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Edited Transcript of BANR earnings conference call or presentation 25-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Banner Corp Earnings Call

WALLA WALLA Apr 29, 2017 (Thomson StreetEvents) -- Edited Transcript of Banner Corp earnings conference call or presentation Tuesday, April 25, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Albert H. Marshall

Banner Corporation - SVP and Secretary

* Lloyd W. Baker

Banner Corporation - CFO, EVP and EVP - Banner Bank

* Mark J. Grescovich

Banner Corporation - CEO, President, Director, CEO of Banner Bank, President of Banner Bank and Director of Banner Bank

* Peter J. Conner

Banner Corporation - CFO of Banner Bank and EVP of Banner Bank

* Richard B. Barton

Banner Corporation - Chief Credit Officer of Banner Bank and EVP of Banner Bank

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Conference Call Participants

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* Jacquelynne Chimera Bohlen

Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research

* Jeffrey Allen Rulis

D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst

* Matthew Timothy Clark

Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst

* Timothy O'Brien

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Good day, and welcome to the Banner Corporation's First Quarter 2017 Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Mark Grescovich, President and CEO. Please go ahead.

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Mark J. Grescovich, Banner Corporation - CEO, President, Director, CEO of Banner Bank, President of Banner Bank and Director of Banner Bank [2]

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Thank you, Allison, and good morning, everyone. I would also like to welcome you to the first quarter 2017 earnings call for Banner Corporation. As is customary, joining me on the call today is Rick Barton, our Chief Credit Officer; Lloyd Baker, our Chief Financial Officer of the Corporation; Peter Conner, our Chief Financial Officer of Banner Bank; and Albert Marshall, the Secretary of the Corporation. Albert, would you please read our forward-looking safe harbor statement.

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Albert H. Marshall, Banner Corporation - SVP and Secretary [3]

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Certainly. Good morning. Our presentation today discusses Banner's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures and statements about Banner's general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and a recently filed Form 10-K for the year ended December 31, 2016. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligation to update information concerning its expectations. Thank you.

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Mark J. Grescovich, Banner Corporation - CEO, President, Director, CEO of Banner Bank, President of Banner Bank and Director of Banner Bank [4]

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Thank you, Al. As announced, Banner Corporation reported a net profit available to common shareholders of $23.8 million or $0.72 per diluted share for the quarter ended March 31, 2017. This compared to a net profit to common shareholders of $0.69 per share for the fourth quarter of 2016 and $0.52 per share in the first quarter of 2016.

Excluding the impact of merger and acquisition expenses, gains and losses on the sale of securities and changes in fair value of financial instruments, earnings increased 9.5% to $24.2 million for the first quarter of 2017 from $22.1 million in the first quarter of 2016. While our core operating performance continued to reflect the success of our proven client acquisition strategies, which produced strong core revenue, we also benefited from the successful integration of our recent acquisitions, which had a dramatic impact on the scale and reach of the company, and is providing a great opportunity for revenue growth.

Following the successful completion of all systems conversions of the acquisitions, we continued to make additional progress in generating operating synergies through the integration of operational activities. More importantly, however, as the result of the hard work of our employees throughout the company, we are successfully executing on our strategies and priorities to deliver sustainable profitability and revenue growth to Banner.

Our first quarter 2017 performance clearly demonstrates that our strategic plan is effective and we continue building shareholder value. Our first quarter 2017 core revenue was strong at $116.4 million and increased 5% compared to the first quarter 2016. We benefited from a larger and improved earning asset mix, a net interest margin that remained above 4%, and good mortgage banking and deposit fee revenue. Overall, this resulted in a return on average assets of 0.97% for the first quarter of 2017.

Once again, our performance this quarter reflects continued execution on our super community bank strategy, that is: growing new client relationships, adding to our core funding position by growing core deposits and promoting client loyalty and advocacy through our responsive service model, while also augmenting our growth with opportunistic acquisitions. To that point, our core deposits increased 8% compared to March 31, 2016. Also, our non-interest-bearing deposits increased 6% from 1 year ago, representing strong organic generation of new client relationships. Our organic net client growth in these product categories is now 89% since December 31, 2009. Reflective of this solid performance, we raised our dividend 9% in the quarter to $0.25 per share.

In a few moments, Lloyd Baker and Peter Conner will discuss our operating performance in a bit more detail.

