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Edited Transcript of UMPQ earnings conference call or presentation 17-Oct-19 5:00pm GMT

Q3 2019 Umpqua Holdings Corp Earnings Call

Portland Nov 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Umpqua Holdings Corp earnings conference call or presentation Thursday, October 17, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Cort Lane O’Haver

Umpqua Holdings Corporation - President, CEO & Director

* Frank Namdar

Umpqua Holdings Corporation - Executive VP & Chief Credit Officer of Umpqua Bank

* Ronald L. Farnsworth

Umpqua Holdings Corporation - Executive VP & CFO

* Torran B. Nixon

Umpqua Holdings Corporation - Senior Executive VP & Chief Banking Officer for Umpqua Bank

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Conference Call Participants

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* Aaron James Deer

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

* Brandon Thomas King

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* David John Chiaverini

Wedbush Securities Inc., Research Division - Senior Analyst

* Jacquelynne Chimera Bohlen

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

* Jeffrey Allen Rulis

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

* Matthew Timothy Clark

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

* Tyler Stafford

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Umpqua Holdings Corporation Third Quarter 2019 Earnings Call. Today's call is being recorded. And at this time, I would like to turn the conference over to Mr. Ron Farnsworth, Chief Financial Officer. Please go ahead, sir.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [2]

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Okay. Thank you, Lisa. And good morning, and thank you for joining us today on our third quarter 2019 earnings call. With me this morning are Cort O’Haver, the President and CEO of Umpqua Holdings Corporation; Tory Nixon, our Chief Banking Officer; Rilla Delorier, our Chief Strategy Officer; Dave Shotwell, our Chief Risk Officer; and Frank Namdar, our Chief Credit Officer. After our prepared remarks, we will then take questions.

Yesterday afternoon, we issued an earnings release discussing our third quarter 2019 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both of these materials can be found on our website at umpquabank.com in the Investor Relations section.

During today's call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the safe harbor provisions of federal securities law. For a list of factors that may cause actual results to differ materially from expectations, please refer to Page 2 of our earnings conference call presentation as well as the disclosures contained within our SEC filings.

And I will now turn the call over to Cort O’Haver.

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [3]

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Okay. Thank you, Ron. Let me begin by providing a brief recap of our quarterly financial performance and then I'll provide an update on Umpqua Next Gen. Ron will discuss the financials in more detail and then we'll take your questions.

Our Q3 2019 financial performance resulted in earnings per share of $0.38. This is down from the $0.51 we earned in the prior quarter and the $0.41 reported in the third quarter of 2018. The change from last quarter is primarily the result of a onetime $75.4 million net gain that was attributable to the sale of our Visa Class B stock and high-premium debt securities that occurred in Q2. This quarter's financial results include a $4.2 million positive adjustment related to the fair value change of our MSR asset. This includes a positive $7.8 million adjustment related to the fair value of mortgage servicing rights held for sale at the end of the quarter. We will continue to execute initiatives, as mentioned previously, to reduce the volatility of the MSR asset.

I'm pleased to report that we generated strong balance sheet growth for the third quarter. Deposit growth of $615 million represents a very robust annualized growth rate of 11.3%. In addition, the healthy increase of $352 million in noninterest-bearing demand balances that we recorded in the quarter represents an annualized growth rate of 21%. We've made deposit growth initiatives a top priority, and these strong early results demonstrate the success of those efforts.

In addition, we also generated strong loan and lease growth of $567 million, which represents an annualized growth rate of 10.8%. Our commercial real estate and residential real estate groups, aided by lower interest rates and typical seasonality, had strong quarters of quality growth. Our corporate banking group grew $150 million in loan balances or 13% annualized. And FinPac, our leasing subsidiary, grew $36 million in balances during the quarter for an annualized growth rate of 10%.

Now for an update on Umpqua Next Gen initiatives. As evidenced by our strong loan and deposit growth this past quarter, our balanced growth initiatives continue to move forward successfully. In addition to the robust growth I just mentioned, I want to highlight that we added more than 4,000 noninterest-bearing accounts during the quarter, in addition to the growth of more than 3,000 noninterest-bearing accounts we reported in the previous quarter. In addition, we recorded annualized growth in treasury management fee revenue of 48% due to the hard work of the bankers across the footprint working alongside the global payments and deposits team as we continue to emphasize banking full relationships.

