COLUMBIA BANKING SYSTEM, INC. annual report, FY2016

Columbia Banking System, Inc. — FY2016 Form 10-K Summary

Business context and reporting period

Columbia Banking System, Inc. is a bank holding company headquartered in Tacoma, Washington. Through Columbia State Bank and Columbia Trust Company, it provides commercial, retail, real estate, consumer, wealth management and trust services across Washington, Oregon and Idaho. The filing covers the fiscal year ended December 31, 2016, including fourth-quarter results. The Bank operated 143 branches and employed 1,819 full-time-equivalent employees at year-end.

Financial performance and condition

Metric	2016	2015	Change
Net interest income	$333.6 million	$324.9 million	+3%
Provision for loan losses	$10.8 million	$8.6 million	+25%
Noninterest income	$88.1 million	$91.5 million	-4%
Noninterest expense	$261.1 million	$266.1 million	-2%
Net income	$104.9 million	$98.8 million	+6%
Diluted EPS	$1.81	$1.71	+6%
Net interest margin, tax-equivalent	4.12%	4.35%	-23 basis points
Return on average assets	1.13%	1.14%	-1 basis point
Return on average common equity	8.26%	7.93%	+33 basis points

Fourth-quarter 2016 net income was $30.7 million, or $0.53 diluted EPS, compared with $26.7 million, or $0.46 diluted EPS, in fourth-quarter 2015.
Total assets increased 6% to $9.51 billion. Loans increased 7% to $6.21 billion, driven by strong originations, while available-for-sale securities increased 6% to $2.28 billion.
Deposits increased 8% to $8.06 billion. Core deposits rose to $7.75 billion and represented 96% of total deposits.
Federal Home Loan Bank advances declined to $6.5 million from $68.5 million, reflecting the use of deposit inflows to repay short-term borrowings. Repurchase agreements totaled $80.8 million.
Cash and cash equivalents were $224.2 million at year-end. Additional liquidity included unused borrowing capacity of approximately $1.50 billion at the FHLB and $61.0 million at the Federal Reserve.
Operating cash flow was $145.8 million. Investing activities used $548.6 million, primarily for loan growth and securities purchases, while financing activities provided $451.6 million, primarily from deposit growth.
Nonperforming assets declined to $33.8 million, or 0.35% of year-end assets, from $35.2 million, or 0.39%. Nonaccrual loans increased to $27.8 million from $21.5 million.
The allowance for loan and lease losses increased to $70.0 million, but declined to 1.13% of loans from 1.17%. Net charge-offs were $8.9 million, or 0.15% of average loans.
Capital remained strong. The Company reported a 12.63% total risk-based capital ratio and a 9.55% Tier 1 leverage ratio; Columbia Bank reported 12.48% and 9.43%, respectively. Both were classified as well-capitalized.
Common dividends declared totaled $1.53 per share, including special dividends, versus $1.34 in 2015. The dividend payout ratio was 85% of diluted EPS. The Board also authorized repurchases of up to 2.9 million shares, although only 266 shares were repurchased during the fourth quarter for tax withholding.

Material changes versus the prior comparable period

Profitability improved primarily because of higher loan and securities volumes, lower acquisition-related expenses and continued deposit growth.
Net interest income increased despite margin compression. The tax-equivalent net interest margin declined because of lower loan and securities yields and reduced accretion from acquired loans.
Noninterest income declined largely because 2015 included a $3.1 million favorable adjustment to the mortgage repurchase liability; the comparable 2016 adjustment was $391 thousand. Financial services and trust revenue also declined 11%.
Noninterest expense decreased because acquisition-related costs fell to $2.7 million from $10.9 million. Excluding acquisition-related items, expenses increased, partly because operating other real estate owned became a $551 thousand net cost versus a $1.6 million benefit in 2015.
Loan quality was mixed: total nonperforming assets improved, but nonaccrual loans, potential problem loans and impaired loans increased. Potential problem loans rose to $31.7 million from $23.7 million.
Unrealized securities losses increased materially to $30.7 million from $18.3 million, principally reflecting changes in interest rates and market spreads. Management did not consider the securities other-than-temporarily impaired.

Guidance, outlook, commentary, risks and unusual items

The filing does not provide formal earnings or revenue guidance. Management’s stated strategy is continued organic growth, expansion of market share, disciplined lending, core-deposit growth and selective acquisitions.
On January 9, 2017, Columbia agreed to acquire Pacific Continental Corporation in an approximately $644.1 million stock transaction using a 0.6430 exchange ratio. Pacific Continental had approximately $2.54 billion of assets at December 31, 2016. Closing was expected in mid-2017 and required shareholder and regulatory approvals.
If completed, the acquisition would push consolidated assets above $10 billion, triggering heightened regulatory requirements, including annual stress testing, additional risk-management requirements, CFPB supervision and eventual debit-card interchange fee limits. Management estimated a potential pre-tax annual interchange impact of approximately $9.5 million for Columbia Bank once the small-issuer exemption no longer applies, plus approximately $300 thousand related to Pacific Continental beginning July 1, 2018.
The filing identifies material exposure to commercial real estate, commercial business lending and Northwest housing markets. Approximately 59% of gross loans were secured by real estate.
Interest-rate risk is significant. Modeling indicated that a gradual 100-basis-point decline could reduce net interest income by $10.0 million in year one and $28.0 million in year two, while a gradual 200-basis-point increase could increase net interest income by $7.5 million and $31.0 million, respectively.
Other principal risks include credit deterioration, collateral-value declines, allowance adequacy, securities impairment, goodwill impairment, acquisition integration, regulatory and compliance costs, cybersecurity, operational disruptions, competition and liquidity constraints.
The Company recorded $883 thousand of 2016 expense related to exiting an Idaho branch location and recognized a deferred $742 thousand gain on a sale-leaseback transaction.
Goodwill totaled $382.8 million, or approximately 4% of total assets. The annual impairment test found no impairment.
After year-end, former Chief Executive Officer Melanie J. Dressel died unexpectedly on February 19, 2017. Hadley S. Robbins was appointed interim CEO on February 22, 2017, and the Company began a search for a permanent CEO.
On January 12, 2017, all outstanding Series B preferred shares were converted into common stock.
The Company and its Bank reported effective disclosure controls and internal control over financial reporting. Deloitte & Touche issued unqualified opinions on the financial statements and internal controls.

Most important facts for an investor to verify

Completion terms, approvals, purchase accounting, dilution and integration costs associated with the Pacific Continental acquisition.
Whether rising nonaccrual, potential problem and impaired loans lead to higher provisions or charge-offs.
Sustainability of the 4.12% net interest margin as acquired-loan accretion declines and interest rates change.
Potential impairment or other-than-temporary impairment in the securities portfolio, which had $30.7 million of gross unrealized losses.
Liquidity availability, deposit stability and reliance on core deposits versus brokered or wholesale funding.
Impact of crossing the $10 billion asset threshold on regulatory expenses, stress testing, CFPB oversight and interchange revenue.
Future dividend levels and share repurchases in light of the 85% payout ratio, acquisition funding needs and regulatory capital requirements.
Management’s response to the unexpected CEO transition and its effect on strategy, retention and acquisition execution.
Potential future effects of CECL credit-loss accounting, which management stated could materially increase reported allowances but could not yet quantify.