BANNER CORP annual report, FY2017

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Banner Corporation — FY2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017; the filing also reports unaudited fourth-quarter results. Banner Corporation is a bank holding company operating Banner Bank and Islanders Bank, primarily across Washington, Oregon, California and Idaho.

Financial performance and condition

  • Revenue and net interest: Total revenue, defined as net interest income before loan-loss provision plus non-interest income, was $486.6 million, up 6% from $458.5 million. Net interest income before provision rose 5% to $393.0 million. Net interest margin increased to 4.24% from 4.20%; the 2017 margin included 10 basis points from acquisition-accounting adjustments.
  • Profit: Net income was $60.8 million ($1.84 diluted EPS), versus $85.4 million ($2.52) in 2016. Pre-tax income increased to $151.3 million from $129.6 million. The 2017 result included a $42.6 million tax charge to revalue deferred tax assets following the Tax Cuts and Jobs Act. Excluding specified items, management-reported core earnings were $98.8 million, or $2.99 diluted EPS; these are non-GAAP measures.
  • Fourth quarter: Banner reported a $13.5 million net loss, or $(0.41) per diluted share, versus fourth-quarter 2016 net income of $22.8 million, or $0.69 per diluted share. The 2017 quarter included $55.0 million of income tax expense, including the tax-law revaluation.
  • Expenses and credit costs: Non-interest expense was $327.3 million, up 1%; higher salaries and professional services, including regulatory-compliance and risk infrastructure costs, were partly offset by no acquisition-related costs (versus $11.7 million in 2016). Loan-loss provision was $8.0 million versus $6.0 million.
  • Assets and lending: Total assets were $9.76 billion, slightly below $9.79 billion in 2016. Net loans increased 2% to $7.51 billion; investment securities were $1.20 billion. Commercial and multifamily real estate loans were approximately 47% of total loans, and construction, land and development loans were 12%.
  • Asset quality: Non-performing loans increased to $27.0 million from $22.6 million, while non-performing assets declined to $27.5 million from $33.8 million, or 0.28% of assets. The $89.0 million allowance equaled 1.17% of loans and 329% of non-performing loans. Net charge-offs were $5.0 million, compared with net recoveries of $2.0 million in 2016.
  • Deposits and liquidity: Deposits rose 1% to $8.18 billion; core deposits were 88% of deposits, up from 87%. Non-interest-bearing deposits increased to $3.27 billion, while certificates of deposit fell to $966.9 million. Cash and cash equivalents were $261.2 million. The company reported $1.15 billion of available Federal Reserve borrowing capacity for Banner Bank, subject to collateral and eligibility.
  • Debt and capital: Year-end borrowings were $194.8 million, including $95.9 million of repurchase agreements, $98.7 million fair value of junior subordinated debentures, and $0.2 million of FHLB advances. The debentures had $136.0 million principal value. Banner Corporation’s total risk-based capital ratio was 13.81%; Banner Bank and Islanders Bank were reported as well capitalized. Tangible common equity to tangible assets was 10.61%, a non-GAAP measure.
  • Cash flow: Operating activities provided $346.7 million in 2017, versus using $75.8 million in 2016. Investing activities used $393.3 million; financing activities provided $60.1 million. Cash and cash equivalents increased $13.5 million to $261.2 million. Cash-flow movements reflect significant loan-sale and securities activity and should be read in the context of banking operations.

Material changes and significant events

  • Banner sold seven Utah branches on October 6, 2017, transferring $253.8 million of loans and $160.3 million of deposits. The sale generated a $12.2 million net gain.
  • In the fourth quarter, Banner restructured its balance sheet to keep year-end assets below $10 billion, primarily by reducing securities and loans held for sale. Management said this delayed certain regulatory requirements and the Durbin Amendment interchange-fee cap.
  • Banner repurchased 545,166 shares for approximately $31.0 million during 2017 and declared $2.00 per share in dividends, including a $1.00 special dividend. The annual payout ratio was 108% of reported basic earnings, affected by the tax charge.
  • Mortgage banking revenue declined to $20.9 million from $25.6 million, as higher rates reduced refinancing activity and one-to-four-family loan sales. Deposit fees and service charges increased to $51.8 million.

Outlook, risks and contingencies

  • Management gave no specific earnings or revenue guidance. It expected the federal corporate tax-rate reduction to benefit future net income; the company estimated a future blended statutory rate of approximately 24%. Some 2017 tax-law accounting remained provisional and could be adjusted through December 2018, including treatment of certain AMT credits.
  • Banner estimated that crossing the applicable $10 billion asset threshold could eventually reduce annual pre-tax revenue by approximately $12 million from the Durbin Amendment, in addition to increased compliance and regulatory costs. Timing depends on the relevant asset-threshold requirements.
  • Interest-rate exposure is significant. Approximately 69% of loans were adjustable or floating rate, but many included floors; management’s model estimated net interest income would rise 2.1% over the next 12 months under an instantaneous 100-basis-point rate increase, while modeled economic value of equity would decline 2.5%. These are model estimates, not forecasts.
  • Credit risks include real-estate concentration, construction and land lending, commercial lending, and exposure to regional economic and agricultural conditions. Management identified $85.5 million of additional classified loans not then on nonaccrual, which could become problem loans.
  • Other material risks include deposit competition and funding costs, securities valuation and interest-rate risk, mortgage-market sensitivity, cyber and third-party service-provider risks, regulatory changes, acquisition integration and goodwill impairment. The upcoming CECL standard was expected to change credit-loss estimation and could increase the allowance; its impact was not yet quantified.
  • Commitments to extend credit totaled $2.30 billion, with additional loan-origination commitments and standby letters of credit. Management said legal proceedings in the ordinary course were not expected to have a material adverse effect.

Investor verification priorities

  1. Confirm the $42.6 million deferred-tax revaluation, remaining provisional tax items, and the assumptions supporting the expected lower future tax rate.
  2. Reconcile reported results with management’s non-GAAP core earnings and assess the contribution of the Utah sale gain and acquisition-accounting accretion.
  3. Review commercial real estate and construction concentrations, classified and delinquent loans, charge-offs, and the adequacy of the allowance, including acquired-loan discounts.
  4. Verify the asset-threshold triggers and timing for added regulatory costs and the estimated $12 million annual Durbin-related revenue impact.
  5. Assess sensitivity to deposit repricing, interest-rate changes and securities values, and evaluate the assumptions in management’s interest-rate models.
  6. Evaluate liquidity against $2.30 billion of credit commitments, short-term repurchase obligations, and the holding company’s reliance on bank dividends; consider the unusually high reported dividend payout ratio.