Our human digital strategic priority continues to be a differentiator for Umpqua. The industry's first human digital banking platform, Go-To, continues to deliver strong enrollments. I'm very pleased to report that just 6 months since launching Go-To, nearly 10% of our consumer DDA customers have already enrolled. This is an important metric as customers engaged with Go-To have a higher primacy and retention rate. In addition, we've introduced our predictive analytics tool, Umpqua Smart Leads, serving commercial and corporate customers in more than half of our markets, and we are seeing significant opportunity for additional fee-based products and services based upon consumer behavior.

Our operational excellence initiatives continues to generate results. Collectively, they've contributed to $26 million or a 5% decline in our total noninterest expenses when comparing year-to-date 2019 to year-to-date 2018. Phase 2 of our operational excellence initiatives are underway and will continue the progress made to-date on reducing noninterest expense. In addition, recognizing the broader rate environment, management is currently reviewing additional opportunities for a Phase 3 initiative currently sized at an additional 3% to 5% of our expense base. I look forward to providing detail on those components and timing of those efforts starting on the January call.

As Go-To adoption builds momentum, we continue to optimize our physical footprint. Last quarter, we announced that we would be consolidating an additional 8 locations. This will bring our store rationalization number to 65 since Q3 of 2017.

As always, we continue to measure and evaluate performance on all stores. And as highlighted previously, we are seeing solid deposit growth across the board. Our focus for the rest of the year is to continue to deploy Go-To, grow deposits and finish the previously mentioned consolidations. We will provide an update on future store rationalization plans in early 2020.

Now back to Ron to cover the financials in detail.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [4]

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Okay. Thank you, Cort. And for those on the call who want to follow along, I'll be referring to certain page numbers from our earnings presentation.

Turning to Page 6 of the release or slide presentation, which contains our quarterly P&L. GAAP earnings per share were $0.38 this quarter compared to $0.51 in the second quarter and $0.41 from the same quarter a year ago. Notable items impacting earnings this quarter were the small positive change in fair value on the MSR asset, impacted in part by a gain on the portions sold 2 weeks ago, along with the fair value loss on the swap derivatives as interest rates declined this quarter and $2 million of exit and disposal costs for recent store consolidations. Ex these items, adjusted earnings were $0.39 per share.

Turning to net interest income on Slide 7. Net interest income increased 1% from Q2 driven by a combination of the strong loan growth and lower premium amortization in the bond book, offset by the 2 Fed funds rate decline this past quarter. Discount accretion on acquired loans remained flat at $5 million this quarter and is expected to decline modestly over the coming quarters.

For the taxable investment income line item, premium amortization on MBS and CMOs was $6.6 million, a couple of million higher than expected due to the drop in long-term yields this quarter, resulting in higher prepayment speeds on the underlying investments. This is a retrospective adjustment and was about $2 million higher than we would expect moving forward, assuming no further change in prepayment speeds.

Our interest expense increased slightly based on continued average balance growth and competition for funding. Recall, in the past, we stated an expectation for a 1- to 2-quarter lag before seeing a drop in interest expense, assuming the Fed reduce short-term rates. With that playing out, the cost for interest bearing deposits increased as expected to 1.19% this quarter and looks to have hit a high watermark in August and started to fall in September. We're expecting this to decline a few basis points in Q4 assuming no further Fed rate cuts.

As reflected on Slide 8, our net interest margin was 3.63% this past quarter. The margin excluding discount accretion was 3.54%, with a 7 basis point decline resulting from the 2 Fed funds rate cuts in Q3. Obviously a different environment than most of us were thinking we'd see this year, but with an asset-sensitive balance sheet, we'd expect the margin to remain under pressure with further rate declines. And rather than speculating as to how many may or may not be on the horizon, for every 25 basis point cut rates, we'd expect about a 5 basis point reduction in margin, all else being equal, which it rarely is.

We are making adjustments to the balance sheet to perform better in a potentially lower interest rate environment, including extending duration in the bond portfolio while reducing premium amortization optionality, reducing the cost of high beta deposit accounts and shortening funding duration. Other moves include reducing more transactional rate-sensitive loan production, with those resources being reallocated to more profitable, balanced commercial relationships.

