Banner Corporation (NASDAQ: BANR) — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing was signed February 25, 2019. This is an annual report, not a standalone fourth-quarter filing; quarterly results are noted below where relevant.
Business context and reporting period
Banner Corporation is a Washington bank holding company operating Banner Bank and Islanders Bank. At year-end it had 182 branches across Washington, Oregon, California and Idaho, plus 17 loan production offices. Its core business is commercial and consumer banking, with lending and mortgage banking activities.
On November 1, 2018, Banner acquired Skagit Bancorp for approximately $180.0 million, primarily in Banner shares. The transaction added approximately $915.8 million of assets, $632.4 million of loans and $810.2 million of deposits, and expanded Banner’s presence in the North Sound region. Skagit’s operations were included for the final two months of 2018; system integration was expected to be completed in the first quarter of 2019.
Financial performance and condition
| Metric | FY2018 | FY2017 | Change / context |
|---|---|---|---|
| Total revenue before loan-loss provision | $515.0 million | $478.2 million | Up 8% |
| Net interest income before provision | $431.0 million | $393.0 million | Up 10%; net interest margin rose to 4.43% from 4.24% |
| Provision for loan losses | $8.5 million | $8.0 million | Increase mainly reflected loan growth, acquired-loan renewals and net charge-offs |
| Non-interest income | $84.0 million | $85.2 million | Lower mainly because 2017 included a $12.2 million gain on the Utah branch sale |
| Non-interest expense | $341.4 million | $319.0 million | Up 7%; includes $5.6 million of acquisition-related costs |
| Net income | $136.5 million | $60.8 million | Diluted EPS was $4.15 vs. $1.84 |
| Effective tax rate | 17.3% | 59.8% | 2017 included a $42.6 million tax charge from the Tax Cuts and Jobs Act; 2018 included $5.5 million of tax benefits, including release of a $4.2 million reserve |
FY2018 core revenue, a company-defined non-GAAP measure, was $512.0 million, up 9%; core earnings were $134.6 million, or $4.09 per diluted share. These measures exclude specified items, including securities and fair-value changes, the 2017 branch-sale gain, acquisition costs and tax adjustments.
Fourth quarter: Net income was $37.5 million, or $1.09 diluted EPS, compared with a net loss of $13.5 million, or $0.41 per diluted share, in Q4 2017. Q4 2018 included $2.5 million of loan-loss provision, $95.4 million of non-interest expense and $3.1 million of income-tax expense. Q4 2017 included substantial Tax Act-related tax expense.
Year-end balance sheet: Assets were $11.87 billion, up from $9.76 billion; net loans were $8.59 billion, up 14%; deposits were $9.48 billion, up 16%; and shareholders’ equity was $1.48 billion. The acquisition, organic growth and renewed securities-investment activity contributed to the asset increase.
Asset quality: Non-performing loans fell to $15.7 million from $27.0 million, and non-performing assets were $18.9 million, or 0.16% of assets, versus $27.5 million, or 0.28%. The allowance for loan losses was $96.5 million, 1.11% of loans and 616% of non-performing loans. Net charge-offs were $1.0 million, compared with $5.0 million in 2017.
Funding, debt and liquidity: Year-end cash and cash equivalents were $272.2 million. Borrowings totaled $773.3 million, comprising $540.2 million of FHLB advances, $119.0 million of repurchase agreements and $114.1 million fair value of junior subordinated debentures. The FHLB advances were primarily due within one year. Banner reported $1.15 billion of potential Federal Reserve borrowing capacity against eligible collateral, with no balance outstanding, and unused federal funds lines totaling $115 million. Core deposits were 86% of deposits; brokered deposits rose to $377.3 million from $57.2 million.
Operating cash flow was $30.8 million, compared with $346.7 million in 2017; investing activities used $976.2 million, while financing activities provided $956.4 million. Cash and cash equivalents ended the year at $272.2 million, up $11.0 million.
