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Edited Transcript of UMPQ earnings conference call or presentation 24-Jan-18 6:00pm GMT

Q4 2017 Umpqua Holdings Corp Earnings Call

Portland Jan 25, 2018 (Thomson StreetEvents) -- Edited Transcript of Umpqua Holdings Corp earnings conference call or presentation Wednesday, January 24, 2018 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Cort L. O’Haver

Umpqua Holdings Corporation - CEO, President & Director

* David F. Shotwell

Umpqua Holdings Corporation - Chief Credit Officer, Chief Lending Officer and EVP

* Ronald L. Farnsworth

Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank

* Torran B. Nixon

Umpqua Holdings Corporation - Head of Commercial & Wealth for Umpqua Bank and EVP of 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

* Brian James Zabora

Hovde Group, LLC, Research Division - Director

* David John Chiaverini

Wedbush Securities Inc., Research Division - Research Analyst

* Jacquelynne Chimera Bohlen

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

* Jared David Wesley Shaw

Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst

* 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

* Michael Masters Young

SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst

* Steven A. Alexopoulos

JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks

* Tyler Stafford

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Thank you for standing by. Good day, and welcome to the Umpqua Holdings Corporation Fourth Quarter Earnings Call. Today's call is being recorded. At this time, I'd like to turn the conference over to Mr. Ron Farnsworth, CFO. Please go ahead, sir.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [2]

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All right. Thank you, Mio. Good morning, and thank you for joining us today on our fourth quarter and full year 2017 earnings call. With me this morning are Cort O’Haver, the President and CEO of Umpqua Holdings Corporation; Dave Shotwell, our Chief Risk Officer; and Tory Nixon, our Head of Commercial and Wealth. After our prepared remarks, we will then take questions.

Yesterday afternoon, we issued an earnings release discussing our fourth quarter 2017 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 L. O’Haver, Umpqua Holdings Corporation - CEO, President & Director [3]

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Thanks, Ron, and welcome to everyone listening in on this morning's call. Let me begin by providing a brief recap of our fourth quarter and full year 2007 (sic) [2017] results and accomplishments. Ron will talk later about the financials in more detail, and then we'll take your questions.

After just over a year as CEO, I'm extremely pleased with the progress we have made. 2017 was truly a pivotal year for Umpqua. We delivered strong financial performance and grew the company while developing and making significant progress on Umpqua Next Gen, our 3-year program to transform the company. Together, all the hard work completed across the organization last year positions us extremely well for 2018 and beyond.

Let me start with financial performance. During the fourth quarter, we reported earnings of $0.38 per share, which compares to $0.28 per share in the prior quarter. Full year 2017 earnings per share were $1.12 compared to $1.05 in 2016. Ron will talk about financials in more detail, but I want to take a moment to say more about our tax benefit of $26.9 million related to the passage of the Tax Cuts and Jobs Act that's included in our fourth quarter results.

In light of this adjustment, we took the opportunity to make additional investments in key areas, including $3.2 million for employee profit-sharing and a $2 million donation to the Umpqua Bank Charitable Foundation. We are also accelerating strategic investments in digital and technology capabilities that will enhance the customer experience for our business customers. And we're planning to increase shareholder returns via higher dividends in 2018. These are key investments that will build on our success last year.

A year ago on this call, I told you that balanced growth was our top priority, and I'm pleased to report that our strategy is working well as our growth last year demonstrates. I'll share a few highlights beginning with our loan growth. Our loan and lease portfolio increased by just over $400 million during the fourth quarter, bringing total growth to $1.6 billion or 9% for the year. 45% of the total loan and lease growth in 2017 was in the commercial portfolio, which includes C&I as well as our leasing business. That portfolio grew 20% over the prior year, which is the result of the strong momentum our corporate banking group has been building. They're able to leverage the bank's balance sheet and size, which is critical part of our overall strategy to drive stronger and more profitable growth. This growth also reflects the strength of Umpqua's market position, brand and culture, which allow us to add key talent and develop new core relationships with small business and middle market companies across the footprint.

With the recent addition of a corporate banking market leader in Orange County, we now have established teams in all of our major Metropolitan markets, demonstrating our commitment to fully building out this division of the bank.

The residential real estate portfolio increased by 11% over the prior year, and our commercial real estate portfolio was up 4% from the previous year. Loan pipelines across the organization are robust, and we remain optimistic about continued loan growth for 2018.

