Banner Corporation — Q2 2012 Form 10-Q
Business context and reporting period. Banner Corporation is a Washington bank holding company operating Banner Bank and Islanders Bank, serving Washington, Oregon and Idaho. This unaudited filing covers the quarter and six months ended June 30, 2012; balance-sheet comparisons are with December 31, 2011 unless noted. Amounts below are in millions except per-share data and ratios.
Financial results and condition
| Metric | Q2 2012 | Comparable period / change |
|---|---|---|
| Net interest income before loan-loss provision | $42.3 | $41.2 in Q2 2011 |
| Net interest margin | 4.26% | 4.09% in Q2 2011 |
| Loan-loss provision | $4.0 | $8.0 in Q2 2011 |
| Other operating income (loss), including fair-value changes | $(9.1) | $9.3 in Q2 2011 |
| Other operating expenses | $35.7 | $40.3 in Q2 2011 |
| Net income | $25.4 | $2.2 in Q2 2011 |
| Net income available to common shareholders | $23.4; $1.27 per diluted share | $0.2; $0.01 per diluted share in Q2 2011 |
- For the first six months, net income was $34.6 million, versus a $5.6 million net loss in 2011; income available to common shareholders was $30.6 million, or $1.69 per diluted share, versus a $9.6 million loss, or $0.58 per share.
- The results include a $31.8 million income-tax benefit from reversing nearly all of the deferred-tax valuation allowance and a $19.1 million net fair-value loss. Management reported Q2 pretax income of $12.6 million excluding fair-value adjustments, a non-GAAP measure; GAAP pretax results were a $6.4 million loss.
- Core revenues excluding fair-value adjustments were $52.3 million in Q2, up 8% from $48.5 million; the reported total including fair-value adjustments was $33.2 million, versus $50.5 million. Six-month core revenues were $102.7 million, versus $95.6 million.
- For the six months, net interest income before provision was $83.4 million, versus $81.3 million; net interest margin was 4.19%, versus 4.01%. Provision for loan losses was $9.0 million, versus $25.0 million.
Balance sheet, cash flow and capital
- Total assets were $4.221 billion; net loans were $3.132 billion, down $81 million from year-end. Deposits were $3.426 billion, down $50 million. Non-interest-bearing deposits rose $27 million to $805 million; transaction and savings accounts made up 66% of deposits. Brokered deposits were $23.5 million, or 0.7% of deposits.
- Cash and due from banks totaled $189.2 million, up from $132.4 million at year-end. Six-month operating cash flow was $39.6 million; investing activities provided $109.0 million and financing activities used $91.9 million, for a $56.7 million net increase in cash.
- Total borrowings, including retail repurchase agreements, FHLB advances and junior subordinated debentures, were approximately $171 million, down from $213 million. The company repaid $50 million of TLGP-guaranteed notes at maturity in March. Junior subordinated debentures were carried at fair value of $70.6 million, up from $50.0 million at year-end, primarily due to a change in valuation assumptions—not new borrowing.
- Stockholders’ equity was $587.2 million, up $54.7 million. The increase included $23.6 million from issuance of 1.24 million shares through the stockholder reinvestment plan. Tangible common equity to tangible assets was 10.92%, a non-GAAP measure. Banner Corporation and both banks exceeded regulatory capital requirements; Banner Bank and Islanders Bank reported total risk-based capital ratios of 16.97% and 16.79%, respectively.
- Management reported $892 million in outstanding loan commitments, including undisbursed loans and unused credit lines. Available borrowing capacity included estimated FHLB facilities and $562 million under the FRBSF Borrower-In-Custody program; no FRBSF funds were borrowed at quarter-end.
Material changes and management commentary
- Asset quality improved: non-performing assets fell to $73.2 million, or 1.73% of assets, from $118.9 million at year-end and $188.4 million a year earlier. Non-performing loans were $47.4 million; REO was $25.8 million. The allowance for loan losses was $80.2 million, equal to 2.50% of loans and 169% of non-performing loans.
- Management attributed lower credit costs to declining delinquencies, non-performing loans and charge-offs, while cautioning that provisioning remained above historical levels and economic and property-market weakness could cause further losses. Classified loans not on nonaccrual totaled a further $120 million. Performing troubled debt restructurings were $58.0 million.
- Net interest margin improved as deposit funding costs fell and fewer non-performing assets reduced the drag on earnings. Lower asset yields and a modestly smaller average earning-asset base partly offset the benefit. Mortgage banking revenue rose with refinancing activity; management cited modest commercial and consumer loan demand.
- Management reversed nearly all of the deferred-tax valuation allowance, reducing it to $7.0 million from $38.2 million. It expects to use the remaining allowance against projected tax expense in Q3 and Q4 2012, and expects tax expense at approximately the statutory rate beginning in 2013, subject to tax-exempt income and credits. Realization of deferred tax assets depends on future taxable income.
- The fair-value changes were non-cash. Management reduced the discount-rate assumptions for certain trust-preferred securities and junior subordinated debentures based on improved performance expectations; the debenture revaluation contributed most of the Q2 fair-value loss. These Level 3 valuations rely on significant unobservable assumptions.
- Regulatory memoranda of understanding with the FDIC/Washington DFI and the Federal Reserve Bank of San Francisco were terminated in March and April 2012, respectively. The U.S. Treasury sold the company’s $124 million of preferred stock to other investors; the sale generated no proceeds for Banner and did not change its capital position. The Treasury retained warrants to purchase up to $18.6 million of common stock.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management expects continued improvement in operating results from lower credit costs and core revenue trends, and anticipates modest further declines in deposit costs. It also notes that recovery remains uneven, with low interest rates, high unemployment, weak loan demand and housing and commercial real-estate risks likely to affect results. Principal risks include loan-credit deterioration, collateral values, interest-rate and funding sensitivity, deposit retention, valuation estimates, regulatory actions, and operational, cybersecurity and litigation risks. Management said there were no material changes to previously disclosed risk factors and no pending legal proceeding believed likely to materially adversely affect the company.
The company has $847.6 million of commitments to extend credit, $6.0 million of standby letters of credit, and $83.8 million of commitments to originate loans held for sale; these amounts do not necessarily represent future cash needs. Amended federal tax returns under IRS review could result in refunds of up to $13.6 million, but no asset was recognized and the outcome is uncertain. Management reported no material control changes and concluded disclosure controls were effective.
Important facts for investors to verify
- How much reported profitability depends on the one-time $31.8 million tax benefit, and whether deferred tax assets are realizable through future taxable income.
- Whether the improved non-performing asset trend continues, and the adequacy of the $80.2 million loan-loss allowance given classified loans and ongoing regional property risks.
- The assumptions and sensitivity underlying Level 3 valuations, particularly the $70.6 million junior subordinated debenture fair value and trust-preferred securities.
- Whether lower funding costs and stronger core revenues can offset lower asset yields, loan contraction and subdued loan demand.
- Deposit stability, upcoming certificate maturities, liquidity against commitments, and the effect of preferred dividends and potential Treasury warrant dilution.