Banner Corporation — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Banner is a Washington-based bank holding company operating Banner Bank and Islanders Bank, focused on commercial banking, lending, deposits, and mortgage banking. Amounts below are in millions unless noted.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income, before loan-loss provision | $43.8 | $42.2 | $86.1 | $83.2 |
| Net interest margin | 4.06% | 4.20% | 4.06% | 4.18% |
| Total operating income | $20.1 | $10.6 | $29.0 | $20.6 |
| Operating expenses | $38.4 | $35.5 | $74.0 | $69.6 |
| Net income | $17.0 | $11.8 | $27.6 | $23.3 |
| Diluted EPS | $0.88 | $0.60 | $1.42 | $1.20 |
Q2 total revenue was $63.9 million versus $52.9 million. Excluding the branch-acquisition bargain gain, fair-value changes, and securities gains or losses, management’s non-GAAP core revenue measure was $54.4 million, up 2% year over year. No loan-loss provision was recorded in either Q2 or the first half. The filing reports Q2 return on average assets of 1.51% and return on average equity of 12.29%.
Financial condition, cash flow, and capital
- At June 30, total assets were $4.745 billion, net loans $3.688 billion, deposits $3.919 billion, and stockholders’ equity $563 million. Since December 31, 2013, assets increased 8%, net loans 10%, and deposits 8%.
- Deposits included $1.210 billion non-interest-bearing, $1.772 billion interest-bearing transaction and savings accounts, and $937 million certificates of deposit. Core deposits were 76% of total deposits. Brokered deposits rose to $88 million from $4 million at year-end.
- Borrowings included $45 million of FHLB advances, $89 million of other borrowings (primarily retail repurchase agreements), and $77 million of junior subordinated debentures carried at fair value.
- First-half cash flow: $40.7 million provided by operations, $137.9 million used in investing, and $106.4 million provided by financing. Cash and due from banks increased $9.2 million to $146.6 million.
- Regulatory capital exceeded well-capitalized thresholds at both banks. Banner Bank’s total risk-based capital ratio was 15.08% and Tier 1 leverage ratio 12.50%; Islanders Bank’s were 19.26% and 13.96%, respectively. Tangible common equity to tangible assets was 11.79%, versus 12.23% at year-end.
- Available liquidity included FHLB credit facilities and approximately $680 million of FRBSF borrowing capacity under the Borrower-In-Custody program; no FRBSF funds were borrowed at quarter-end.
Material changes and unusual items
- Banner completed the purchase of six Oregon branches from Umpqua Bank on June 20, adding approximately $212 million in deposits, $88 million in loans, and 10,500 customer relationships. The acquisition generated a $9.1 million bargain purchase gain and $2.0 million of related expenses; management estimated a net earnings benefit of $4.5 million, or $0.23 per diluted share.
- On June 30, Banner terminated its proposed Idaho Banking Company acquisition after another bidder prevailed in the bankruptcy-court auction; Banner stated it would be reimbursed for transaction expenses.
- After quarter-end, on August 7, Banner announced a definitive agreement to acquire Siuslaw Financial Group for approximately $57.5 million in consideration, about 90% stock and 10% cash, subject to approvals and other conditions. Closing was anticipated in late Q4 2014.
- Q2 net interest income rose 4%, but margin fell 14 basis points year over year as asset yields declined. Deposit costs fell, partly offsetting lower asset yields. Lower mortgage refinancing activity reduced mortgage banking revenue.
- Asset quality improved: nonperforming loans were $19.7 million, down 24% year over year; nonperforming assets were $24.2 million, or 0.51% of assets. The $74.3 million allowance equaled 1.97% of loans and 376% of nonperforming loans. Performing troubled debt restructurings totaled $37.5 million; an additional $62 million of classified loans were not on nonaccrual.
- Fair-value gains included a $2.9 million gain on a trust-preferred CDO following a post-quarter-end auction, plus a gain on single-issuer trust-preferred securities; fair-value losses on junior subordinated debentures partly offset gains. These valuations rely on significant unobservable inputs.
Outlook, risks, and contingencies
Management described economic expansion as modest and uneven and expected continued pressure from low interest rates. It anticipated only modest further deposit-cost reductions, with limited remaining opportunity, and warned that prolonged low rates could compress margins as asset yields reset downward. Management stated that liquidity and capital were adequate and that interest-rate risk was within internal policy limits; its modeling estimated a 0.5% decline in next-12-month net interest income under a +100-basis-point shock and a 0.7% decline under +400 basis points.
Key risks include borrower defaults and real-estate values, adequacy of loan-loss reserves, interest-rate and funding pressures, deposit retention and competition, regulatory examinations and capital-rule changes, fair-value estimation uncertainty, and operational, cybersecurity, litigation, and acquisition-integration risks. The company reported no pending legal proceeding it believed would materially affect financial condition or operations, and no material change in previously reported risk factors. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- How much of reported earnings growth is attributable to the one-time $9.1 million bargain purchase gain, and whether acquired branches deliver the expected benefits.
- Whether loan growth can be sustained without deterioration in credit quality, and whether the $74.3 million allowance remains adequate as classified and restructured loans evolve.
- Trends in net interest margin and funding mix, particularly brokered deposits, certificate maturities, and the effect of interest-rate changes.
- Assumptions and subsequent developments behind Level 3 trust-preferred security and debenture valuations.
- Regulatory and shareholder approvals, final consideration, integration costs, and timing for the proposed Siuslaw acquisition.