Now turning to deposits. Total deposits increased by $927 million or 5% for the year. That primarily reflected growth and demand in savings accounts with a small decline in time deposits. It's important to note that as a part of our focus on balanced growth, we've developed a comprehensive deposit strategy that includes all areas of the bank, and here are a few highlights: We're emphasizing multifaceted relationships across the bank, and it's working well. Total deposit growth for 2017 within the commercial and wealth division was $422 million, which represents 60% of growth in the commercial loan portfolio last year. Of the $422 million of deposit growth, a little under half was from our corporate banking teams.

We're making strategic investments in our digital and training platforms to build on that progress. And we're investing in other deposit-rich areas, including digital capabilities, which I'll discuss more in a moment, and in key divisions like wealth management. Last year, we added an experienced wealth executive who has restructured the team and product offerings and is now focused on generating significant deposit and fee growth.

Consistently with industry expectations, total mortgage banking revenues declined year-over-year. The increase in interest rates caused the mortgage landscape to further shift away from refinance activity to a heavy-purchase-driven market. Industry outlooks call for that to continue in 2018. Our overall mortgage originations declined by 13% from the 2016 level, reflecting a 29% decrease in refinance volume. Mortgage banking continues to be a core business and a profitable segment for the bank. The business model is highly scalable, and our cost to originate a loan is below industry average.

Capital and liquidity are strong, and credit quality remains stable. We are not seeing any early indicators or warning signs of deterioration within any of our loan portfolios. Let me now provide a brief update on Umpqua Next Gen.

On past calls, we've discussed our strategy to build on Umpqua's customer-centric brand in order to differentiate ourselves in the marketplace and create a new, competitive advantage. We call this strategy human digital banking, an approach that combines technology with one of our most powerful assets, our people, to create a unique offering in our markets.

As part of our human digital strategy, we're redeploying capital to transform Umpqua into an organization that uses technology, data and analytics to empower our people to build even deeper and more valuable, profitable customer relationships. Our investments in digital and data will make it possible for our customers to bank in a more convenient way and will empower our associates to be even more effective and efficient in providing smart, valuable solutions for our customers. This is particularly important as we continue to rightsize our physical footprint to reflect changing customer preferences while remaining focused on growing deep customer relationships.

As one example, I'm pleased to report that earlier this month, we successfully introduced a suite of new digital offerings and capabilities, including a new mobile-optimized website, enhanced online origination capabilities and new digital products, supported by an aggressive digital marketing campaign. Together, they're a powerful offering designed to attract new customers, and we're already starting to see strong results and look forward to providing updates on our human digital initiatives later this year and over the course of our Next Gen program.

Regarding store consolidations, as we discussed last quarter, in 2017, we identified 30 locations for closure in Q1 of this year and began that process earlier this month. Consolidations of all 30 store locations will be completed by the end of Q1, and we identified 1 additional location that will be closing in mid-April. Going forward, we plan to incorporate additional Umpqua Next Gen tracking and metrics into our quarterly earnings calls and materials. Look more for that later in 2018.

Now back to Ron to cover financial results.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [4]

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

On Page 5, we've updated our 2020 financial goals discussed last October to reflect the recent federal tax reform. The major change is lowering our effective tax rate from 36% to 25%. Of the increased earnings resulting from the lower tax rate, we are planning for: One, approximately 20% of the benefit will be invested in key areas in 2018, resulting in increased operating expense due to investments in profit sharing, staffing and additional digital and marketing initiatives that support and accelerate our Umpqua Next Gen initiatives; two, approximately 35% to 40% for increased dividends to shareholders starting in March 2018; and three, the balance to be retained in equity for future investment.

Net of these changes, we are increasing our 2020 goals as highlighted on the page, noting our return on tangible common equity goal has increased from greater than 13% in the flat rate environment to now greater than 14.5%. And for the moderately increasing rate scenario, we are increasing it from greater than 15% to greater than 17.0%. A similar increase is shown for return on assets.

I want to reiterate that we are framing these 3-year financial goals separately between a flat rate scenario and a moderately increasing rate scenario with those rate pass noted at the bottom of the page.