While we have been effectively executing on our strategies to protect our net interest margin, grow client relationships, deliver sustainable profitability and prudently invest our capital, we have also focused on maintaining the improved risk profile of Banner. Again this quarter, our credit quality metrics reflect our moderate risk profile and our nonperforming assets remained very low.

As expected, due to the addition of new loans and the migration of acquired loans out of the discounted loan portfolio, we recorded a $2 million provision for loan losses during the first quarter. At the end of the quarter, our ratio of allowance for loan and lease losses to total loans was 1.56% when including the net loan discount on acquired loans, and our tangible common equity ratio was a strong 10.7%. In a moment, Rick Barton, our Chief Credit Officer, will discuss the credit metrics of the company and provide some context around the loan portfolio and our success at maintaining a moderate credit risk profile.

In the quarter and throughout the preceding 7 years, we continued to invest in our franchise. We have added talented commercial and retail banking personnel to our company, and we have invested in further developing and integrating all of our bankers into Banner's proven credit and sales culture. While these investments have increased our core operating expenses, they have resulted in core revenue growth, strong customer acquisition, year-over-year growth in the loan portfolio, strong deposit fee income growth and positive year-over-year operating leverage.

Further, we've received marketplace recognition of our progress and our value proposition, as the Small Business Administration named Banner Bank Community Lender of the Year for the Seattle and Spokane District for 2 consecutive years. And this year named Banner Bank Regional Lender of the Year for the second consecutive year. Also, Banner ranked 29th out of 100 in the Forbes 2017 best banks in America.

The successful execution of organic growth plan, augmented with strategic acquisitions, and our persistent focus on improving the risk profile of Banner has now resulted in 24 consecutive quarters of profitability, and our tangible book value increased to $31.68 per share versus $30.38 per share at March 31, 2016.

I'll now turn the call over to Rick Barton to discuss the trends in our loan portfolio. Rick?

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Richard B. Barton, Banner Corporation - Chief Credit Officer of Banner Bank and EVP of Banner Bank [5]

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Thanks, Mark. Credit quality at Banner during the first quarter of 2017 continued the pattern of stability established over the past -- last several quarters. Our portfolio's moderate risk profile is clearly demonstrated by its credit metrics that will now be briefly recapped. But at this juncture, I will again reiterate my belief that overall, credit metrics have plateaued and cannot be expected to further improve.

Delinquent loans were 0.51% compared to 0.41% at year-end and 0.61% a year ago. This type of fluctuation is expected when delinquencies are at low levels. The company's level of adversely classified assets remains low. Nonperforming assets decreased 14 basis points during the quarter to 0.21% of total assets. This improvement was driven by reduction in nonperforming loans $4.5 million and REO $8.1 million. Not reflected in these totals are the remaining nonperforming loans of $10 million acquired from Siuslaw and AmericanWest Banks, which are not reportable under purchase accounting rules. If we were to include the acquired nonperforming loans in our nonperforming asset totals, the ratio of nonperforming assets to total assets would still be a modest 31 basis points, down from 46 basis points last quarter. Performing troubled debt restructures remain stable at 23 basis points of total loans.

Gross charge-offs for the quarter decreased slightly to $1.5 million. However, net charge-offs did increase by $1.2 million as loan loss recoveries during the quarter were down by a similar amount. After a first quarter provision of $2 million and net loan losses of $1.5 million, the allowance for loan and lease losses for the company now totals $86.5 million and is 1.17% of total loans compared to 1.15% for the linked quarter. As shown in the press release, the remaining net accounting mark against acquired loans is $29 million. When this amount is added to the traditional allowance for loan and lease losses, the adjusted allowance totals $115.5 million or 1.56% of total loans, down from 1.57% last quarter and 1.67% at March 31, 2016. Coverage at this level, 1.56%, remained substantial and aligns with our goal of a moderate risk profile.

Loans did decrease by $30 million from the linked quarter, but were up by $235 million when compared to March 31, 2016.