Moving now to noninterest income on Slide 9. We generated total noninterest income of $88.5 million for the quarter. The drop in long-term interest rates created a fair value loss on the swap derivative of $4.6 million, up slightly from Q2, while they had a like amount of net fair value gain on the MSR asset. Before I get into home lending activity, we're pleased to see continued growth in other noninterest income components, such as treasury management fee revenue.

And for mortgage banking, as shown on Slide 10 and also in more detail on the last page of earnings release, for-sale mortgage originations increased 73% from the second quarter, mostly from the seasonal lift but also boosted by the drop in long-term rates. With this decline in market rates, our gain on sale margin increased to 3.7% based mostly on higher pricing. The change in fair value of the MSR asset was a positive $4.2 million this quarter, which is a combination of the passage-of-time charge and changes in inputs as reflected in the lower table.

Included in the $11 million credit for changes to inputs was a $7.8 million gain on sale, which closed in early October but was held for sale as of quarter end. Excluding the portions sold, the remaining MSR was valued at 94 basis points. As discussed last quarter, we're analyzing another potential sale of a similar amount early next year, and are positioning the asset and allocated capital to focus on more full relationships, carrying deposit balances, which will improve the overall profitability of the business and reduce potential future volatility to the P&L from these rate-related changes.

Turning now to Slide 11. Noninterest expense was $183.6 million, up slightly from the prior quarter but in line with expectations. The bridge on the right side shows the moving parts from the second quarter, with the expected home lending seasonal increase being the largest component. We had an increase related to our reclass to other noninterest income and an increase in group insurance costs, offset by reductions in OREO, marketing, restructuring and payroll taxes.

Note the efficiency ratio was 57.8% on the face of the P&L for Q3, but our internal measure was 57% when adjusting out the security gains and MSR and CVA fair value charges discussed earlier, higher than expected but reflective of the recent Fed rate cuts impact on margin. Also point out the year-to-date 5% drop in expense from the Phase 1 initiatives is holding, which provides us more opportunity as we look into 2020. Regarding the operational excellence program, as Cort mentioned, our Phase 2 initiatives will result in annualized savings of $6 million to $10 million next year, and we are currently aggregating Phase 3 initiatives, expected to be 3% to 5% of our expense base.

Turning now to the balance sheet, beginning on Slide 12. We increased our interest-bearing cash this quarter to just under $0.75 billion, along with a slight increase in investment securities, targeting longer-duration assets funded with the increase in shorter-duration borrowings.

The mix of loans and deposits is shown on Slide 13. Our strong loan balance growth this quarter was centered in commercial and owner-occupied real estate, along with multifamily and residential. The decline in consumer loans continued as a result of our targeted wind down of the indirect dealer auto portfolio. Within deposits, we had strong growth in noninterest-bearing demand balances, supported by over 4,000 new customer checking accounts, along with an increase in time deposits. Broker deposits were down $40 million and public deposits also declined $40 million during the quarter.

Slide 14 reflects the repricing characteristics of our loan and lease portfolio, knowing our floating and adjustable rate loan mix remain consistent over the past few quarters. And on Slide 15, we have highlighted the geographic diversification of our loan portfolio across the footprint. We also provide some selected loan and underwriting characteristics for each major area. And as mentioned on previous calls, we are happy with the granular nature of the loan book.

Slide 16 reflects our credit quality stats and highlights the strength of our portfolio as shown by the continued decline in nonperforming assets, now down to 0.25% of total assets and a consistent low level of overall net charge-offs. The provision for loan loss increased to $23 million this quarter, in part by funding the stronger loan growth, along with a small uptick in net charge-offs. The upper-right chart shows the level of classified loans in the range of 7.5% to 8.5% of total capital. The slight uptick this past quarter was driven by the ag book, reflective of market stresses. And in the bottom-right chart, we break out our FinPac leasing group net charge-offs from that of the rest of the bank, knowing the leasing component has been fairly consistent around the 3% to 3.5% for the past year. Keep in mind that the weighted average yield of this portfolio is a very healthy 10%.

Slide 17, introduces our expectations for the upcoming change to the current expected credit loss or CECL model to account for loan loss reserves. While this takes effect at the start of 2020, we've been prepping for the change for the last few years and have now performed 8 parallel runs with the new models. Granted these estimates are based on our views of the economic environment today, and these could change by the first quarter of 2020 but, for now, we're estimating overall increase in our allowance for loan loss to be around 1% in gross loans and leases compared to the 0.73% we have today.

