BANNER CORP quarterly report, Q3 FY2011

Banner Corporation — Q3 2011 Form 10-Q

Reporting period: Three and nine months ended September 30, 2011; balance-sheet comparisons are to December 31, 2010. Amounts below are in millions of dollars unless stated otherwise. Banner is a Washington bank holding company operating Banner Bank and Islanders Bank, primarily in Washington, Oregon and Idaho.

Financial performance and position

Metric	Q3 2011	Q3 2010	Nine months 2011	Nine months 2010
Net interest income before loan-loss provision	$41.7	$39.9	$123.0	$117.0
Loan-loss provision	$5.0	$20.0	$30.0	$50.0
Net income (loss)	$6.0	$(42.7)	$0.4	$(49.2)
Net income (loss) available to common shareholders	$4.1	$(44.7)	$(5.5)	$(55.1)
Diluted earnings (loss) per common share	$0.24	$(2.83)	$(0.33)	$(7.31)

Interest and margins: Q3 net interest margin was 4.10%, up 47 basis points year over year; nine-month margin was 4.04%, up 41 basis points. Q3 interest income fell 9% to $49.6 million, but interest expense fell 45% to $7.8 million, primarily reflecting lower deposit costs and a shift toward core deposits.
Other income and expenses: Q3 total other operating income was $10.3 million, including a $3.0 million recovery of a prior-period securities impairment and a $1.0 million loss from fair-value changes. Core other operating income excluding impairment and fair-value items was $8.4 million, down from $9.3 million. Q3 operating expenses declined 11% to $41.0 million, mainly due to lower real-estate-owned (REO) costs. Nine-month expenses were $119.4 million, broadly flat year over year.
Balance sheet at September 30: Assets were $4.292 billion, down 3% from year-end 2010. Net loans were $3.139 billion, down 5%; deposits were $3.537 billion, down 1.5%; stockholders’ equity was $521.5 million. Cash and due from banks totaled $288.3 million.
Credit quality: Nonperforming assets were $151.6 million, or 3.53% of assets, versus $254.3 million and 5.77% at year-end 2010. Nonperforming loans were $83.1 million. The allowance for loan losses was $86.1 million, 2.67% of loans and 104% of nonperforming loans. REO was $66.5 million.
Debt and funding: Deposits were the principal funding source. FHLB advances were $10.6 million; other borrowings were $139.7 million, including $89.6 million of customer repurchase agreements and $50 million of FDIC-guaranteed senior notes; junior subordinated debentures were $48.8 million. Total borrowings, including the debentures, declined from $267.8 million at year-end to $199.0 million.
Cash flow, nine months: Operating activities provided $74.4 million; investing activities used $31.7 million; financing activities used $116.0 million. Cash and due from banks decreased $73.3 million to $288.3 million. Financing outflows included deposit and borrowing reductions and $7.1 million of dividends; securities purchases were a major investing use.
Capital: Banner Corporation’s Tier 1 leverage ratio was 13.19%; Banner Bank’s was 11.61%, above the 10% minimum required under its regulatory MOU. The filing states the Company and both banks exceeded applicable regulatory capital requirements.

Material changes versus comparable periods

Q3 returned to profitability, versus a substantial loss in Q3 2010; year-to-date net income was slightly positive, but preferred dividends and discount accretion left a loss attributable to common shareholders.
Loan-loss provision fell to $5.0 million in Q3 and $30.0 million year to date, from $20.0 million and $50.0 million, respectively. Nonperforming assets declined materially, though credit costs and REO impairments remained significant.
Core deposits increased $191 million from December 2010 and rose to 63% of deposits; total deposits nevertheless declined $54 million as certificates of deposit ran off. Certificates were $1.313 billion, with $1.045 billion scheduled to mature within one year.
Net loans contracted $167 million from year-end, particularly in land and land development, residential mortgage, and construction lending. Securities increased $181 million to $548 million.
The allowance declined from $97.4 million at year-end. The filing reports nine-month net charge-offs of $41.3 million, compared with $48.8 million in 2010.

Outlook, risks and unusual items

Management said credit indicators had improved and expected credit costs, though still elevated by historical standards, to have less adverse impact as problem assets decline. It described economic recovery as modest and uneven and said loan demand remained modest; it anticipated construction and land balances would continue to decline in the near term, with potential stabilization and growth in other lending if conditions improve. No numerical earnings or revenue guidance was provided.
Banner Bank and the holding company remain subject to regulatory memoranda of understanding. The bank MOU requires, among other measures, a Tier 1 leverage ratio of at least 10%, plans to reduce commercial real estate concentrations and classified assets, and restrictions on dividends to the parent. The holding company is restricted from paying common or preferred dividends or paying principal or interest on junior subordinated debentures without prior written regulatory non-objection.
On October 25, 2011, Banner filed amended federal tax returns seeking up to $13.6 million in refunds. IRS review and approval are uncertain; no related asset or tax benefit was recorded as of September 30.
A full valuation allowance remained against the net deferred tax asset; no income-tax expense or benefit was recorded for the 2011 quarter or nine-month period. Fair-value estimates for certain trust-preferred securities and subordinated debentures rely on significant unobservable inputs. Management reported $32 million of current par value in trust-preferred securities and disclosed a nonaccrual trading security with $4.3 million amortized cost and $1.4 million fair value.
Interest-rate sensitivity modeling estimated that an immediate, sustained 100-basis-point rise would increase next-12-month net interest income by 1.0%, while a 400-basis-point rise would reduce it by 0.4%; modeled economic value of equity declined under rising-rate scenarios. These estimates depend on management assumptions.
The company completed a 1-for-7 reverse stock split effective June 1, 2011. It raised $13.7 million through its dividend reinvestment/direct stock purchase plan during the first nine months. Management reported disclosure controls were effective and no material internal-control change during the quarter. No pending legal proceeding was identified as expected to materially affect the Company.

Important facts for investors to verify

Whether the reduction in nonperforming assets, charge-offs and loan-loss provisions continues, and whether the $86.1 million allowance remains adequate given continuing housing-market and collateral-value risks.
How much of the potential $13.6 million tax refund, if any, the IRS approves and when any benefit may be recognized.
Compliance with both regulatory MOUs, including Banner Bank’s 10% Tier 1 leverage requirement and restrictions on dividends and debt payments.
Deposit retention and repricing, upcoming certificate maturities, liquidity needs, and the maturity of the $50 million FDIC-guaranteed senior notes in March 2012.
Fair-value assumptions for less-liquid securities and subordinated debt, plus the actual effects of interest-rate changes on earnings and economic value.
The filing’s cover page marks the Company as a “shell company,” despite its description of operating subsidiary banks; verify this apparent reporting inconsistency against the original filing.