Quarter-over-quarter declines in multifamily construction, $10 million; residential construction and land, $28 million; agricultural loans, $56 million; and 1-4 family real estate portfolio, $11 million, were responsible for this relatively small portfolio decrease. The multifamily decline came from the expected payoff of a completed project. The residential construction and land pay down was the combined result of very robust home sales in the first quarter, the purchase of finished lots or local builders by national homebuilders and an unusually wet winter that slowed progress on several acquisition and development projects. The decrease in agricultural loans was driven by seasonal crop sales, and the 1-4 family reduction continued a pattern driven by the low interest rate environment. When these just discussed portfolio segments are excluded, the balance of the Banner portfolio grew by 5.2% on an annualized basis in the first quarter of 2017.

The growth was diversified and balanced across the remainder of the portfolio. And as noted in the press release, our loan origination pipelines indicate the potential for significant future loan growth.

In summary, Banner's loan portfolio and credit metrics were marked by stability during the just completed quarter further seasoning the portfolio's moderate risk profile.

With that, I'll turn the stage over to Lloyd for his comments.

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Lloyd W. Baker, Banner Corporation - CFO, EVP and EVP - Banner Bank [6]

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Thank you, Rick, and good morning, everyone. As Mark has noted, Peter Conner, our Chief Financial Officer for Banner Bank is, again, with us here today, and after a few general remarks from me, Peter will provide more detailed insight into the first quarter results. In particular, Peter will address the more unusual or volatile items in the income statement, which on balance were a net positive for the quarter, but were also more numerous than is often the case. By contrast, our core operations were very consistent with trends we've reported for a number of periods.

Banner Corporation's first quarter 2017 operating results continued to reflect the successful execution on our strategic initiatives, including significant benefits from the -- as a result of the acquisition of AmericanWest Bank. As well as meaningfully increased regulatory costs as a result of our approach to and subsequent breach of the $10 billion asset threshold. Our financial performance this quarter, again, was driven by strong revenue generation, reflecting in the increased scale of the company. While we had an expected decrease in revenues compared to the immediately preceding quarter as a result of normal seasonal patterns compared to the same quarter a year earlier, growth in average earning asset balances, coupled with strong net interest margin and growth in noninterest income, allowed our revenues from core operations to increase by 5%. Similar to previous periods, fully appreciating Banner's core operating results for each of the periods presented requires a clear understanding of the impact of the merger and acquisition-related expenses as well as the valuation adjustments for certain financial instruments that we carry at fair value and [ win ] material gains and losses on the sale of investment securities. However, I'm pleased to note that we did not incur any acquisition-related expenses in the first quarter.

For the first quarter of 2017, Banner reported net income of $23.8 million or $0.72 per diluted share. This amount was net of $688,000 of net charges for valuation adjustments for financial instruments, partially offset by a small net gain on the sale of securities, which together, net of related tax effects reduced earnings for the quarter by $0.01 per diluted share. By comparison, acquisition-related expenses were $788,000 in the fourth quarter, which along with $1.1 million of fair value charges, partially offset by $311,000 of securities gains, reduced earnings net of taxes by $0.03 per diluted share for that quarter. For the first quarter a year ago, acquisition expenses were much larger, $6.8 million, while fair value charges and securities losses combined were just $50,000. All of which together net of tax effects reduced earnings by $0.13 per diluted share in that quarter.

Excluding the acquisition-related expenses, fair value adjustments in securities gains and losses, our earnings from core operations were $24.2 million or $0.73 per diluted share for the current quarter compared to $23.8 million or $0.72 per diluted share in the immediately preceding quarter and $22.1 million or $0.65 per diluted share in the first quarter a year ago. As we have done in previous earnings releases, again this quarter, we've included a reconciliation of earnings from core operations and other non-GAAP financial information in our press release, which I encourage you to review. As I noted, underlying this earnings growth are revenues from core operations, which is revenues excluding gains and losses on the sale of securities and net fair value adjustments, although slightly decreased from the immediately preceding quarter were strong and at $116.4 million for the quarter ended March 31, 2017, were 5% greater than the same quarter a year ago. This solid core revenue generation continues to reflect the successful execution of our super community bank business model and the increasing value of the Banner franchise.

First quarter net interest income before provision for loan losses decreased to $94.9 million compared to $97.2 million in the preceding quarter, primarily reflecting fewer days in the current quarter and a much higher acquired loan discount accretion in the fourth quarter. However, as a result of increased earning asset balances and a stronger net interest margin, Banner's net interest income for the first quarter of 2017 was 4% greater than the same quarter a year earlier.