It's also important to note the following: We're assuming no recessionary or lower rate environment here. If those were to occur over the next 3 years, it is reasonable to expect that our financial results will differ. Two, as we discussed last quarter, we are in the middle of our operational and back office efficiency review. We have engaged Boston Consulting Group in this project and expect to discuss opportunities and timing for future cost savings in our April earnings call. Any benefit arising from this review is expected to be accretive to the financial goals presented on this page. The financial goals exclude fair value adjustments and exit disposal costs. We are exploring strategies to reduce volatility from fair value adjustments to future earnings. More to come on this also in our April earnings call. And last, our excess capital is projected to decline over the coming 2 years to around half of current levels before rebounding slightly in 2020 when seasonal comes into play.

Share repurchase is still expected to cover net share issuance with a generally flat common share count, and dividends will be maintained in the 50% to 70% payout ratio range of earnings, noting again that we plan to increase our dividend starting in March 2018 to maintain a similar payout ratio. Let me now spend a few minutes reviewing fourth quarter results.

Turning to Page 7 of the slide presentation, which contains our summary P&L. Fourth quarter earnings were $83 million or $0.38 per share, up from $61 million or $0.28 per share in the third quarter and up from $69 million or $0.31 per share in the same quarter a year ago. At a high level, the $0.10 increase from Q3 to Q4 resulted from $0.12 or $27 million of net benefit to the income tax line given the revaluation of our net deferred tax liability resulting from federal tax reform; $0.02 of benefit from a combination of the change on MSR and junior subordinated debenture fair value marks along with merger expense and exit disposal costs; $0.03 of increased expense in response to the net benefit this quarter from tax reform, including employee profit-sharing and charitable foundation contribution and other expense; and $0.01 of lower gain on portfolio loan sales.

Turning to net interest income and margin on Slide 8 and noted on Page 7 of the earnings release, net interest income was flat from Q3. Within this total, our credit discount accretion declined $4 million this quarter. This increase, excluding credit discount, reflects the benefit of continued strong loan growth over the past few quarters and an increasing rate environment.

Also within net interest income, our interest income on investments was up slightly, representing lower premium amortization. And our interest expense on deposits increased $1.2 million or 4 basis points based in part on the growth this quarter and modest repricing based on the recent fed funds' rate increase. Our deposit beta based on the fed rate increases over the past year has been 16%, driven primarily by higher cost public funds and broker deposits.

For the fourth quarter, our net interest margin was down 4 basis points, reflecting the lower credit discount accretion. While the margin ex-credit discount was up 1 basis point at 3.79%, slightly above our prior guidance range given deposit betas are still relatively low.

On Slide 9, the provision for loan and lease losses was $13 million, up slightly from Q3, based primarily on continued strong loan growth. As shown later in the deck on Page 15, net charge-offs were 25 basis points annualized, and our NPA ratio increased slightly to 37 basis points of assets based on 2 loans. Overall, credit quality remains very strong.

Moving now to noninterest income on Slide 10. The decrease in total noninterest income from Q3 to Q4 was driven in part by lower gain on portfolio loan sales, noting the change in MSR and trust preferred fair values mostly offset each other. On the home lending front, as shown on Slide 11, and also in more detail on the last page of our earnings release, for sale mortgage originations declined 5% as expected given the seasonally slower fourth quarter. Our gain on sale margin decreased to 3.51% this quarter, reflecting in part a lower lock pipeline and at the end of September. Absent the decline in rates, we expect a normal seasonal bell curve for 2018 in both mortgage originations and gain on sale margin.

Turning to Slide 12. Noninterest expense was $193 million. The bridge we provide on the right side details the major moving parts, including merger expense declined to 0 as expected. Home lending direct expense dropped a little over $2 million, again as expected with lower volume. In response to tax reform, we had $5.2 million of expense for an employee profit-sharing contribution and a contribution to the Umpqua Bank Charitable Foundation.

In the next 2 categories for consulting professional and other, total of $6.7 million increase and includes several smaller moving parts. The majority of this amount was recorded in response to the Q4 benefit of tax reform, including items to be deducted for the 35% tax rate in effect for 2017. The $1.5 million increase in exit disposal costs were a total of $3 million for the quarter, relates to the Q1 2018 store consolidations and includes severance and estimated loss on disposal. We expect gains on about half of the property exits but cannot recognize them until the properties are disposed of, which will be later in Q1 and Q2.