The estimated changes by portfolio are noted in the upper-right table, with the reduction in commercial reserves offset by increases in the other categories. The largest projected increase relates to our lease and equipment finance portfolio, which carries higher losses but also has a much higher yield to compensate for it. Noting we typically carry just over 2 years of charge-offs from the reserve historically for this portfolio, and this increase reflects the approximate 5-year life of these assets. The remaining changes are reflected primarily of the duration on the loan. We'll continue to refine and update ahead of adoption in Q1 2020. Absent the significant change in the economic outlook, this should be a fair estimation of the overall impact.

And lastly, on Slide 17, I want to highlight capital. Knowing that all of our regulatory ratios remain in excess of well-capitalized levels, with our Tier 1 common at 10.9% and total risk-based capital at 13.6%. We've broken out the mix of each ratio with regulatory well-capitalized minimums, our in-house cushions above well-capitalized and what we consider excess capital. With our quarterly common stock dividend at $0.21 per share, the total payout ratio was 55% this quarter.

Also, our tangible book value per share was $11.27, which, when you also account for the $0.21 in dividends to shareholders last quarter, increased to 5%. Our excess capital is approximately $200 million and will provide us with several opportunities no matter the economic or rate scenario over the intermediate-term horizon.

To conclude, our focus is on executing all aspects of our Umpqua Next Gen strategy, improving financial results and generating solid returns to shareholders over time, including a healthy dividend. And with that, we will now take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will take our first question from Jeffrey Rulis.

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [2]

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Jeff, you on mute?

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [3]

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Yes. Can you hear me?

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [4]

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Yes.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [5]

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Yes.

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

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Okay. Good. So on the expense front, I just wanted to confirm that with Phase 1 complete, are there -- I guess, Q4, are there any Phase 2 savings still to come this year? You itemized the $6 million to $10 million next year, but are we relatively flat on savings for the rest of the year?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [7]

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There'll be a small amount in Q4 for the Phase 2 component, but the vast majority will be in the 2020 run rate.

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

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Okay. And a comfortable, I guess, a base expense level for this quarter, could we just ex some of the reclass and disposal costs, knowing that the mortgage side is going to be variable?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [9]

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Yes, that'd be around $179 million ballpark, ex the reclass and the -- ex disposal cost. And I expect that number will drop in Q4, partially due to lower seasonal holding activity we typically see in Q4, partly due to some of the Phase 2 components you talked about earlier, but -- so it should be less than $179 million. You can probably look back at the last handful of Q4s to get a sense of the home lending delta.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [10]

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Got you. And then the net charge-offs, that increase, was it any one category or any trends that you drew from that number?

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Frank Namdar, Umpqua Holdings Corporation - Executive VP & Chief Credit Officer of Umpqua Bank [11]

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Jeff, this is Frank Namdar. No, that was really centered in one $3.6 million charge-off that was centered in the C&I space on a credit that we had been working out of, which is now completely gone. We still view the trends as quite positive.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [12]

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But maybe a little lumpy this quarter. But -- and Frank, on the provisioning levels, you anticipate any -- given the CECL impact, at least preliminarily, thoughts on provisioning in the next year?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [13]

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This is Ron. I'll say, in terms of -- obviously, CECL is going to change the game when it comes to economic forecast, and so you could see provision spike, assuming an economic forecast. The bank mix includes the -- any kind of a downturn well ahead of charge-offs coming to fruition. So absent that, I would expect it to be consistent with what you've seen on a quarterly basis. You're just going to have this more acceleration in a downturn and then also more of a credit and a recovery on the front end.

Very difficult to say today, it's going to be $18 million or $22 million, all else being equal, it should be in this range. But again, it's going to be predicated upon individual bank's view of the economic outlook over the coming year.

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Operator [14]

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Our next question comes from Matthew Clark.

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

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For the Phase 3 expenses, it sounds like we'll get more color in January. But any sense for whether or not that may begin next year? Or will it be more of a 2021 event?