Our reported net interest margin was 4.25% for the quarter ended March 31, 2017, a 7 basis point decrease from the preceding quarter, largely as a result of the decreased accretion income, which was particularly high in the fourth quarter, but was 10 basis points above the margin in the first quarter a year ago, which included a comparable dollar amount and yield effect from discount accretion. More important, excluding the impact of acquisition accounting, our contractual or normalized net interest margin for the first quarter of 2017 was 4.15% compared to 4.13% in the preceding quarter and 4.01% in the first quarter a year ago.

Again this quarter, loan yields and the net interest margin were positively impacted by increased market interest rates, while deposit pricing remained generally unchanged. In addition, the timing worked well for us, as we re-leveraged the balance sheet above the $10 billion mark with first quarter purchases that boosted the yield on the securities portfolio.

Deposit fees and service charges were $12.2 million in the first quarter, unchanged from the preceding quarter and in line with our seasonal expectations. Deposit fees and service charges increased 3% compared to the same quarter a year earlier, a direct result of growth in core deposit accounts and related transaction activity.

As noted in the press release, mortgage banking revenues decreased to $4.6 million for the first quarter compared to $5.1 million in the fourth quarter and $5.6 million in the first quarter a year ago. The decrease in mortgage banking revenues compared to the preceding quarter reflected an expected seasonal pattern for 1-4 family loan originations amplified by the dampening effect of higher interest rates. In addition, gains on the sale of multifamily loans were quite modest in the current quarter. Although we did complete a substantial amount of loan sales during the quarter, significantly reducing the amount of loans held-for-sale at March 31, 2017.

Total noninterest expenses were $78.1 million in the first quarter compared to $79.9 million in the preceding quarter and $84 million in the first quarter of 2016. In total, noninterest expenses were in line with our expectations. Although, there were a number of unusual items, which Peter will address in his comments. I will also leave most of the balance sheet discussion to Peter. However, I do want to note that we had particularly strong first quarter deposit growth that was not entirely in line with our normal seasonal experience, which generally results in modest first quarter, second quarter balance growth, with stronger growth usually concentrated in the second half of the year.

Finally, I believe it's worth noting that our tangible book value per share increased to $31.68 at March 31, 2017 compared to $30.38 at March 31, 2016, a 4.3% increase, as growth in retained earnings and amortization of the core deposit intangibles more than offset the dividend payments of $0.92 per share and dilutive effect of stock repurchases over that 12-month period.

This concludes my prepared remarks. In summary, Banner had another good quarter and an encouraging start to 2017. As always, I look forward to your questions, but first, Peter will add some more color.

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [7]

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Thank you, Lloyd, and good morning, everybody. I will provide some additional detail on our first quarter financial results. As Mark and Lloyd noted and as we announced in our earnings release, we reported net income of $0.72 per share for the first quarter. The $0.03 increase from the prior quarter was due to several items. Net interest income declined $0.04 due to a decline in acquired loan accretion and fewer calendar days in the first quarter. Noninterest income increased $0.03 due to a credit workout-related gain on the sale of a single loan and a reduction in the negative market adjustment on liabilities [ compared to ] fair value. Reductions in noninterest expense contributed $0.03 and a reduction in the effective tax rate contributed another $0.01 to the increase from the prior quarter.

As Lloyd mentioned, total assets for the first quarter ended above $10 billion at $10.068 billion. That took -- the growth in total assets was driven by re-leveraging the balance sheet through purchases of investment securities throughout the quarter. The securities portfolio grew $421 million and ended the quarter at $1.5 billion. The average yield on investment portfolio increased 30 basis points to 2.36% from 2.06% in the prior quarter, as new securities were put on at higher market rates during the first quarter. Loans held-for-sale declined $160 million due to the bulk sale of multifamily loans originated in the prior 2 quarters. As Rick mentioned, the permanent held-for-investment loan portfolio declined modestly by $30 million due to expected seasonal paydowns in agricultural portfolio and robust home sales out of the residential construction portfolio. The quarterly decline in the permanent first-lien residential mortgage portfolio outstandings moderated in the first quarter as the rate of prepayments declined with rising rates and the portfolio continues to season.