Also of note this quarter, we exited our loss sharing agreements with the FDIC at a small net cost of less than $0.5 million. Given the exit, we no longer have to share future [managed] recovered under former loss share loans.

As Cort and I both mentioned earlier, we're making additional investments in people and technology in response to tax reform and have incorporated them into our 3-year financial goals. The first half of 2018 will have several moving parts and expense, including: One, digital marketing investments we're making ahead of the store consolidations early in 2018 in order to maximize growth opportunities; two, the seasonal payroll tax increase we see every Q1 of approximately $4.5 million, which runs down then over the balance of the year; three, annual merit increases starting later in Q1; four, home lending expenses at approximately 250 basis points of volume for the full year. From a timing perspective, Home lend expenses are generally 30 to 40 basis points higher in the beginning of the year and the decline over the remainder of the year; five, consulting and professional fees related to various reviews underway; six, exit disposal costs related to completion of the 2018 store consolidations; and lastly, additional staff and technology-related investments we're making, utilizing approximately 20% of the benefit from tax reform.

These will be reduced by savings from store consolidations of approximately $12 million annualized starting later in Q2. With these moving parts, we expect our overall fiscal 2018 GAAP expense to be in the range of $192 million to $197 million for the first quarter, declining over the year to be in the range of $178 million to $183 million by the fourth quarter of 2018. And again, that this -- I'll reiterate that this guidance excludes any benefit from our operations and back office efficiency review currently underway. We will discuss initiatives stemming from this engagement in our upcoming April call and are expecting to reduce future expense forecasts as a result of the opportunities identified.

It's important to note that while utilizing 20% of the expected benefit from lower tax rates on expense initiatives adds about 1% to our efficiency ratio for the year, the benefits to shareholders are a much higher return on investment with higher dividends and higher return on tangible equity and we believe strikes an appropriate balance for all constituents involved as we execute our Next Gen initiative.

Turning now to the balance sheet, beginning on Slide 13. This past year, our loan book increased 9% while deposits increased 5%, leading to the higher loan-to-deposit ratio and lower interest-bearing cash. Our goal for the coming year is balanced growth among loans and deposits, noting we expect we'll be seasonally slower on deposits in the first half of the year, making that up in the second half of the year. Also, our tangible book value per share is $9.98, which, when you also account for the dividends to shareholders, increased 12% this past year.

And lastly, on Slide 16, I want to highlight capital. Note that all of our regulatory ratios remain in excess of well-capitalized levels, with our Tier 1 common at 11% and total risk-weighted capital at 14%. Our total payout ratio was 50% this quarter. I also want to note that towards the end of the first quarter in 2018, we plan to redeem $10 million of higher cost in trust preferred debt, which should provide just under $1 million in annual net interest income. Our excess capital is approximately $240 million, and as discussed earlier, we expect this to decline moderately over the coming 2 years.

To conclude, our focus is on executing our Umpqua Next Gen strategy, improving financial results and generating solid returns for 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) And we'll take our first question from Michael Young with SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [2]

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I wanted to start with just loan growth outlook for 2018 now that you've got sort of the commercial hiring done that you want to have in place but then, I guess, the potential offset of if you're looking to exit anymore lending categories post your kind of review of return on capital there.

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Torran B. Nixon, Umpqua Holdings Corporation - Head of Commercial & Wealth for Umpqua Bank and EVP of Umpqua Bank [3]

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Sure. Michael, this is Tory Nixon. We had -- loan growth in '17, the commercial bank was about $1.1 billion. And I think it was kind of the -- this continued buildout in corporate banking, the addition of what we're doing on the wealth side and the activities in the pipeline. I kind of see '18 to look similar -- a similar mix and a slight real increase of what we did in '17.