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [16]

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Hey, Matt, it's Cort. So we're working on that right now as we speak. We'll provide that guidance and transparency in January. Let me just say, we're working on it real hard right now and, obviously, we'd like to execute on some of that in 2019, before we get into first of the year, but we'll give you more clarity in January. So I'm not exactly giving you the answer you want, but I want you to know we're working on it.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [17]

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Okay. And then just on the $179 million clean run rate to consider for the fourth quarter, does that include any disposal costs or any other charges? Or is that all in?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [18]

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That should be all in. Actually, it should be lower than that, just given the seasonal decline in home lending activity. But we don't expect any significant excess disposal costs in Q4.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [19]

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Okay. And then just last one for me, on the bump up in classified, the 8 basis points. I know it's still relatively low level but just wanted to get a sense for what drove that migration.

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Frank Namdar, Umpqua Holdings Corporation - Executive VP & Chief Credit Officer of Umpqua Bank [20]

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This is Frank Namdar again. Migration is really driven by the ag space. So the ag space has been really hit with the tariff situation, commodity prices being quite low and also labor, and really the increase is centered in that. Again, I view the trends as really pretty positive. I mean if you look back, I mean, into 2017, let's not forget our classified numbers were at $345 million versus the $217 million that we see today. So I think we made -- we're making pretty good progress, and I view that as pretty -- as being pretty stable still going forward.

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Operator [21]

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(Operator Instructions) We'll take our next question from Tyler Stafford.

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Tyler Stafford, Stephens Inc., Research Division - MD [22]

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I just wanted to also start on expenses. And maybe I missed this in the opening remarks, Cort, but are you guys planning to close that last final round of branch closures in 2020? Or is that off the table now?

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [23]

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So like I said in the opening remarks, we -- first of all, we constantly review the performance of our stores. I tell you, since we made the announcement of doing 30% or 100%, whatever the exact number was in '17, obviously, the need for low-cost funding is greater than it was. And as interest rates have risen and we've seen greater performance out of our stores, we're a lot more picky and particular about what stores we consolidate. So to answer your question, we're going to hold through the balance of this year. I think we're at 65% or 67% since we made the announcement, and we'll evaluate any other consolidations and closures into 2020. I would bet you'd see us do some additional store consolidations in 2020, but we're not planning on doing any in the next 90 days.

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Tyler Stafford, Stephens Inc., Research Division - MD [24]

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Okay, thanks for clearing that up. On the MSR sales, how much expense saves do you expect to realize from this first tranche of sales and then the potential second?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [25]

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Good point. Again, the driver of that was to shift the capital allocated into more relationship business. But there will be some expense reductions, mostly variable costs related to the system processing. I'd say that'd be less of $1 million on a quarterly basis.

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Tyler Stafford, Stephens Inc., Research Division - MD [26]

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Okay. Got it. So the Phase 3 would not include anything related to the MSR exit on expenses?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [27]

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No, it would not. It would not.

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Tyler Stafford, Stephens Inc., Research Division - MD [28]

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Got it. Maybe just simplistically on the loan yield side, I guess I was surprised the magnitude of the loan yield compression, just given that the variable rate loans are just 28% or 29% or so. Was -- I guess was there anything unique about that level of compression this quarter, prepaid fees, et cetera, that we should think about going forward that was a little bit more unique?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [29]

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Good question. And again, discount accretion was relatively flat. It was nothing significant on the fee income side driving that. I mean maybe 0.5 bp to 1 bp but nothing outsized beyond that point. I think what it reflects is just the rapid decline in LIBOR and the prime-based stuff through the quarter. And keep in mind, too, there's also the adjustable rate loans that aren't fully floating but have adjust periods that, during this quarter, would have been impacted, along with new production would come on at lower yields compared to 2, 3 quarters ago. I mean as a reminder...

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Tyler Stafford, Stephens Inc., Research Division - MD [30]

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And then, Ron, just lastly for me, I appreciate the details on the CECL methodology and specifically around the FinPac portfolio. I'm just curious if you guys would expect to slow down the growth rate of that or alter pricing at all, just given the more punitive reserving nature of that portfolio?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [31]

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Not at all. That's a great return on allocated capital, 10%-plus overall portfolio yield. I think what this reflect -- the economic reality hasn't changed in the way we account for. So we'll have some capital allocation for the reserve, and then it will be a nonevent for -- specific to that portfolio. Does that cover your question, Tyler?

