Banner Corporation — Q2 2013 Form 10-Q
Business context and reporting period. Banner Corporation is a Washington bank holding company operating Banner Bank and Islanders Bank, focused on community banking in Washington, Oregon and Idaho. This unaudited filing covers the quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods unless noted. Amounts are in U.S. dollars.
Financial performance and position
| Metric | Q2 2013 / June 30, 2013 | Comparable / change |
|---|---|---|
| Net income available to common shareholders | $11.8 million; diluted EPS $0.60 | Q2 2012: $23.4 million; $1.27 diluted EPS |
| Six-month net income available to common shareholders | $23.3 million; diluted EPS $1.20 | 2012: $30.6 million; $1.69 diluted EPS |
| Net interest income before loan-loss provision | Q2: $42.2 million; six months: $83.2 million | Down 1% for both periods year over year |
| Net interest margin | Q2: 4.20%; six months: 4.18% | Q2 2012: 4.31%; six months 2012: 4.23% |
| Core operating revenue, excluding fair-value adjustments, securities gains and OTTI | Q2: $53.1 million; six months: $104.0 million | Up 2% for Q2 and 1% for six months |
| Operating expenses | Q2: $35.5 million; six months: $69.6 million | Q2 down 1%; six months down 5% |
| Loans / deposits | Net loans: $3.213 billion; deposits: $3.460 billion | Since Dec. 31, 2012: loans up $55 million; deposits down $97 million |
| Allowance / nonperforming loans | Allowance: $76.9 million, or 2.34% of loans; NPLs: $26.1 million | Allowance covered 294% of NPLs; no loan-loss provision in Q2 or first half |
| Total assets / equity | $4.236 billion / $520.3 million | Assets down 0.7%; equity up 3% from year-end |
| Cash flows, six months | Operating +$50.6 million; investing -$68.6 million; financing -$41.8 million | Cash and due from banks fell $59.9 million to $121.4 million |
Material changes and notable items
- Reported Q2 net income was lower than in 2012 despite a return to pretax profitability: 2012 results included a $31.8 million income-tax benefit from reversing most of the deferred-tax-asset valuation allowance. Q2 2013 recorded $5.7 million of tax expense.
- 2012 also included a much larger fair-value loss on financial instruments, particularly junior subordinated debentures. Fair-value adjustments were a $255,000 loss in Q2 2013 versus a $19.1 million loss in Q2 2012; six-month losses were $1.6 million versus $17.4 million.
- Credit indicators improved: nonperforming assets declined to $32.9 million (0.78% of assets) from $50.2 million at year-end and $73.2 million a year earlier. REO fell to $6.7 million from $15.8 million at year-end.
- Deposit mix shifted toward lower-cost funding: non-certificate core deposits were 73% of deposits, compared with 66% a year earlier; certificates declined to $944 million. The company reported deposits down $97 million during the first half.
- Available-for-sale securities had $7.4 million of gross unrealized losses at June 30, versus $1.1 million at year-end; management attributed declines primarily to interest rates and market spreads and said it did not consider individual losses to be OTTI. The securities valuation decline reduced other comprehensive income.
Liquidity, debt and capital
- Deposits were $3.460 billion. Borrowings included $54.3 million of FHLB advances, $90.8 million of other borrowings (primarily retail repurchase agreements), and $73.5 million of junior subordinated debentures at fair value.
- Management reported FHLB facilities with potential capacity up to $741 million in aggregate, subject to collateral and other conditions, and estimated an additional $569 million of capacity under the Federal Reserve borrower-in-custody program. No Federal Reserve borrowing was outstanding at quarter-end.
- Loan commitments and unused credit lines were substantial: commitments to extend credit were $1.018 billion, with total commitments to fund loans reported at approximately $1.063 billion. Many commitments may not be drawn.
- Regulatory capital ratios exceeded minimums. Banner Corporation reported total capital to risk-weighted assets of 16.99% and Tier 1 leverage of 13.26%; Banner Bank reported 16.02% and 12.46%, respectively. Tangible common equity to tangible assets was 12.22%, up from 11.80% at year-end.
- Six-month cash dividends paid were $2.5 million; the company declared cumulative common dividends of $0.24 per share for the first half, including $0.12 per share for Q2.
Outlook, risks and contingencies
- Management described the economic recovery as modest and uneven and expects ongoing economic stress to remain challenging. It cited continued asset-quality improvement, core revenue growth and profitability, but provided no specific numerical earnings or revenue guidance.
- Management expected modest further deposit-cost declines as certificates mature, while noting that the scope for additional reductions is limited. Rising mortgage rates may reduce refinancing activity. Prolonged low interest rates could further compress margins as asset yields decline and deposit costs have little room to fall.
- Interest-rate modeling estimated that an instantaneous +400 basis-point shock would reduce next-12-month net interest income by 1.7% and economic value of equity by 28.8%. These are model estimates dependent on assumptions; management said measured risk was within internal guidelines.
- Credit risks include housing and commercial real-estate conditions, collateral values, borrower performance and the adequacy of loan-loss reserves. In addition to $26.1 million of nonperforming loans, $104 million of other classified loans were not on nonaccrual and could migrate to that category. Performing troubled debt restructurings totaled $51.7 million.
- An IRS review of amended returns seeking approximately $9.8 million of refunds related to 2008–2009 NOL carrybacks remained unresolved. No asset was recognized for the claim; management expected resolution during 2013, but approval was uncertain.
- Management said no pending legal proceeding was expected to have a material adverse effect. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether improvement in nonperforming assets, charge-offs and REO continues, and whether the $76.9 million allowance remains adequate against classified loans and economic conditions.
- Whether core revenue growth can offset pressure on net interest margin, particularly if rates rise, mortgage refinancing slows or deposit costs reach their practical floor.
- How much of reported earnings reflects recurring operations versus fair-value movements, securities recoveries and the prior-year deferred-tax benefit; assess the company’s non-GAAP core measures alongside GAAP results.
- Deposit retention and funding needs, including certificate maturities, loan commitments, use of FHLB advances and availability of contingent borrowing capacity.
- Changes in unrealized securities losses, Level 3 valuations and assumptions for trust-preferred securities and junior subordinated debentures.
- The outcome of the IRS refund review and any regulatory examination or capital-rule changes that could affect reserves, liquidity or capital.