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

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And then Michael, Cort. On the consumer and home lending side, right now, applications are firming up on the home lending side, much like last year. And then on the consumer side, pretty strong and expecting, much like we did last year, out of the consumer side.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [5]

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Okay. Great. And I just wanted to also clarify kind of the expense comments. Obviously, the acceleration of the investment on the front end. So the magnitude of investment, you expect to be relatively similar. But we're just going to pull it forward and get it done quicker, and then we're going to end up at a lower net-net kind of expense run rate exiting the year. Is that kind of the thought process?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [6]

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That's correct. So it will be higher in the first half of the year. Q1 will be higher than Q2, and that will be dropping down through Q4. So by Q4, we expect our GAAP expense to be $178 million to $183 million, probably a very small exit disposal cost. If we do any additional consolidations, we pull any forward from '19 and '18, we'll guide to that over the course of the summer months. So $178 million to $183 million in Q4 of expense. But also just keep that -- keep in mind that, that excludes any benefit we get out of our operational efficiency review, which we look forward to talking about in April.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [7]

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Okay. And if I could sneak one last one in, just on the deposit side. Did you see any pull-forward of deposits from -- in, like, the public fund space or anywhere else as a result of the tax changes from people prepaying property taxes or anything like that?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [8]

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No. Not -- no pull-forward we noticed on that front.

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Operator [9]

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We'll take our next question from Steven Alexopoulos with JPMorgan.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks [10]

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I wanted to drill down first on the loan side a bit further. You strung together 2 really good quarters of C&I loan growth here. How sustainable do you think the C&I loan growth is at the pace you've put up the last 2 quarters?

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Torran B. Nixon, Umpqua Holdings Corporation - Head of Commercial & Wealth for Umpqua Bank and EVP of Umpqua Bank [11]

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Steven, it's Tory Nixon again. I think it is sustainable. We've gone to great effort and lengths to higher and kind of organize this corporate banking franchise up and down the West Coast, and we now have a leader and a team in every major metropolitan market, and we're starting to really see some traction and some growth out of all of the markets. And at this point, we expect that to continue.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks [12]

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Okay. And then on the multifamily, you had nice growth there in the quarter, too. Give some color on that. Are you guys just more willing at this stage to grow that portfolio again?

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Torran B. Nixon, Umpqua Holdings Corporation - Head of Commercial & Wealth for Umpqua Bank and EVP of Umpqua Bank [13]

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This is Tory again. I mean, we're seeing some -- yes. We're seeing some slight growth, really, in the production side of multifamily, but again, it's mostly smaller ticket to our multifamily division. And I think we're kind of keeping a very small growth number in a very tight box in that space.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks [14]

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Okay. And then on the deposit side, you guys had good deposit growth in the quarter, but it was almost entirely money market accounts. Curious what you're paying on those. And how do you think about the deposit mix as you fund this strong loan growth that's coming?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [15]

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This is Ron, Steve. So in terms of overall money market balances there in that, call it, 35 to 50 bp range on average, in terms of the growth over the course of the year, the coming year, we do expect to see growth across all categories. I'd like to think time deposit growth is going to kick in here again as -- if we do see another 1 or 2 increases. But we've got a lot of focus on the consumer side. We're growing DDA. So our goal is going to be balanced growth across the categories. I hope that helps. And again, the betas just are low, right? I think the online banks have taken a lot of the hot money out of the system over the past 10 years.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap and Small-Cap Banks [16]

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And Ron, since you're our accretion guru, maybe one for you. Was the accretion about $3.3 million this quarter? I don't understand why it was so low. I don't know if that's a scheduled level. And how should we think about a run rate there?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [17]

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Sure. All-in accretion -- credit discount accretion was about $4 million this quarter, down from $8 million in the prior quarter. Recall, the prior quarter included some acceleration related to smaller acquired portfolio sales. I would expect that $4 million we had in here in Q4 just to continue the moderate declines where maybe a year out from now, Q4 of '18, it's in the $1 million to $2 million quarter range. It's going to be pretty small.

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Operator [18]

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And we'll go next to Aaron Deer with Sandler O'Neill and Partners.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [19]

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Following up on the comments, the C&I growth has been pretty impressive. I'm curious, Tory, in addition to hiring folks and just getting some good traction on that front, what have -- how have you employed kind of pricing relative to the market? Are you -- you've been pretty aggressive on that front to bring in this business. And how are the current yields on new production relative to kind of what's existing in the book for the C&I?

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Torran B. Nixon, Umpqua Holdings Corporation - Head of Commercial & Wealth for Umpqua Bank and EVP of Umpqua Bank [20]

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So I'll answer the yield first. I mean, we're over the -- just if I look at October, November and December, we saw slight increases in new production yield. So we're kind of seeing that as a general kind of flow and increase in the market. As far as acquiring relationships, I mean, it's been as much about hiring the right folks with access to the market, knowledge of the market, a customer base that we've been able to bring into the bank. And so we haven't had to be aggressive on the pricing front. It's been -- I -- in my view, it's been definitely in-market and it's allowed us to be successful, I think, in bringing those relationships over.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [21]

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That's great. And then the -- obviously, credit metrics remain pretty healthy, but the trends and NPAs have been up the past couple of quarters. Hoping you could just give a little bit of color in terms of what categories those -- the problem credits are in or if there's any sort of correlations there that you would look at.