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Tyler Stafford, Stephens Inc., Research Division - MD [32]

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Yes. No, it did. There was just the footnote on that Slide 17 that said possible changes to pricing. So I didn't know what that was, just a general statement or if that was specific to the FinPac portfolio given the increase there.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [33]

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It is a general statement around the portfolio in total and/or the industry, as we see potential pricing changes will obviously reflect it. Certain categories or products on the loan side and the marketplace could change just given the nature. You could also see much shortening terms based off the accounting methodology. But I don't think anything has been hard and fast in the market yet. I'm expecting we won't see any movement on that front until early 2020.

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Operator [34]

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We'll take our next question from Jackie Bohlen.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [35]

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I just wanted to clarify, the expense base that you discussed for the 3% to 5% that you're looking into savings on -- for Phase 3, should we look at that as a general $179 million? Or is that something that would include the reduction from Phase 2?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [36]

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I would factor in the $179 million, well, a lot of moving parts, right? So you get the $179 million core number in Q3, which seasonally is higher given the higher mortgage volume, it'll drop off in Q4. I would expect you'll see the same seasonal play in that over the course of 2020 by quarter. The Phase 2 would be taken off of that, and then the 3% to 5% we're talking about is on top of all of that.

And basically, we're looking at that as -- how do you manage the bank in a lower -- lower-interest rate environment? It's going to be continue to manage your operating costs and your costs of funding in shortened duration. So we are not hoping for the best on that front. We're going to make sure we plan for the potential of a lower-rate environment, so we can do what we can to help improve earnings and provide a good return to shareholders.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [37]

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Okay. So this -- the Phase 3, is that in part driven by the environment that we operate within? Or is that something where, if we were still in a higher-rate environment, you would have naturally progressed to that level?

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [38]

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Jackie, it's Cort. So it's both. Like Ron just said, in this low-rate environment, obviously, we have to be very strict about how we manage our associated costs. And he just nailed it, right? Our noninterest-bearing deposit growth and all the success we've shown this year, we're going to continue those efforts because it does lower our borrowing cost. Managing our fixed costs, we have opportunity. Let's just be honest. We do have opportunity to manage down our fixed costs, and that will be a part of the Phase 3 initiatives that someone just asked me.

And so -- and I'll go to another component. But so -- we were already working on that. I mean quite honestly, earlier this year, we started looking at our cost and our productivity prior to the rate declines we saw early summer. So we feel good about the progress we've made in just identifying these opportunities. So it's a little bit of both, Jackie. We were working on it anyway, knowing that we think we have opportunities, and here comes the short end of the curve coming off quicker than we thought.

The other thing I'd say, just the other important driver of what we do next year is on the continued work and success in our noninterest income. We've seen substantial improvement over the last 2 years on what we're doing in treasury management, with our commercial and our small business customers. And that'll be another important piece of how we generate our revenue and EPS in a declining rate environment. So those are really the 3 main drivers of our strategic financial focus in this low-rate environment, probably beyond 2020, to be quite frank.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [39]

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Okay, that's helpful. And then just one last one for me. Ron, when you mentioned -- understanding a static environment -- it never winds up being static. And 5 basis points in NIM compression for every 25 basis points decline. My interpretation of other remarks you made is that you're going to be actively managing the balance sheet and what you do in order to potentially reduce that 5 basis points. Is that what you intended to say?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [40]

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That is correct. And also I'll point out that on the heels of -- we had 6 Fed funds rate increases and then 2 coming off the table here over the last quarter. I talked about last quarter, we expect to see a lag in terms of the cost of deposits that will start to drop here in Q4, and that's incorporated under the 5 basis points for every 25 bp move in Fed fund as well. So -- but we're doing everything we can to help manage the balance sheet to negate the negative impacts of margin compression in a rate-sound world.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [41]

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Okay. And so with that in mind -- and that does include the rate declines that we've already had. If we were to have future rate cuts, then we'd have that similar lag, but those would also be included in the future as well, correct?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [42]

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Correct.

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Operator [43]

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We'll take our next question from Aaron Deer.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [44]

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Following up on the expense inquiries. The 3% to 5% that could come through Phase 3, then you mentioned potential additional store closings. Are those additional store closings included as part of that 3% to 5% estimate that could come out of Phase 3? Or is that -- would that be on top of that?

