BANNER CORP quarterly report, Q2 FY2020

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Banner Corporation (NASDAQ: BANR) — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. Banner is a regional bank holding company operating primarily in Washington, Oregon, California, Idaho and Utah. Results include AltaPacific, acquired November 1, 2019. Unless otherwise noted, amounts are in U.S. dollars.

Financial performance and condition

  • Q2 earnings: Net income was $23.5 million, or $0.67 per diluted share, versus $39.7 million, or $1.14, in Q2 2019. First-half net income was $40.4 million, or $1.14 per diluted share, versus $73.0 million, or $2.09.
  • Revenue and interest: Q2 GAAP revenue was $147.3 million, up 6% from $139.4 million. Net interest income was $119.5 million, up 2%; total non-interest income was $27.8 million versus $22.7 million. First-half net interest income rose 3% to $238.7 million.
  • Margins: Q2 net interest margin was 3.84% on a reported basis and 3.90% tax-equivalent, compared with 4.38% and 4.44%, respectively, a year earlier. First-half tax-equivalent margin was 4.07%, versus 4.43%.
  • Credit costs and asset quality: Q2 provision for loan credit losses was $29.5 million, compared with $2.0 million a year earlier; first-half provision was $51.3 million versus $4.0 million. The loan allowance was $156.4 million, or 1.52% of loans, at June 30. Nonperforming loans were $37.4 million, compared with $39.6 million at year-end and $18.4 million a year earlier; nonperforming assets were $39.9 million, or 0.28% of assets.
  • Expenses and profitability: Q2 non-interest expense increased 3% to $89.6 million. GAAP efficiency ratio was 60.85%, versus 62.22%; adjusted efficiency ratio was 57.95%, versus 59.56%. Return on average assets was 0.68%, versus 1.36%.
  • Balance sheet: Total assets were $14.41 billion, up from $12.60 billion at December 31, 2019. Loans were $10.28 billion, up 10.5%; deposits were $12.02 billion, up 19.6%. Core deposits were $10.97 billion, or 91% of deposits.
  • Liquidity and cash flow: Cash and cash equivalents were $420.0 million, versus $307.7 million at year-end. For the first half, operating cash flow was $15.7 million, investing cash outflow was $1.62 billion and financing cash inflow was $1.71 billion. The investing outflow reflected loan growth and securities purchases; funding included substantial deposit growth.
  • Debt and capital: FHLB advances were $150.0 million, down from $450.0 million at year-end; other borrowings were $166.1 million. Banner issued $100 million of 5.000% fixed-to-floating subordinated notes due 2030, receiving about $98.1 million net. Consolidated total capital ratio was 14.15% and CET1 ratio 10.67%; tangible common equity to tangible assets was 8.76%, down from 9.77% at year-end.

Material changes versus comparable periods

  • Q2 earnings declined chiefly because of the sharply higher credit-loss provision, despite higher revenue and lower funding costs. First-half earnings also fell substantially year over year.
  • Lower market rates reduced asset yields: Q2 average yield on interest-earning assets fell to 4.19% from 4.97%, while funding costs declined. Management cited repricing of floating-rate loans and low-yield PPP loans as factors in margin compression.
  • Mortgage banking income rose to $14.1 million in Q2 from $5.9 million, reflecting stronger residential refinancing production and gain-on-sale spreads. Deposit fees and service charges fell 46% to $7.5 million, affected by Durbin Amendment interchange limits, pandemic-related fee waivers and lower transaction activity.
  • Loans and deposits grew rapidly, substantially reflecting PPP lending and related customer deposits. The AltaPacific acquisition also contributed to year-over-year balance-sheet and expense growth.
  • CECL adoption on January 1, 2020 increased the loan allowance by $7.8 million and the unfunded-commitment allowance by $7.0 million; the net-of-tax adoption adjustment reduced equity by $11.2 million.

Outlook, management commentary and risks

  • Management gave no specific earnings or financial guidance. It said pandemic-related expenses could increase in coming quarters depending on the duration of COVID-19, and expected near-term net interest income and margin pressure from the pandemic and low rates.
  • At June 30, Banner had modified 3,314 loans totaling $1.10 billion; about 62% had completed their initial deferral period. These modifications were not treated as TDRs under applicable relief guidance. Banner had funded 8,655 PPP loans totaling $1.12 billion; the loans were SBA-guaranteed and carried no loan-loss allowance at quarter-end. PPP forgiveness and administration remain subject to evolving rules.
  • Management attributed the elevated credit provision to current conditions, forecast economic deterioration and COVID-related risk-rating downgrades. The allowance depends on forecasts and other estimates and may change materially. Classified loans not on nonaccrual totaled $288.1 million; management noted that some could later become nonperforming.
  • COVID-19 risks include borrower defaults, prolonged recession, reduced business activity, operational and cybersecurity issues from remote work, third-party disruptions and pressure on liquidity, earnings and capital. The filing also warns that sustained adverse conditions or stock-price weakness could trigger goodwill impairment.
  • Banner suspended further share repurchases to preserve capital. The board’s repurchase authorization expired in March 2020 and was not expected to be renewed. The filing announced plans, subject to regulatory approval, to merge Islanders Bank into Banner Bank in Q1 2021.
  • Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter, apart from controls related to CECL implementation. It reported no pending legal proceeding expected to have a material adverse effect.

Important facts for investors to verify

  • How borrower payment performance develops as loan deferrals end, particularly across commercial real estate, commercial business and other COVID-sensitive exposures.
  • Whether the $156.4 million loan allowance and $10.6 million unfunded-commitment allowance remain adequate as economic forecasts, risk ratings and charge-offs change.
  • PPP loan forgiveness timing, servicing costs and compliance with changing SBA requirements.
  • Whether low rates, PPP loan yields, deposit repricing and continued refinancing activity sustain pressure on net interest margin and fee income.
  • Deposit stability after pandemic-related and PPP-related balances normalize, and refinancing or maturity needs for certificates of deposit and borrowings.
  • Capital trends after the decline in tangible common equity ratio, suspended buybacks and subordinated-note issuance; also verify any future dividend or repurchase decisions.