics, we continue to anticipate muted commercial real estate loan growth in the near term. That said, it is important to note that the portfolio continues to perform well and similar to last quarter less than 1.5% of the total CRE portfolio is adversely classified at this time. There has been negligible change in our office portfolio performance. It continues to be granular in size, diversified in geographic location, and overall credit performance has been solid. In line with prior disclosures and as reflected in the investor presentation, the office portfolio currently represents 6.3% of total loans and is split roughly fifty-fifty between investor CRE and owner occupied and adversely classified loans in this asset class are limited to $1.2 million.

It is worth noting that there has been no meaningful change in the portfolio of loans secured by office properties within the major metropolitan areas across our geographic footprint. Multifamily real estate loans were up 9.5% in the quarter as multiple affordable housing projects completed construction and were moved into the permanent bucket. In total, the multifamily portfolio was split approximately 55% affordable housing and 45% market rate and as I have commented before the average loan size is less than $1 million with balances spread across our footprint. Construction and development loan balances declined by $6 million in the quarter or 40 basis points. The decline in residential construction outstandings continued in the quarter as sales of completed residential starts continue to outpace new takedowns, down 2% in the quarter and down nearly 20% when compared to September 2022.

Commercial construction loans were also down in the quarter primarily due to the expected refinancing of various projects upon completion. These declines were partially offset by increased outstandings on the multifamily construction projects underway. Multifamily construction outstandings are up 64% year-over-year, a reflection of the strong origination of affordable housing projects as well as a modest level of origination of market rate, middle income project for strong sponsors. When compared to September of 2022, in total, construction and land development loans reflect an increase of 4%, driven primarily by the growth in the multifamily construction portfolio and to a much lesser extent to growth in the land development book. As discussed last quarter, the pace of residential construction starts continues to be slower than historical norms.

Builders remain proactive in moving completed products and while they continue to benefit from the general lack of resale housing inventory on the market, they remain cautious with the level of inventory under construction. In total, residential construction exposure remains acceptable at 5% of the portfolio, flat with last quarter and of that 45% is comprised of our custom 1-to-4 family residential mortgage loan product. When you include multifamily, commercial construction and land, the total construction exposure remains at 14% of total loans and as is customary the portfolio continues to be diversified both in product mix and price point with starts to spread across our geography. In short, the portfolio continues to perform well. As expected, agricultural loan balances increased again this quarter due to operating line usage, up 8% when compared to the linked quarter.

Balances are up 12% year-over-year. And lastly, as noted in the earnings release, we again reported growth in the consumer mortgage portfolio, up 7% in the quarter continuing the trend of retaining completed all in one custom construction loans on balance sheet. I will close in the same way I started, noting that Banner’s credit metrics continued to be strong and our super community bank model continues to serve our clients well. And I will reiterate a theme that has been consistent of late, which is that our credit quality metrics should not be expected to get better than they currently are. We will not be immune to credit deterioration that emerges as we move through this cycle. Still, the credit culture that runs throughout Banner is a source of strength, so two are the solid reserves for loan losses and capital base, all of which position us well for the future.

With that, I’ll turn the microphone over to Rob for his comments. Rob?

Rob Butterfield: Great. Thank you, Jill. I will start, so today we reported $1.33 per diluted share for the second quarter compared to $1.15 per diluted share for the prior quarter. The $0.18 increase in earnings per share was primarily due to lower provision for credit losses, lower losses on the sale of securities, and lower negative fair value adjustments on financial instruments carried at fair value. Core revenue, excluding the loss on sale of securities and changes in investments carried at fair value, decreased $883,000 from the prior quarter primarily due to higher deposit cost leading to a decline in net interest income. Total loans increased to $133 million during the quarter with an increase of a $139 million for portfolio loans, partially offset by a decrease of $6 million and held for sale loans.

The increase was primarily due to 1-to-4 family real estate loans increasing $99 million and multifamily loans increasing $67 million partially offset by a $49 million decline in business loans. Total securities declined a $195 million. The decline was due to the sale of $57 million of available for sale securities and normal portfolio cash flows, and also a decrease in the fair value of available for sale securities due to an increase in interest rates. Any additional security sales during the fourth quarter will be dependent upon market conditions. Deposits increased $75 million during the quarter due to a $143 million increase in retail time deposits partially offset by a $41 million decline in brokered CDs and a $26 million decrease in core deposits.

We have not increased the rates on our deposit rate specials since the end of May. Banner’s liquidity and capital profile continue to remain strong with all capital ratios in excess of regulatory well capitalized levels, and we continue to maintain significant off balance sheet borrowing capacity. Advances from the Federal Home Loan Bank decreased to $130 million during the quarter, ending the quarter at a $140 million. Net interest income was essentially flat with a decrease of $752,000 from the prior quarter due to an increase in funding cost, offsetting the increase in earning asset balances and yields. Compared to the prior quarter, average loan balances increased $242 million, while loan yields increased 14 basis points due to floating and adjustable rate loans re-pricing as well as new production coming on at higher interest rates.

Total average interest bearing cash and investment balances declined by $219 million from the prior quarter. While the average yield on the combined cash and investment balances increased 2 basis points. Total cost of funds increased 22 basis points to a 108 basis points due to increases in rates paid on deposits and borrowings. The 22-basis point increase in funding cost was lower than the 46 basis points increase in funding costs we experienced in the second quarter. The total cost of deposits increased 30 basis points to 94 basis points, reflecting both increases in the rates paid on interest bearing deposits as well as a shift in the mix of deposits with a portion of non-interest bearing deposits moving into CDs and other interest bearing deposits.

