Columbia Banking System, Inc. — 2011 Q2 Form 10-Q Summary
Business context and reporting period
Columbia Banking System, Inc., through Columbia Bank, is a commercial banking organization primarily serving Washington and Oregon. This unaudited Form 10-Q covers the three and six months ended June 30, 2011, with comparisons to the same periods in 2010 and balance-sheet comparisons to December 31, 2010.
During the quarter, the Bank completed FDIC-assisted acquisitions of Summit Bank on May 20, 2011 and First Heritage Bank on May 27, 2011. The acquisitions expanded the company’s geographic footprint between Seattle and Bellingham, Washington. Acquired assets and liabilities were recorded provisionally at estimated fair value and included FDIC loss-sharing arrangements covering 80% of specified losses and recoveries.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Change |
|---|---|---|---|
| Net interest income | $49.4 million | $40.7 million | Up 21% |
| Total noninterest income | $3.5 million | $13.2 million | Down $9.7 million |
| Net income applicable to common shareholders | $8.6 million | $3.9 million | Up 119% |
| Diluted EPS | $0.22 | $0.11 | Up $0.11 |
| Net interest margin | 5.49% | 4.66% | Up 83 basis points |
| Noninterest expense | $37.2 million | $34.7 million | Up 7% |
| Return on average assets | 0.80% | 0.47% | Improved |
| Return on average common equity | 4.81% | 2.59% | Improved |
For the six months ended June 30, 2011, net income applicable to common shareholders was $14.4 million, or $0.36 diluted EPS, compared with $10.8 million, or $0.34 diluted EPS, in the prior-year period. Net interest income was $99.8 million versus $79.0 million, and net interest margin was 5.64% versus 4.72%.
Revenue, defined by management as net interest income plus noninterest income, was $52.9 million in the second quarter, down 2% year over year, and $97.9 million for the first six months, down 12%. The filing attributes the decline primarily to unfavorable changes in the FDIC loss-sharing asset, partly offset by acquired-loan accretion income of approximately $8.9 million in the quarter and $21.3 million year to date.
Balance sheet, credit quality, cash flow and liquidity
| Balance-sheet item | June 30, 2011 | December 31, 2010 |
|---|---|---|
| Total assets | $4.43 billion | $4.26 billion |
| Total loans, net | $2.54 billion | $2.37 billion |
| Noncovered loans, net | $1.93 billion | $1.85 billion |
| Covered loans, net | $607.3 million | $517.1 million |
| Securities available for sale | $989.8 million | $763.9 million |
| Total deposits | $3.48 billion | $3.33 billion |
| Shareholders’ equity | $727.7 million | $706.9 million |
| Cash and cash equivalents | $269.5 million | $514.1 million |
- Noncovered nonaccrual loans declined to $59.4 million from $89.2 million at year-end 2010.
- Total nonperforming assets excluding covered assets declined to $103.2 million, or 2.72% of period-end noncovered assets, from $126.7 million, or 3.40%.
- The noncovered allowance for loan and lease losses was $54.1 million, or 2.72% of noncovered loans, compared with $61.0 million, or 3.18%, at year-end.
- Second-quarter noncovered net charge-offs were $3.4 million versus $10.7 million in the prior-year quarter. Six-month net charge-offs were $9.1 million versus $22.2 million.
- Six-month operating cash flow was $42.5 million, compared with $38.2 million in 2010. Investing activities used $138.2 million, primarily reflecting securities purchases, while financing activities used $149.0 million. Cash and cash equivalents decreased by $244.6 million during the first six months.
- Core deposits increased approximately $144.5 million, or 5%, from year-end. Brokered and other wholesale deposits were $48.9 million, approximately 1% of total deposits.
- At June 30, 2011, FHLB advances were approximately $120.2 million before acquisition-date fair-value adjustments, repurchase agreements were $25.0 million, and long-term subordinated debt was $25.8 million.
- Commitments to extend credit were $644.2 million, compared with $612.0 million at year-end.
- The company and Columbia Bank qualified as well-capitalized. At the company level, total risk-based capital was 24.15%, Tier 1 risk-based capital was 22.89%, and the leverage ratio was 14.19%.
Material changes versus prior comparable periods
- Profitability improved substantially because of higher net interest income, lower noncovered loan-loss provisions, and reduced net charge-offs.
- Net interest income benefited materially from accretion of discounts on acquired loans; management stated that accretion increased the second-quarter net interest margin by approximately 0.96 percentage points.
- Noninterest income fell sharply because the FDIC loss-sharing asset generated a $6.4 million reduction in income in the second quarter, compared with a $3.4 million increase in the prior-year quarter. For the first six months, the comparable change was a $21.2 million unfavorable variance.
- Noninterest expense increased because of the Summit Bank and First Heritage acquisitions, added banking teams, higher compensation, and FDIC clawback expense.
- The allowance for noncovered loans declined despite a $2.2 million second-quarter provision, reflecting charge-offs, loan growth and improving reported asset quality.
- Investment securities increased by $225.9 million from year-end as management invested in short-term, high-quality debt instruments. The portfolio had a $21.5 million net-of-tax unrealized gain at June 30, 2011.
Outlook, commentary, risks and unusual items
The filing does not provide formal earnings or revenue guidance. Management indicated continued focus on commercial relationship banking, internal growth, selective FDIC-assisted acquisitions and disciplined deployment of capital. Management also cautioned that the level of second-quarter provisioning does not necessarily signal a trend.
- The Summit Bank and First Heritage acquisition accounting remained provisional at June 30, 2011, particularly for acquired loans and related FDIC indemnification assets.
- The FDIC loss-sharing asset was $206.2 million. Its value depends on estimates of future loan losses, recoveries, prepayments and other cash flows.
- The company recorded a $2.1 million present-value FDIC clawback liability, including a $448 thousand second-quarter expense. The liability could change based on projected losses over the applicable loss-sharing periods.
- Noncovered OREO was $22.7 million, and covered OREO was $24.2 million. Noncovered OREO incurred additional write-downs during the period.
- Management identified risks from Washington and Oregon economic conditions, real-estate concentration, borrower delinquencies, collateral values, interest-rate changes, liquidity, regulatory requirements, FDIC insurance costs, acquisition integration, goodwill impairment and the adequacy of loan-loss reserves.
- Subsequent to quarter-end, the company redeemed junior subordinated debentures and terminated two trusts for cash payments of $3.1 million on July 7, 2011 and $22.9 million on July 29, 2011.
- The company declared a quarterly common-stock dividend of $0.06 per share on July 28, 2011, payable August 24, 2011.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. Routine litigation was not expected to have a material adverse effect based on information then known.
Investor verification checklist
- Verify the final purchase accounting for Summit Bank and First Heritage Bank, including acquired-loan fair values, goodwill, core deposit intangibles and FDIC indemnification assets.
- Monitor FDIC loss-sharing asset realizations, future covered-loan provisions and the potential FDIC clawback liability.
- Assess whether improved nonaccrual loans, nonperforming assets and charge-offs persist after acquisition-related effects and loan accretion are normalized.
- Reconcile reported net interest margin and earnings with acquired-loan accretion, which materially enhanced current-period results.
- Evaluate commercial real estate, commercial business and construction-loan concentrations, collateral values and reserve coverage.
- Review liquidity after the post-quarter-end debt redemptions and the decline in cash and cash equivalents.
- Track securities valuation, unrealized gains and potential other-than-temporary impairment, including the $18.8 million FHLB stock position.
- Confirm future dividend capacity, capital ratios and the effect of any additional acquisitions or capital raising.