Banner Corporation — Q1 2013 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2013. Banner Corporation is a Washington bank holding company operating Banner Bank and Islanders Bank, with community banking and mortgage-banking activities in Washington, Oregon and Idaho. The filing reports one business segment. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless noted.
Financial and operating highlights
- Profitability: Net income was $11.6 million, or $0.60 per diluted share, versus $9.2 million and $0.40 a year earlier. Prior-year income available to common shareholders was $7.2 million after preferred dividends and discount accretion; the preferred stock was subsequently redeemed.
- Revenue and margins: Net interest income before loan-loss provision was $41.0 million versus $41.5 million. Net interest margin was 4.16%, up one basis point; net interest spread was 4.13% versus 4.10%. Total revenue was $51.0 million versus $52.1 million, while management’s non-GAAP core revenue measure was $50.9 million versus $50.4 million.
- Costs and taxes: Operating expenses declined to $34.1 million from $37.9 million. Income before taxes was $16.9 million; income tax expense was $5.3 million, an effective rate of about 31.3%. The prior-year quarter had no tax provision while a full deferred-tax valuation allowance remained in place.
- Cash flow: Operating activities provided $25.2 million; investing activities used $15.2 million; financing activities used $35.6 million. Cash and due from banks fell $25.6 million in the quarter to $155.7 million.
- Balance sheet and funding: Total assets were $4.238 billion, down 0.7% from year-end 2012. Net loans were $3.163 billion, up $5 million; deposits were $3.521 billion, down $37 million. Stockholders’ equity was $516.1 million, and tangible common equity was 12.10% of tangible assets. FHLB advances were $0.3 million; other borrowings, mainly retail repurchase agreements, were $88.4 million; junior subordinated debentures were $73.2 million.
- Credit quality: No loan-loss provision was recorded, compared with $5.0 million in Q1 2012. The allowance was $77.1 million, or 2.38% of loans and 231% of nonperforming loans. Nonperforming loans were $33.4 million, down from $64.9 million a year earlier; nonperforming assets were $44.9 million, or 1.06% of assets, versus $93.1 million and 2.24% a year earlier. Performing troubled debt restructurings totaled $54.6 million. Management also identified $87 million of other classified loans not on nonaccrual.
- Capital and liquidity: Banner Corporation’s total risk-based capital ratio was 17.06%; Banner Bank’s was 16.19%, and Islanders Bank’s was 18.20%. Both banks exceeded “well-capitalized” thresholds. Management reported $948 million of potential Banner Bank FHLB capacity and estimated $579 million of additional borrowing capacity through the Federal Reserve’s Borrower-In-Custody program; no Federal Reserve borrowing was outstanding.
Material changes versus comparable periods
- Earnings per share and common earnings improved, helped by lower credit costs, lower funding expense, reduced operating expenses, and growth in deposit fees and mortgage banking revenues.
- Interest expense fell 43% to $3.5 million, but interest income fell 6% to $44.5 million as earning-asset yields declined. Average earning-asset yield was 4.52% versus 4.76%; deposit cost declined to 0.31% from 0.52%.
- Core non-interest income increased 11% to $9.9 million. Reported other operating income was lower, at $10.0 million versus $10.6 million, in part because fair-value movements differed between periods.
- Net charge-offs were $0.4 million versus $6.4 million a year earlier. REO declined to $11.2 million from $27.7 million a year earlier; Q1 2013 REO sales produced $0.8 million in gains.
- Deposits shifted toward lower-cost transaction and savings accounts: these represented 72% of deposits, compared with 65% a year earlier. Certificates declined by $214 million year over year.
Outlook, risks, contingencies and unusual items
- Management described economic recovery as modest and uneven. It expected additional modest deposit-cost reductions from certificate repricing but said the pace of reductions had slowed and further opportunity was limited. Continued low rates could pressure loan and securities yields and compress margins.
- Interest-rate simulation showed estimated next-12-month net interest income changes ranging from a 0.9% decline under a 50-basis-point rate decrease to a 0.5% decline under a 100-basis-point increase. A 400-basis-point increase was modeled to reduce economic value of equity by 25.7%. These estimates depend on assumptions about deposit behavior, repricing and prepayments.
- The company had filed amended federal tax refund claims for 2008 and 2009 that could yield up to $13.6 million. The IRS review remained uncertain; no asset was recorded, and management expected resolution during 2013.
- Reported results included a $1.3 million net loss from fair-value changes, partly offset by a $1.0 million securities-sale gain and a $0.4 million other-than-temporary impairment recovery. The sale gain and recovery related to securities previously written off. Some trust-preferred securities and related debentures were valued using Level 3 models and significant unobservable assumptions.
- Off-balance-sheet commitments included $976.8 million to extend credit and $71.2 million to originate loans held for sale. The filing notes that commitments may expire undrawn and are not necessarily future cash requirements.
- Management said the allowance was adequate but cautioned that estimates may prove incorrect and future provisions could adversely affect results. Other stated risks include borrower credit deterioration, real-estate values, interest-rate changes, deposit retention, regulation, competition, systems and third-party risks. The bank and company memoranda of understanding with regulators had been terminated in 2012. No pending legal proceeding was identified as likely to have a material adverse effect; no material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether the decline in nonperforming assets and charge-offs continues, and how the $87 million of other classified loans performs.
- Whether the $77.1 million allowance remains adequate as loan growth, collateral values and economic conditions change.
- Whether margin and earnings can be sustained as asset yields decline and deposit-cost reductions become more limited.
- The outcome and timing of the IRS review of the potential $13.6 million refund claims; no refund asset was recognized.
- The sensitivity of reported earnings and equity to Level 3 fair-value assumptions for trust-preferred securities, collateralized debt obligations and junior subordinated debentures.
- The distinction between GAAP results and management’s non-GAAP “core” revenue and earnings measures; the filing states these are supplemental and may not be comparable across companies.