Total deposits increased $300 million in the first quarter. Core deposits grew $201 million, as a result of continued success in acquiring new client deposit account relationships and average balance growth with existing clients. Total time deposits grew $99 million due to the issuance of $137 million in brokerage CDs as part of the bank's re-leveraging strategy. Total cost of deposits was 14 basis points, up 1 basis point from the prior quarter due to modest maturity extension of the CD portfolio.

Net interest income declined $2.3 million due to a decline in loan accretion, driven by a higher-than-normal pace of acquired loan portfolio prepayment interest income in the prior quarter, along with a large prepayment fee received on the originated portfolio also recorded in the fourth quarter. The decline in net interest income was partially offset by the growth in the securities portfolio, as we re-lever the balance sheet at higher yields, after staying below $10 billion in total assets at year-end. The net interest margin declined 7 basis points to 4.25% from 4.32% in the prior quarter, 9 basis points of the change was due to the decline in acquired loan accretion. The decline was partially offset with an increase in the yield on investment portfolio, as new securities were put on at higher rates in the first quarter. On a core basis, excluding the effects of purchase accounting, the net interest margin increased to 4.15% from 4.13% in the prior quarter. The improvement in the core margin was driven by the improvement in the investment portfolio yield in the first quarter.

Contractual loan yields, excluding acquired loan accretion declined to 4.69% from 4.72%. However, excluding the effect of the large prepayment in the fourth quarter within the originated portfolio, fourth quarter contractual loan yields were 4.67% and we realized a 2 basis point improvement in contractual loan yields over the prior quarter, principally as a result of the increase in prime and LIBOR rates on our floating rate loans.

Going forward, we expect the margin to benefit from the increase in contractual floating rate loan yields we observed at the end of March, partially offset by the increase in investment securities as a larger percentage of the total earning assets.

Core noninterest income increased $1.2 million from the prior quarter. The increase was the result of a $2.5 million gain on the sale of a single loan taken as partial settlement on a previously resolved problem credit. Generally offsetting this gain was a decline in mortgage banking revenues due to lower 1-4 family residential mortgage production volume as a result of a normal seasonal slowdown in housing market in the first quarter, coupled with lower refinancing activity, which declined from 42% of total production in the fourth quarter to 35% in the first quarter. In addition, multifamily gain on sale income declined in the first quarter due to the effect of a low premium received on a portfolio of unhedged, seasoned, multifamily loans originated at lower coupons in the prior 2 quarters.

Deposit fees remained flat compared to the prior quarter, primarily as a result of 2 fewer calendar days in the first quarter compared to the fourth quarter. We continued to see good net account growth throughout the franchise, including the former AmericanWest markets. The success of Banner's deposit account acquisition strategy is reflected in the growth of our core deposit balances in the first quarter.

As Lloyd mentioned, there was some volatility in the first quarter noninterest expenses. Core noninterest expense, excluding M&A costs declined $991,000 compared to the prior quarter. The decline was due to a combination of nonrecurring and seasonal items, partially offset by expected increases in compliance-related infrastructure development associated with crossing the $10 billion in asset level.

Compensation expense increased due to a combination of normal payroll tax and benefits expense increases in the first quarter, combined with the build out of the compliance staff. Professional services expense increased due to outside consulting engagements facilitating the enhancement and further development of the bank's risk management compliance and DFAST capabilities. Marketing expense declined in the first quarter due to elevated marketing and shareholder contribution activity in the fourth quarter combined with seasonal and timing-related reductions in advertising and promotions in the first quarter.

Real estate operations expense declined as a result of $1.2 million in gains on sale recorded in the first quarter as a credit to expense compared to $850,000 in gains in the fourth quarter. Miscellaneous expenses declined as a result of a partial release of the unfunded loan commitment reserve associated with a single borrower. Seasonal and timing-related reductions and other miscellaneous expenses, which were partially offset with nonrecurring expense for customer refunds of certain deposit fees charged in prior years. The effective tax rate declined 34.4% in the fourth quarter to 33.2% in the first quarter. The decline was due to one-time credit tax expense in the first quarter, and reassessment of the effective tax rate based on the mix of tax exempt income and [ state apportionment rates ]. The effective tax rate is anticipated to run between $33.5 million and $34.0 million for the remainder of 2017.

This concludes my prepared remarks. Mark?