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [45]

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No. They would not be included in that 3% to 5%, Aaron.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [46]

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Okay. And then I was a little surprised to hear that classifieds increase there is largely driven by ags. And your markets don't seem like soybean markets or something necessary. What type of products are in that ag book that's causing the uptick there?

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Frank Namdar, Umpqua Holdings Corporation - Executive VP & Chief Credit Officer of Umpqua Bank [47]

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Aaron, Frank Namdar. Really a lot of dairy, fruits, vegetables, specifically apples and cherries. A lot of the apple and cherry markets here really export out to China. And that has been impacted, so they're looking at alternative routes for those apples and cherries. So those would be the primary sectors.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [48]

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Okay. And then any additional color you can give behind just the elevated loss rates here in the third quarter?

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Frank Namdar, Umpqua Holdings Corporation - Executive VP & Chief Credit Officer of Umpqua Bank [49]

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I think we've been and we'll continue to kind of bounce along the bottom. And the elevated loss rate really was centered this quarter in 1 account that we had been working out of that we took a charge of $3.6 million on and is now completely out of bank.

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Cort Lane O’Haver, Umpqua Holdings Corporation - President, CEO & Director [50]

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Hey, Aaron, it's Cort. We've traditionally, historically operated with pretty short views relative to problem credits, and that hasn't changed under my leadership. Our credit folks are instructed, "if see an issue, just deal with it as quick as you can and run it through, and we can collect it at later grade." But we just don't sit on slow-pay, bad-type customers, we just move. And our portfolio is so granular, granular, excuse me, and albeit, I know it showed up in the numbers, it's just the way we choose to operate this company.

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Operator [51]

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(Operator Instructions) We'll take our next question from Michael Young.

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Brandon Thomas King, SunTrust Robinson Humphrey, Inc., Research Division - Associate [52]

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This is Brandon King on for Michael Young. And I wanted to touch on deposit growth. Of course, deposit growth was very strong this quarter, imagine loan growth, and a good chunk of that came from noninterest-bearing deposits. And I know you guys have focused on growing operating balances. But I wonder -- I'm trying to see if there were any other factors affecting that growth, such as expectations for loan growth coming up in the fourth quarter? And to see if there are any expectations to pre-fund that growth.

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Torran B. Nixon, Umpqua Holdings Corporation - Senior Executive VP & Chief Banking Officer for Umpqua Bank [53]

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Brandon, this is Tory Nixon. I think that -- 2 parts to the question: the first is, as Cort mentioned in his opening remarks, I think he's mentioned it a couple of times actually with Ron was, there's a very significant kind of bank-wide initiative on core deposit growth for the company. And we've been working on that for a few months or few -- actually, couple of quarters now. And I've seen great success with that.

Our commercial and corporate banking businesses had their largest deposit growth quarter in a long, long time this past quarter. Our retail bank has doubled. The -- one of the metrics we have is consumer account acquisition per store, per month. And over the last 18 months, they've doubled their production. So there's a lot of really good efforts there being done by the bankers in the field in all lines of business to grow core deposits for the company.

The second part of your question I think was about loan growth. And we're -- our pipeline is strong. Our lending pipeline is strong. Our deposit pipeline is strong. And our core fee income pipeline is very, very strong. So we're seeing a lot of really good momentum. And I'm excited about where we're going with the future of the company.

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Brandon Thomas King, SunTrust Robinson Humphrey, Inc., Research Division - Associate [54]

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And just shifting over to capital management. As excess capital continue to grow, has strategy changed as far as how to deploy that capital through, I mean, possible increases or a changing M&A outlook?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [55]

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Brandon, hi. This is Ron. Good question. I think, overall, we like to maintain a healthy dividend payout ratio in that, call it, 50% to 70% range buybacks. We've intentionally held to just offsetting share issuance over the course of the year, so we've got a neutral change in the share count. So -- and then excess capital of $200 million, right, it's given us great opportunity to continue very strong organic growth. It's been relatively consistent over the past year, so it hasn't increased or decreased significantly. I would expect, though, over the coming year, similar to many areas that were successful, that excess capital number will just continue to modestly decline on a quarterly basis and provide us a great opportunity no matter which way the economy goes.

