Banner Corporation — Q1 2018 Form 10-Q
Business context and reporting period. Banner is a regional bank holding company operating Banner Bank and Islanders Bank in the Pacific Northwest and other western states. This unaudited filing covers the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017, and earnings comparisons with Q1 2017. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2018 / March 31, 2018 | Comparable period / prior year-end |
|---|---|---|
| Net income | $28.8 million; diluted EPS $0.89 | Q1 2017: $23.8 million; $0.72 per diluted share |
| Net interest income | $99.4 million; net interest margin 4.35% | Q1 2017: $94.9 million; 4.25% margin |
| Total revenue | $120.7 million | Q1 2017: $113.9 million |
| Non-interest income | $21.4 million, including a $3.3 million fair-value gain | Q1 2017: $19.0 million, including a $0.7 million fair-value loss |
| Non-interest expense | $81.7 million | Q1 2017: $76.3 million |
| Income tax expense / effective rate | $8.2 million / 22.3% | Q1 2017: $11.8 million / 33.2% |
| Total assets | $10.32 billion | December 31, 2017: $9.76 billion |
| Loans receivable, gross | $7.56 billion | December 31, 2017: $7.60 billion |
| Total deposits | $8.54 billion | December 31, 2017: $8.18 billion |
| Cash and cash equivalents | $242.0 million | December 31, 2017: $261.2 million |
| Shareholders’ equity | $1.25 billion | December 31, 2017: $1.27 billion |
Cash flow, margins, debt and asset quality
- Cash flow: Operating activities used $74.8 million, versus $185.8 million provided in Q1 2017. Investing activities used $478.3 million, principally reflecting securities purchases. Financing activities provided $534.0 million, including $359.6 million of net deposit growth and $192.0 million of net short-term FHLB advances. Cash and cash equivalents declined $19.2 million during the quarter.
- Profitability and costs: Net interest margin rose 10 basis points year over year to 4.35%. The reported efficiency ratio worsened to 67.67% from 66.97%; the company’s adjusted, non-GAAP ratio was 67.42% versus 65.30%. Return on average assets was 1.16%, compared with 0.97%.
- Borrowings: At March 31, FHLB advances were $192.2 million, other borrowings $101.8 million, and junior subordinated debentures at fair value $112.5 million. FHLB advances had been just $0.2 million at year-end. The increase in the debentures’ carrying value included a $13.8 million fair-value change related to issuer-specific credit risk, recorded in other comprehensive income under newly adopted accounting guidance.
- Credit quality: The allowance for loan losses was $92.2 million, or 1.22% of gross loans, against $89.0 million, or 1.17%, at year-end. Nonperforming loans were $22.5 million, down from $27.0 million at year-end but above $18.1 million a year earlier. Nonperforming assets were $23.5 million, or 0.23% of assets. The quarter’s $2.0 million loan-loss provision matched both Q1 2017 and Q4 2017; net loan recoveries were $1.2 million.
- Capital and liquidity: Tangible common equity was $990.2 million, or 9.85% of tangible assets, versus 10.61% at year-end. Banner and both subsidiary banks exceeded applicable “well-capitalized” regulatory thresholds. Management stated that it believed liquidity resources were adequate; it reported available FHLB and Federal Reserve borrowing capacity subject to collateral and other conditions.
Material changes versus comparable periods
- Net income increased about 21% year over year. Management attributed the improvement to growth in interest-earning assets, higher asset yields and margin, fair-value gains on trading securities, and the lower federal corporate tax rate. Core earnings, a company-defined non-GAAP measure, were $26.3 million, or $0.81 per diluted share, versus $24.2 million, or $0.73.
- Non-interest expense rose 7%, principally due to compensation and staffing for compliance and risk-management infrastructure ahead of crossing the $10 billion asset threshold, as well as wage increases. The prior-year period also benefited from a gain on sale of real estate owned.
- Q1 total assets increased $554.1 million as Banner resumed balance-sheet growth after its strategy to remain below $10 billion through year-end 2017. Securities increased $492.7 million from year-end, largely through purchases of agency mortgage-backed securities. Management said the expansion was funded mainly by deposits and, to a lesser extent, borrowings.
- Loans held for sale rose to $141.8 million from $40.7 million at year-end, largely reflecting strong multifamily loan production and no sales of those loans in the quarter. The loan portfolio itself declined $42.8 million from year-end, including seasonal declines in agriculture and commercial real estate.
- Available-for-sale securities had $22.4 million of gross unrealized losses at quarter-end, compared with $8.6 million at year-end; management attributed the decline in fair value primarily to higher interest rates and market spreads and said it did not consider the losses other-than-temporary. AOCI nevertheless improved from a $5.0 million loss to $1.4 million of income, reflecting accounting reclassification effects as well as other changes.
Outlook, commentary and risks
- No specific numerical earnings or revenue guidance was provided. Management described its strategy as pursuing growth in interest-earning assets and deposits while maintaining a moderate risk profile and strong asset quality.
- Management cautioned that rising rates could cause deposit costs to increase faster than yields on earning assets, compressing net interest margin and net interest income. Its modeled scenarios estimated higher net interest income under instantaneous rate increases, but lower economic value of equity; a 400-basis-point increase corresponded to an estimated 19.4% decrease in economic value of equity. These are model estimates, not forecasts.
- Credit risks include potential deterioration in regional economic and real-estate conditions, borrower repayment capacity, collateral values, and the possibility that reserves prove insufficient. The company also identified $87.0 million of additional classified loans not on nonaccrual status as credits of concern.
- Other disclosed risks include deposit competition and retention, regulatory and compliance costs, market and fair-value estimation uncertainty, interest-rate exposure, technology and third-party service disruptions, and litigation. Management reported no pending legal proceeding it believed would materially adversely affect financial condition or operations, and no material change to previously disclosed risk factors.
- Banner early adopted financial-instrument guidance that moved changes in the debentures’ instrument-specific credit risk from earnings to other comprehensive income and required equity securities’ fair-value changes through earnings. It also adopted revenue-recognition guidance; the principal effect was net presentation of merchant-services costs against fee income, with no change to the timing or total amount of revenue recognized.
- The company was preparing for new lease accounting, which it expected to increase reported assets and liabilities for operating leases, and was evaluating the expected-credit-loss standard. Management said the latter could increase the loan-loss allowance, but had not quantified the effect.
Important facts for investors to verify
- Whether deposit growth and funding costs can sustain the expanded securities and interest-earning-asset strategy, particularly as rates rise and brokered deposits increased to $169.5 million from $57.2 million at year-end.
- How much of reported earnings growth is repeatable: Q1 included a $3.3 million trading-securities fair-value gain and benefited from a lower tax rate; core earnings and core revenue are non-GAAP measures.
- Whether asset quality and reserve coverage remain adequate, including trends in the $87.0 million of classified loans not on nonaccrual and the impact of forthcoming expected-credit-loss accounting.
- The effect of securities valuation changes on equity and the sensitivity of economic value of equity to interest-rate movements; review management’s assumptions behind its interest-rate simulations.
- Capital and liquidity headroom after the company crossed $10 billion in assets, including the costs and requirements of enhanced regulation, capital distributions, share repurchases, and the large outstanding loan commitments.
- The filing reports $2.39 billion of commitments to extend credit at March 31, while MD&A describes total outstanding loan commitments of approximately $2.52 billion; investors should check the definitions and reconciliation of these amounts.