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Mark J. Grescovich, Banner Corporation - CEO, President, Director, CEO of Banner Bank, President of Banner Bank and Director of Banner Bank [8]

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Thank you, Rick and Lloyd and Peter for your comments. That concludes our prepared remarks, and Allison, we will now open the call and welcome your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from Jeff Rulis of D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [2]

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On the loan growth front, the average loan growth was decent, but with obviously period-end balances. Were those impacted by some late run-off, I think maybe Rick mentioned multifamily sale. But if you could talk about the timing of growth and maybe what impacted the period-end balance?

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Richard B. Barton, Banner Corporation - Chief Credit Officer of Banner Bank and EVP of Banner Bank [3]

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Okay, Jeff. This is Rick. I'll try to address that very quickly. The multifamily pay down was in the final month of the quarter. The ag sales, the rundown in the construction and land portfolio and the multifamily was -- or not multifamily, single-family was spread throughout the quarter without any unusual lumpiness in those reductions.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [4]

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Okay. And how's production or net production so far in Q2, obviously some positive comments on -- expecting some growth to return, but more specifically, how has April been from a net production standpoint?

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Richard B. Barton, Banner Corporation - Chief Credit Officer of Banner Bank and EVP of Banner Bank [5]

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Without trying to get too far out over my skis, we're very pleased at the way April is shaping up for the bank.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [6]

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Fair enough. And then the -- I guess trying to hammer down the cost side of things on the -- you referenced additional compliance costs, and maybe this is for Lloyd or Peter, but I think in the run rate as of Q4 you had about $1 million already baked in and you've identified up to $4 million to $5 million by year-end, as those costs ramp. What -- at what point, are we, I guess, added in Q1 -- kind of in the run rate?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [7]

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Hi, Jeff. This is Peter. I think it's first helpful just to reconcile the first quarter expenses. The -- if we eliminate the nonrecurring and one-time and unusual expenses in the first quarter, we're running -- we run around $80 million in expense for the quarter. Included in that $80 million is about $2 million to $3 million of compliance-related infrastructure build. So we still have a little bit left to go in terms of additional ramp up, if you will, in the infrastructure-related build into the second and third quarters.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [8]

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Got it. Okay. That's helpful. And then maybe one last one just on the kind of the -- well, I guess, in the healthcare segment. What exposure do you have, if any, kind of portfolio wide in that segment overall?

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Richard B. Barton, Banner Corporation - Chief Credit Officer of Banner Bank and EVP of Banner Bank [9]

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Jeff, this is Rick. I don't have an exact number, but our healthcare exposure is a very modest portion of the portfolio. And I would gauge it at less than 5% of the total loan portfolio.

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Operator [10]

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Our next question will come from Matthew Clark of Piper Jaffray.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [11]

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First one on the multifamily gain on sale. Obviously, large bulk sale with not much in the way of gain. I guess, can you talk about what you expect for gain on sale margins maybe going forward and whether or not it might make some sense to portfolio those loans instead of selling them in this case?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [12]

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Good morning. This is Peter. I'll speak to the gain on sale. So multifamily has a cadence of origination and sales that typically runs about 90 days. And under that normal origination and sell cycle, we expect somewhere between 1.5% and 2% net gain on sale and that's what we're seeing in the current production environment. The bulk sale in the first quarter was unusual, but it was a seasoned portfolio that was originated in the second half of 2016 at lower coupons. And so the reduction in premium was purely a function of interest rates. So we expect going forward that business to run on an even keel generating about $30 million a month in production and $90 million a quarter in sales typically.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [13]

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Got it. Okay.

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Lloyd W. Baker, Banner Corporation - CFO, EVP and EVP - Banner Bank [14]

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Well, and Matt, this is Lloyd. I guess I'll speak up for Rick. We've been on record for some time now of saying that multifamily was not a segment that we intended to have a significant balance sheet commitment to. And that's been the case and continues to be the case from a credit decision asset allocation standpoint. So while we did benefit -- while we had less gain on sale, we did benefit from the carry, which is what you're thinking about and in terms of holding on to the multifamily, we did benefit from the carryover that couple quarter period of time. But we intend to continue to run that unit as an origination-for-sale unit.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [15]

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Okay. And then just on the purchase accounting accretion, unusually low it seemed here in the first quarter. I know it was unusually high in the fourth quarter. But can you remind us, how much you have left that you expect to accrete into interest income and what do you think a more normal run rate could be? Could we be somewhere closer to the third quarter or do you think this lower level is where it's going to [ drift ] from?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [16]

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Yes, this is Peter. So yes we had a somewhat muted quarter in terms of loan accretion. We have $29 million in remaining loan discounts and that will -- a portion of that will get accreted into interest income over the remaining life. It was -- it's hard to predict what prepayment activity would be, but I would peg the normal run rate result somewhere between what we saw in the fourth quarter and what we saw in the first quarter. So I think it's -- I would split the difference in terms of thinking about the projection.

