Business Context and Reporting Period
Columbia Banking System, Inc. is a regional bank holding company operating Columbia State Bank and Columbia Trust Company across Washington, Oregon and Idaho. The Form 10-K covers the fiscal year ended December 31, 2017, including fourth-quarter results. The Company operated 155 branches and employed 2,120 full-time-equivalent employees at year-end.
On November 1, 2017, Columbia completed its acquisition of Pacific Continental Corporation, adding approximately $2.94 billion of assets, $1.87 billion of loans measured at fair value and $2.12 billion of deposits. The acquisition caused consolidated assets to exceed $10 billion, triggering heightened regulatory requirements.
Key Financial Metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net interest income | $368.0 million | $333.6 million | 10% |
| Provision for loan losses | $8.6 million | $10.8 million | Down $2.1 million |
| Noninterest income | $109.6 million | $88.1 million | 24% |
| Noninterest expense | $291.0 million | $261.1 million | 11% |
| Net income | $112.8 million | $104.9 million | 8% |
| Diluted EPS | $1.86 | $1.81 | 3% |
| Net interest margin, tax-equivalent | 4.18% | 4.12% | Up 6 basis points |
| Return on average assets | 1.11% | 1.13% | Down 2 basis points |
| Return on average common equity | 8.00% | 8.26% | Down 26 basis points |
| Total assets at year-end | $12.72 billion | $9.51 billion | 34% |
| Loans at year-end | $8.36 billion | $6.21 billion | 35% |
| Deposits at year-end | $10.53 billion | $8.06 billion | 31% |
| Shareholders' equity | $1.95 billion | $1.25 billion | 56% |
Operating cash flow was $128.5 million, compared with $145.8 million in 2016. Investing activities used $199.5 million, while financing activities provided $189.3 million. Cash and cash equivalents increased to $342.5 million from $224.2 million.
Credit metrics weakened year over year. Nonperforming assets increased to $79.5 million, or 0.63% of year-end assets, from $33.8 million, or 0.35%. Nonaccrual loans increased to $66.2 million from $27.8 million. Net charge-offs declined to $3.0 million from $8.9 million. The allowance for loan and lease losses increased to $75.6 million, but declined to 0.91% of loans from 1.13%.
Liquidity remained supported by $10.04 billion of core deposits, representing 95% of total deposits, and unused borrowing capacity of approximately $1.43 billion at the Federal Home Loan Bank and $100.1 million at the Federal Reserve Bank. Year-end borrowings included $11.6 million of Federal Home Loan Bank advances, $79.1 million of repurchase agreements, $35.6 million of subordinated debentures and $8.2 million of junior subordinated debentures.
The Company and Bank were well-capitalized. The Company's CET1, total risk-based capital and leverage ratios were 11.74%, 12.98% and 10.96%, respectively. Columbia Bank's corresponding ratios were 12.01%, 12.81% and 10.82%.
Material Changes Versus the Prior Comparable Period
- Pacific Continental materially expanded the balance sheet, loan portfolio, deposits, branch network and equity base. The Company issued approximately $636.4 million of common stock as acquisition consideration and recorded $383.1 million of goodwill and $46.9 million of core deposit intangible assets.
- Noninterest income benefited from a $14.0 million gain on the sale of the merchant card services portfolio. The Company transitioned merchant processing to an outsourced model and recorded $1.1 million of related revenue share during 2017.
- Noninterest expense included $17.2 million of Pacific Continental acquisition-related costs, compared with $0.3 million in 2016, along with higher personnel, legal, professional and integration expenses.
- The effective tax rate increased to 37% from 30%, primarily because the Tax Cuts and Jobs Act required a $12.2 million remeasurement of deferred tax assets. The law reduced the federal corporate tax rate from 35% to 21% beginning in 2018.
- The Company terminated its FDIC loss-sharing agreements, paid the FDIC $4.7 million and recorded a one-time pretax charge of $2.4 million. The Company will retain future recoveries and bear future losses on the previously covered assets.
- The Series B preferred stock was converted into common stock in January 2017. Common dividends declined to $0.88 per share from $1.53, because 2016 included special dividends.
- The Company authorized a stock repurchase program for up to 2.9 million shares. Actual fourth-quarter repurchases were limited to 1,201 shares withheld for employee tax obligations.
Guidance, Outlook, Commentary and Risks
The filing does not provide formal earnings or revenue guidance. Management expects continued growth in core deposits, relationship-oriented commercial lending and Northwest market share, while seeking operating efficiencies and potential strategic acquisitions.
Beginning July 1, 2018, the Company expects the debit-card interchange fee cap to reduce pretax annual revenue by approximately $10 million because it no longer qualifies for the small-issuer exemption. The Company is also subject to annual stress testing, enhanced risk-management requirements and primary CFPB consumer-compliance oversight as a result of exceeding $10 billion in assets.
Management identified integration execution, acquired-loan performance, goodwill impairment, credit quality, commercial real estate concentrations, interest-rate sensitivity, liquidity, regulatory compliance, cybersecurity, technology failures, competition and natural disasters as significant risks. A 100-basis-point gradual decline in interest rates was estimated to reduce net interest income by $17.3 million in year one and $43.2 million in year two; a 200-basis-point gradual increase was estimated to increase net interest income by $9.1 million and $37.1 million, respectively.
The securities portfolio contained $34.3 million of gross unrealized losses at year-end. Management did not consider these securities other-than-temporarily impaired, but future market or credit deterioration could require impairment charges. Goodwill totaled $765.8 million, and no impairment was identified at year-end.
The Company expects to adopt the current expected credit loss standard in 2020. Management stated that the eventual effect cannot currently be reasonably estimated and could materially increase the allowance for credit losses. The remaining $8.2 million of junior subordinated debentures were redeemed on January 8, 2018. A $0.22 per-share quarterly dividend was declared on January 25, 2018.
Important Facts for Investors to Verify
- Assess whether Pacific Continental integration produces the anticipated cost savings, revenue growth and operating efficiencies, given that acquisition-related expenses were $17.2 million in 2017.
- Monitor nonperforming assets, commercial-business loan deterioration and potential problem loans, which increased to $41.6 million.
- Evaluate the allowance coverage ratio after the acquisition and the potential effect of future credit losses under CECL.
- Confirm the earnings impact of the approximately $10 million annual interchange-fee effect beginning July 2018.
- Review the sustainability of net interest margin as rates change and acquired-loan accretion declines.
- Consider the scale of goodwill and other intangible assets, totaling $824.0 million, relative to shareholders' equity.
- Verify liquidity, deposit retention and reliance on core versus brokered or wholesale deposits.
- Review capital ratios, dividend restrictions, the 2.9 million-share repurchase authorization and the Company's ability to fund future acquisitions.
- Consider the $34.3 million of unrealized securities losses and the potential for future other-than-temporary impairment.
- Note that management and the independent auditor reported effective internal control over financial reporting, but the Pacific Continental control environment was excluded from the year-end assessment.