Banner Corporation (BANR) — 2020 Third-Quarter Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and nine months ended September 30, 2020, compared with the corresponding 2019 periods. Banner is a regional bank holding company operating Banner Bank and Islanders Bank, principally in Washington, Oregon, California, Idaho and Utah. At quarter-end, it reported $14.64 billion in assets, $10.16 billion in loans, $12.22 billion in deposits and $1.65 billion in shareholders’ equity. Results reflect the COVID-19 pandemic, PPP lending and the November 2019 AltaPacific acquisition.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $121.0 million | $116.6 million | $359.9 million | $349.4 million |
| Provision for credit losses | $13.6 million | $2.0 million | $64.9 million | $6.0 million |
| Total non-interest income | $28.2 million | $20.9 million | $75.1 million | $61.7 million |
| Total non-interest expense | $91.6 million | $87.3 million | $276.4 million | $264.0 million |
| Net income | $36.5 million | $39.6 million | $77.0 million | $112.6 million |
| Diluted EPS | $1.03 | $1.15 | $2.17 | $3.23 |
| GAAP efficiency ratio | 61.35% | 63.50% | 63.54% | 64.23% |
- Revenue and margins: Q3 total GAAP revenue (net interest income plus non-interest income) was $149.2 million, up 9% year over year. Tax-equivalent net interest margin was 3.72% for Q3 and 3.93% for the nine-month period, versus 4.29% and 4.38%, respectively, in 2019. Lower asset yields, including on PPP loans and excess liquidity, more than offset lower funding costs for margin purposes.
- Other income: Mortgage banking income rose to $16.6 million in Q3 and $40.9 million year to date, mainly on stronger residential refinance production and higher sale spreads. Deposit fees declined to $8.7 million in Q3 and $26.1 million year to date, reflecting lower transaction activity, pandemic-related fee waivers and the Durbin Amendment’s impact.
- Cash flow: For the first nine months, operating cash flow was $138.2 million (2019: $68.5 million), investing cash flow was negative $1.65 billion (2019: negative $27.3 million), and financing cash flow was positive $1.91 billion (2019: positive $11.1 million). Cash and cash equivalents ended the period at $705.5 million, up from $307.7 million at year-end 2019. Investing outflows chiefly reflected securities and loan activity; financing inflows chiefly reflected deposit growth.
- Balance sheet and liquidity: Total assets increased $2.04 billion from year-end 2019. Deposits rose $2.17 billion to $12.22 billion, including a $2.37 billion increase in core deposits; certificates of deposit fell to $915.4 million and brokered deposits were zero. Cash and cash equivalents totaled $705.5 million. Banner reported $2.36 billion of available FHLB credit capacity at Banner Bank and $29.8 million at Islanders Bank, plus approximately $989.9 million of available Federal Reserve BIC capacity; no Federal Reserve borrowings were outstanding at quarter-end.
- Debt and capital: FHLB advances were $150.0 million, down from $450.0 million at year-end 2019. Other borrowings were $177.0 million. Banner issued $100 million of 5.000% fixed-to-floating subordinated notes in June, receiving approximately $98.1 million net; the notes qualify as Tier 2 capital. Total shareholders’ equity was $1.65 billion. Tangible common equity to tangible assets, a non-GAAP measure, was 8.78%, down from 9.77% at year-end. Banner Corporation and both banks exceeded regulatory well-capitalized thresholds.
Material changes versus comparable periods
- Q3 net income declined 8% and nine-month net income declined 32% year over year, primarily reflecting substantially higher credit-loss provisions and higher expenses, partly offset by net interest income and mortgage banking growth.
- The allowance for credit losses on loans reached $168.0 million, or 1.65% of loans, compared with $100.6 million at December 31, 2019. The allowance for unfunded commitments was $12.1 million, versus $2.7 million at year-end. Net charge-offs were $5.3 million for the nine months, compared with $4.7 million in 2019.
- Non-performing loans were $34.8 million, down from $39.6 million at year-end but up from $18.3 million a year earlier. Non-performing assets were $36.7 million, or 0.25% of assets. Classified substandard loans increased to $423.2 million from $113.4 million at year-end; management attributed the increase primarily to proactive downgrades in industries exposed to COVID-19.
- Loans grew 9% from year-end, including $1.15 billion in PPP loans. Core deposits increased sharply, partly due to PPP proceeds, stimulus payments and customers holding more liquidity. Residential mortgage loans retained in portfolio declined as refinancing loans were originated for sale.
- Banner adopted CECL (Topic 326) on January 1, 2020. Adoption increased loan and unfunded-commitment allowances by a combined $14.8 million pre-tax and reduced opening equity by $11.2 million after tax.
Outlook, commentary, risks and unusual items
- COVID-19 and credit outlook: Management said the pandemic’s ultimate effect remained uncertain and could continue to pressure economic activity, borrowers, funding, revenue and asset values. The quarterly and year-to-date provisions reflected expected lifetime losses based on economic forecasts and, in Q3, risk-rating downgrades. Management cautioned that future allowance estimates are sensitive to forecasts and other assumptions.
- Borrower relief and PPP: Banner had deferred payments or waived interest on 3,370 loans totaling $1.09 billion year to date. By September 30, deferral periods had ended on approximately 78% ($849.7 million); $239.6 million remained on deferral, including 107 loans totaling $160.4 million receiving a second deferral. Banner had funded 9,103 PPP loans totaling $1.15 billion and expected to process forgiveness applications in Q4 2020. PPP loans were fully SBA-guaranteed and had no loan-loss allowance recorded at quarter-end.
- Management outlook: The filing provides no specific earnings or revenue guidance. Management expected COVID-19-related expenses to continue in following quarters depending on the pandemic’s duration and said near-term net interest income and margin could remain adversely affected. Future credit losses, loan demand and deposit levels depend on uncertain economic conditions.
- Capital and corporate actions: Banner halted further share repurchases to preserve capital. It announced plans to merge Islanders Bank into Banner Bank; regulatory approval was received in October 2020, with completion expected in Q1 2021. Goodwill was not considered impaired at September 30, but sustained adverse conditions or a lasting decline in share price could trigger an impairment charge.
- Unusual and contingent items: Q3 included $778,000 of COVID-19 expenses; year-to-date COVID-19 expenses were $3.2 million. The filing reports no pending legal proceeding management believed would materially adversely affect financial condition or operations. Disclosure controls were deemed effective, with no material change to internal controls other than CECL implementation.
Important facts for investors to verify
- Whether credit quality, classified loans and the allowance remain adequate as borrower relief expires and economic forecasts change.
- Repayment performance on the $239.6 million still under deferral, including second-deferral loans, and the timing and servicing economics of PPP forgiveness.
- Whether unusually strong deposit growth persists, and the effect of deposit mix, liquidity deployment and low market rates on net interest margin.
- Regulatory capital ratios and tangible common equity as assets and credit costs evolve; assess the subordinated notes and halted buybacks in that context.
- Execution and expected effects of the Islanders Bank merger, as well as potential goodwill impairment if adverse conditions or lower market valuation persist.
- Assumptions underlying management’s CECL forecasts and the comparability of non-GAAP adjusted earnings and efficiency measures with GAAP results.