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Lloyd W. Baker, Banner Corporation - CFO, EVP and EVP - Banner Bank [17]

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But Matt, this is Lloyd, again. Just Peter has made this point in the past and I'll bring it up again, which is that, that will naturally decline over time, okay? And so the first quarter was actually pretty consistent with the first quarter a year ago. And that accretion income will decline over time, which is why, again, we are so much more focused on what's really happening with contractual loan yields. And as both Peter and I noted, we had meaningful improvement in contractual loan yields compared to a year ago and some improvement compared to the most recent quarter.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [18]

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Yes. And that was my next question, really on the margin outlook, the uptick in the core loan yields. Obviously you're going to have a mix change here with securities increasing relative to earning assets. But I mean, is the outlook for maybe some modest improvement and then some stabilization with the latest rate hike, is that how you kind of see this unfolding?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [19]

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Yes, we -- this is Peter. So we did see and observe some improvement in loan yields at the end of March with the rate hike. And so we will -- we do expect that benefit to continue into the second quarter. However, as we noted the build out of the investment portfolio was done over the first quarter, and so the effect of that average build in the investment portfolio and the increasing percentage of those securities in earning assets really won't be felt until the full second quarter. So we'll have some offsetting effects of having a higher percentage of our earnings assets in securities in the second quarter relative to the first quarter that'll offset the improvement we saw in the loan yield. So I would characterize it as a modest improvement in contractual net interest margin going into the second quarter due to the fact that we'll have a higher carry balance of securities going into Q2.

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Operator [20]

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Our next question will come from Jackie Bohlen of KBW.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [21]

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Kind of layering into the margin question again. I am looking more at the actual yield. How much of that was related to purchases in the quarter and how much more do you think there could be expansion into the second quarter as a result?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [22]

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Hi, Jackie, this is Peter. Are you referring to the investment portfolio?

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [23]

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Yes -- sorry, the investment securities portfolio.

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [24]

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Yes, we leveled off at the end of March. And so we -- going forward, we would just contemplate a normal proportionate growth of the investment securities and not take any additional leverage, but we really are focused on growing the loan portfolio going forward. So I would not anticipate any significant meaningful increase in the investment book other than just a proportionate growth to total assets going forward.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [25]

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Okay. And would it be correct to assume that the linked quarter increase in the yield on investment securities, that, that -- there could be more benefit in 2Q just as the full quarter run rate plays out from your 1Q purchases?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [26]

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Yes, there's a little bit of that. We were fortunate in re-levering right from the beginning of the year when rates were high. And so we'll see some of that carry benefit going into Q2. But most of it, I would say, vast majority of that increase in the yields was already reflected in the first quarter.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [27]

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Okay, that's helpful. And then switching over to deposits. Have you had any movement in rates with the March increase?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [28]

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We have not -- the price competition has been benign in the first quarter. I will say, however, that we did intentionally extend our CD maturity portfolio a bit for liquidity and asset liability purposes, which did have a modest impact to the contractual deposit cost by, I believe, about a basis point. And you'll see us continue to emphasize core deposits, but we'll also -- we also plan to keep our CD balances where they are without any more meaningful or significant runoff that we experienced in prior years.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [29]

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Okay. And those haven't been -- I'm sorry. Go ahead, Mark.

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Lloyd W. Baker, Banner Corporation - CFO, EVP and EVP - Banner Bank [30]

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This is Lloyd. I was going to say, you got your finger on the $64 question, right, for banking, which is what is going to happen with rates moving up with deposit pricing, and we would be insincere if we told you, we had more insight into that than anybody else.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [31]

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Well I certainly don't have any either. So at this point then no increases, the CD cost increase is just purely on an extension of -- and intentional extension of duration and probably some of the brokered CDs that were added in the quarter had an impact on that as well?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [32]

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Exactly.