I will note the pace of movement out of non-interest bearing slowed compared to the prior quarter, with non-interest bearing deposits remaining robust at 39% of total deposits. The average cost for brokered CDs this quarter was 5.29%. These added 7 basis points to the cost of deposits for the quarter. Net interest margin decreased 7 basis points to 3.93% on a tax equivalent basis. The decrease was driven by increases in funding cost on interest bearing liabilities outpacing the increase in yield on earning assets. We expect that interest margin will see some additional moderate compression during the fourth quarter, contention on market conditions. Total non-interest income increased $4.2 from the prior quarter due to lower losses on the sale of securities and lower negative fair value adjustments.

The current quarter included a $2.7 million loss on the sale of securities, the payback on these trades averaged two and third years. In addition, we recorded a $700,000 negative fair value adjustment on investments held for trading as market rates increased. Core non-interest income, excluding the loss on sale of securities and changes in investments carried at fair value, decreased $131,000 due to declines in bank owned life insurance and miscellaneous income, offsetting increases in deposit fees and mortgage banking income. Deposit fees and other service charges increased $316,000 as lower expenses on debit card transactions offset the reduction in NSF fees due to the discontinuation of charging returned item fees implemented in June. Income for mortgage banking operations increased $363,000 due to a let lower negative fair value adjustment on multifamily loans held for sale.

Year-to-date, we have recorded $831,000 in losses on the multifamily loans held for sale. This business line has been effectively shut down for all of 2023 due to the lack of an active secondary market with year to date originations for this group being less than $1 million. As such, during the quarter, we made the decision to formally discontinue the multifamily origination per sale business line. Income from residential mortgage operations was slapped for the quarter. Miscellaneous income decreased $486,000, primarily due to a loss of $276,000 on the disposition of assets related to two branch consolidations. Total non-interest expense increased $486,000 from the prior quarter. The expense for the quarter includes $623,000 of expenses associated with the discontinuation of the multifamily origination for sale business line.

Compensation expense decreased by $881,000 as declines in salaries and payroll taxes offset and increase in severance related expenses. Advertising and marketing expenses increased due to summer marketing campaigns. Professional and consulting expenses increased due to normal timing of annual audit expenses. REO expenses declined due to the gain on the sale of an REO property. Despite the competitive deposit rate environment, retail deposit balances increased during the quarter as our teams remained focused on delivering on our value proposition being connected, knowledgeable and responsive. The strength of the company’s balance sheet positions us well for being able to take advantage of the ongoing market disruption. This concludes my prepared comments, and now I will turn it back to Mark.

Mark?

Mark Grescovich: Thank you, Rob and Jill, for your comments on the quarter. That concludes our prepared remarks, and we will now open the call and answer your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions]. So our first question comes from the line of David Feaster of Raymond James. Your line is now open. Please go ahead.

Q – : Good morning.

Mark Grescovich: Good morning, David.

David Feaster: Maybe I was just hoping that we could dig into a bit, some of the trends that you’re seeing on the core funding side. It looks a lot of the growth that we’re seeing – we’ve seen the migration slow, which is great, a lot of the growth that we’re seeing in – in the interest bearing checking, high yield savings. I am just curious some of the underlying trends that you’re seeing, where are you seeing the most opportunity to drive core deposit growth and now – and just how new core deposit pricing is – is kind of trending for those products.

Rob Butterfield: Yes, David. It’s – it’s Rob. So I think you hit on some of it there, I mean, we saw the stabilization overall core deposits for the quarter, we did see the mix continuing to move out of some of the non-interest bearing and – and lower yielding products into the higher yield savings account that we are offering. But the – the pace did continue to slow throughout the quarter and what we’re – what we’re thinking now is that, we expect that pace to even slow further into the fourth quarter and then we as we go into 2024, we would expect that we would see the point, in the first part of the year, we see stabilization there. As far as, the growth that we are seeing is mainly in that high yield savings account, and the rates on that range from 2% to 4% depending on the tier.

The average cost in that account right now is around 350. But if you’re looking at time deposits, time deposits on average are probably coming in, that 425 to 450 range for new retail time deposits.

David Feaster: And maybe just putting that together with kind of where new loan yields are, just maybe stepping back to just I am curious how you think about some of the implications of a higher for longer rate environment, maybe just on the margin and NII trajectory, as we look forward. I mean, just kind of given what you’re talking about, where new loan yields are, the re-pricing of the earning asset base, it seems like margin might be closer to a trough here or at least nearing it. I am just curious kind of how you think about the margin trajectory and – any other impacts on the business if we do stay in a higher for longer environment.

Rob Butterfield: Yes. So, David, on the – on the margin expectations there, I mean, we are expecting to see some additional moderate compression, probably for the fourth quarter of this year because we think the funding cost is going to, while it’s – while the pace of increase is going to slow there, we do think that it’s going to still outpace the increase in – in the yield on earning assets for the fourth quarter but I would say it’s – I would consider it moderate, call it, mid single digit something – something in that range, maybe. But then as we go into 2024, I mean, if, assuming those trends continue where we continue to see the slowdown in the funding cost and the yield on earning assets coming on at higher yields, we would expect in the first part of 2024 that we would start to see stabilization in the net interest margin. As we go through the quarter, we’ll have a better visibility on our expectations for 2024.