Capital and shareholder returns: Banner Corporation’s total risk-based capital ratio was 13.12%, Tier 1 leverage ratio 10.98%, and common equity Tier 1 ratio 10.75%. The company and both banks met applicable regulatory requirements and were described as well-capitalized. Tangible common equity to tangible assets, a non-GAAP measure, was 9.62%, down from 10.61%. Banner repurchased 594,711 shares for $34.4 million and declared $1.96 per share in dividends, including a $0.50 special dividend.
Material changes versus the prior comparable period
- Net income increased substantially, but comparison is affected by the 2017 $42.6 million Tax Act charge and 2018 tax benefits. Core earnings were $134.6 million in 2018 versus $98.8 million in 2017.
- Net interest income and margin improved with higher earning-asset balances and yields. Interest expense rose 70% to $32.7 million as funding costs and borrowings increased.
- Skagit’s acquisition materially increased year-end assets, loans, deposits, goodwill and intangible assets; goodwill rose to $339.2 million from $242.7 million.
- Loans grew $1.09 billion, including $631.7 million acquired and $454.0 million of organic growth. Securities increased to $1.90 billion as Banner resumed balance-sheet leveraging after reducing assets below $10 billion at year-end 2017.
- Total deposits increased $1.29 billion, while FHLB advances increased from $0.2 million to $540.2 million. Brokered deposits also increased notably.
- Non-performing loans and assets declined, while the allowance increased in dollars but fell as a percentage of total loans.
Outlook, risks, contingencies and unusual items
- No specific earnings or revenue guidance was provided. Management described a strategy of organic growth, selective acquisitions, core-deposit expansion, investment in delivery and risk-management infrastructure, and maintaining a moderate risk profile.
- Banner Bank exceeded $10 billion in assets for four consecutive quarters. The filing said CFPB supervisory and enforcement authority would apply beginning in the second quarter of 2019. The Durbin Amendment interchange-fee cap was expected to take effect July 1, 2019; management estimated an annual reduction of approximately $15 million in debit-card fee income and pre-tax earnings after implementation.
- CECL was expected to apply beginning in the first fiscal year after December 15, 2019. Banner was evaluating the impact; the size of any initial allowance adjustment was not yet clear.
- Key risks include interest-rate and funding-cost changes, regional economic weakness, real-estate and construction lending exposure, credit losses, deposit competition, integration of Skagit, regulatory costs, cybersecurity and third-party operational risks, and the transition away from LIBOR. Commercial and multifamily real estate loans were 45% of loans; construction and land loans were 13%. Washington accounted for 49.8% of loans.
- Interest-rate sensitivity modeling estimated that an immediate, sustained 400-basis-point increase would reduce next-12-month net interest income by 2.9%; a 100-basis-point decrease was estimated to reduce it by 3.5%. These are model estimates and depend on assumptions.
- Professional and legal expenses included a $4.0 million accrual for pending litigation in Q4 2018. The company separately stated that it was not party to legal proceedings it believed would materially adversely affect its financial condition, operations or cash flows.
- Management and the auditor concluded that internal control over financial reporting was effective as of year-end. However, the assessment excluded non-integrated Skagit operations; acquired loans and deposits represented approximately 7% and 8% of company totals, respectively.
Most important facts an investor should verify
- Whether Skagit integration was completed as expected and whether anticipated benefits were realized without significant customer, employee or deposit attrition.
- Whether the projected approximately $15 million annual interchange-income and pre-tax earnings reduction occurred after the July 2019 Durbin Amendment implementation.
- How deposit pricing, brokered-deposit reliance and the $540.2 million of short-term FHLB advances affected funding costs and net interest margin as rates changed.
- Whether credit performance remained sound in the growing construction, commercial real estate, commercial business and geographically concentrated loan portfolios, and whether the allowance remained adequate.
- The eventual impact of CECL on the allowance, regulatory capital and reported earnings, and the terms and costs of the LIBOR transition.
- The outcome and any further accruals related to the pending litigation, and the completion of Skagit internal-control integration.