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Lloyd W. Baker, Banner Corporation - CFO, EVP and EVP - Banner Bank [33]

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Right.

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Operator [34]

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Our next question will come from Tim O'Brien with Sandler O'Neill + Partners.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [35]

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A question on -- so you guys had pay offs, good pay offs in the construction, land and development book. Is there a seasonal aspect, can you just give a little color on what your outlook is for, I mean, that total part of your business, including commercial et cetera? Do you see decent growth opportunities there in '17? Or is that going to be contributing to overall growth as you anticipate and is that business strong and healthy and moving forward and can you give a little color?

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Richard B. Barton, Banner Corporation - Chief Credit Officer of Banner Bank and EVP of Banner Bank [36]

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Tim, this is Rick. As I noted, there was some runoff in the first quarter that was driven by purchases by national homebuilders, both of finished lots and a couple of local builders. We expect that to have a permanent impact on the number of customers in the portfolio. But we feel that the remaining book of business that we have, as we go through the year, we'll see the same kind of expansion possibilities that we had in 2016 as we went through the year. Velocity out of the vertical construction of residential homes is continuing at a very robust pace with very little standing inventory. So we feel that there is room for the market to continue to go for additional period of time. Little harder to project on the commercial and multifamily construction part of the portfolio. There are continuing opportunities in the marketplace and we're being selective about the ones that we choose to take on. And I think I would characterize that area more as a replacement as loans pay off rather than significant expansion of commercial and multifamily construction.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [37]

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And then a question on loans that repriced in the quarter. Do you have a ballpark or a hard number dollar amount of loans that -- whose rates moved as a result of either changes in LIBOR or the fed rate hike in March?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [38]

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Yes, Tim, this is Peter. So 20% -- 25% of our loan book is indexed to prime and there is roughly another 9% that's indexed to floating-rate LIBOR. So we're just right around 1/3 of our portfolio is what we consider floating or adjustable and responds basically immediately to changes in short-term rates.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [39]

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Any of those have active floors or could -- had active floors that came off floors? And is there any residual with active floors?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [40]

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All of our floor compression is gone. We've kind of -- we've worked through all of that over the last 2 or 3 years. So there is no impact from trying to reach the strike price any longer. So we're -- we had no effect from the floors in the repricing in the first quarter.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [41]

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Great. And then as far as -- what was the wholesale funding you put on, or [ use cap ] this quarter for your leverage strategy. Was that termed out? Was it laddered? How was that structured?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [42]

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So we did the combination of brokered CDs and FHLB advances, I mean typically, we'll ladder both of those sources over a prospective period out to 2 years typically. So we'll do a combination of short-term and midterm funding on both sources.

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Timothy O'Brien, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [43]

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And going forward, you mentioned -- you hinted that you extended the life of -- the weighted average life, I guess, of your CD book a little bit or attempted to do that this quarter and that resulted in a net cost increase of a basis point, am I characterizing that fairly accurately?

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Peter J. Conner, Banner Corporation - CFO of Banner Bank and EVP of Banner Bank [44]

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Yes, we -- in terms of our pricing tactics within each market, we obviously look at our competition and our mix and where we fall across all of our CD tenors, and we've begun to emphasize the longer tenors more in the last 2 quarters just because the price relative to the yield curve in the longer terms in the 24 and 36-month tends to be more favorable. And also, the liquidity benefits and the asset liability benefits of extending our liabilities has a positive effect on our asset liability profile. We intend to stay modestly asset sensitive and we continue to be in that position at the end of the quarter.

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Operator [45]

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(Operator Instructions) Showing no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Grescovich for any closing remarks.

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Mark J. Grescovich, Banner Corporation - CEO, President, Director, CEO of Banner Bank, President of Banner Bank and Director of Banner Bank [46]

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Thank you, Allison. As I've stated, we're pleased with our solid first quarter 2017 performance and see it as continuing evidence that we're making substantial and sustainable progress on our disciplined strategic plan to build shareholder value by executing on our super community bank model by growing market share, strengthening our deposit franchise, improving our core operating performance, maintaining a moderate risk profile, and prudently deploying excess capital. I'd like to thank all my colleagues who are driving this solid performance for our company.

Thank you, again, for your interest in Banner and joining us on our call today. We look forward to reporting our results to you again in the future. Have a great day, everyone.

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Operator [47]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.