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Operator [56]

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(Operator Instructions) We'll take our next question from David Chiaverini.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [57]

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A couple of questions for you, starting with premium amortization. I know it's tough to gauge, but -- and it's been volatile in a wide range the past 4 quarters. So what's the expectation, your best guess, I should say, for premium amortization in the fourth quarter, if the 10-year yield does remain at the current level?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [58]

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It should be down a couple of million. So it'll be in that $4 million to $5 million range, all else being equal, which -- unfortunately, for last year, it hasn't. But again, the way we account for that is under retrospective adjustment method. So as interest rates change significantly and the corresponding prepayment expectations change significantly, you'll see these swings regardless of if you want to get into that low 2% normalized book yield, it'd be a $4 million to $5 million a quarter premium amortization number.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [59]

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Got it. Okay. And in terms of basis points, do you have that? I guess a level for comparison...

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [60]

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That book yield or that level would be roughly -- yes, that book yield would be roughly 2.25% at that level.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [61]

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Okay. And then shifting gears to loan growth. You mentioned about how the pipelines look strong. Should we still be thinking about mid- to high single-digit loan growth over the next few quarters?

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Torran B. Nixon, Umpqua Holdings Corporation - Senior Executive VP & Chief Banking Officer for Umpqua Bank [62]

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Hi, David. This is Tory Nixon again. Yes, I would. I think that's a nice number to think about for us.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [63]

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Okay. And then similarly, on the core fee income, you mentioned about how the pipeline there is strong. How does this pipeline compare to last quarter, the past few quarters or maybe even the year ago quarter as well?

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Torran B. Nixon, Umpqua Holdings Corporation - Senior Executive VP & Chief Banking Officer for Umpqua Bank [64]

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So we launched this initiative on growing core fee income about almost 18 months ago, and there's certainly a lag in the time to build and to grow significantly. And to give you an indication, there's a few areas where we track really heavily. And I'll give you some stats. On commercial card, revenue for us is up 47% in those 18 months. Our international banking revenue and FX is up 31%. Our merchant is up 13%. Our treasury management fees are up 20%. So there's just nice growth in terms of number of customers, prospects, existing customers and then just the general pipeline across all of the core fee businesses.

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Operator [65]

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We have a question from Tyler Stafford.

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Tyler Stafford, Stephens Inc., Research Division - MD [66]

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Ron, to your point earlier in one of the other responses, we have had 5 or 6 rate increases since Next Gen was laid out. We had, I guess, 2 cuts now and, admittedly, the tenure is 50 or 60 basis points lower than I think when you gave that -- the initial Next Gen profitability goals. But I'm just curious, given where we are at now, how do you feel about plausibility to hit those profitability goals, either in the flat rate or moderately increasing rate environment, I guess, before we should think about Phase 3 potential impacts?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [67]

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I'd say one of the other big moving parts aside from the tenure is really more the belly of the curve, right, being much lower as well, with just the drastic change over the last year. So obviously, NIM -- today, it doesn't look like NIM plus 4 Fed funds moves from 2 years ago projected. So with that it'd be on the lower end of that range. But definitely, that's why we're also looking at Phase 3 and continue to operate as efficiently as we can and look at all costs, be it funding costs and/or fixed operating costs. As Cort mentioned, they help offset the impact of margin, if rates do decline. And if you go back a year and rates were increasing and the (inaudible) has happened today, we all think rates are going to decline. And that could happen, regardless, we're going to manage the cost structure of the company to ensure we're in the best position we can be.

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Operator [68]

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(Operator Instructions) We'll take our next question from Matthew Clark.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [69]

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Just wondering how much you had in the way of CDs maturing in the fourth quarter. At what rate? And what's the weighted average rate on new CDs?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [70]

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Good question. And we did showed the rate volume analysis at the back. I'd say on the CD side, probably the biggest delta in terms of rate is going to be some of the broker deposits from earlier in the year rolling off at 25 to 45 basis points lower, depending on the cadence in the quarter in which they came in. But that also is incorporated in the couple of basis point drop in the overall customer deposits side laid out, assuming no more changes from the Fed.

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Operator [71]

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And that does conclude today's question-and-answer session. I would like to turn the call back over to Ron Farnsworth for any additional or closing remarks.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - Executive VP & CFO [72]

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Okay. I want to thank everyone for their interest in Umpqua Holdings, and their attendance on the call today. This will conclude the call. Goodbye.

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Operator [73]

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Thank you. That does conclude today's presentation. Thank you for your participation. You may now disconnect.