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David F. Shotwell, Umpqua Holdings Corporation - Chief Credit Officer, Chief Lending Officer and EVP [22]

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Dave Shotwell here, Chief Risk Officer. Nonperforming assets did click up last quarter, but it was concentrated in 2 individual relationships. One was a larger, old, vintage ag loan, and one was a single-asset real estate loan. So those 2 combined for about $21 million net, some resolutions we had during the quarter, and it was limited to those credits. We're not seeing any kind of systemic deterioration. If you look at classified loans in the bank and you look at kind of early-stage delinquencies, those are both solid to trending down.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [23]

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Okay. And what -- with the ag loan, what category was that in, in terms of cross or...

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David F. Shotwell, Umpqua Holdings Corporation - Chief Credit Officer, Chief Lending Officer and EVP [24]

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That would have been in C&I.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [25]

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No. I mean, in terms of the type of ag.

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David F. Shotwell, Umpqua Holdings Corporation - Chief Credit Officer, Chief Lending Officer and EVP [26]

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We don't get into the detail on that. But suffice to say, it was a grower, and we're now in aggressive workout mode with that borrower.

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Operator [27]

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We'll go next to Matthew Clark with Piper Jaffray.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [28]

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The FDIC assessment expense this quarter was down, cut in half. Just curious if there's anything unusual there, if that's a good run rate from here.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [29]

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Yes. We went back through and recast some of the data in our [CO], and the color forward's going back 1 year or 2, recognize that $2 million credit. I expect that'll be in the $4 million to $4.5 million range accordingly going forward.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [30]

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Okay. And then the nonmortgage portfolio loan sale gains, I know it came down a little bit. I think last quarter, you guys talked about maybe not doing much of that going forward. Is that still the case? Should we see that -- should we expect those portfolio loan sales to dry up?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [31]

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Yes. Yes. The plans we laid out for the 3-year goals exclude portfolio loan sales. What you will see in that line item quarterly would be your typical SBA activity, which is probably about 1/3 to 40% of the balance we had this quarter.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [32]

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Okay. Great. And then for the next round of branch closures, I guess when should we expect you guys to identify kind of the next tranche of that 70 that's remaining?

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Cort L. O’Haver, Umpqua Holdings Corporation - CEO, President & Director [33]

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Matt, Cort. So, yes, we'll get through the first 31 now by mid-April. And obviously, on the last call, we mentioned, we were going to reduce by 100 over the next 3 years. We've already identified the next 30. And I think relative to when we would make that announcement, both to our customers, our associates and then you all, will become a little bit dependent on how we do relative to the closures and maintaining our performance to our forecast relative to any attrition, if we have any. We have forecasted some attrition. And then we'll balance that against our performance there and then -- other opportunities in the bank. So I mean, I guess, I'd tell you is, right now, we don't have anything else scheduled this year. Like we had messaged on the last call, it doesn't mean that we wouldn't consider it this year, but we don't have anything scheduled. But we do have them identified.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [34]

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Okay. And then on the home lending expense down $2.3 million this quarter, I think, to just over $29 million, I guess how much of that $29 million is variable -- was variable this quarter?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [35]

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Roughly 2/3.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [36]

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Okay. And then just on the MSR, I guess how much of that was kind of normal course MSR amortization embedded in that $2 million mark?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [37]

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Right. Yes. Also, we had an increase in rates over the course of the quarter so it ended up 1%, pretty much where we were at the start of the year for the valuation. The normal passage of time, charge or erosion of the MSR is in that -- anywhere from $3 million to $5 million quarter range, depending on you're coming off of a quarter of a wild shift in rates or not.

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Operator [38]

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We'll go next to Jared Shaw with Wells Fargo Securities.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [39]

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Just looking at the -- so the assumptions on the provision going forward, where you say 30 to 40 basis points of loans, is that 30 to 40 basis points of net loan growth in annual provision? Or is that on the total balance of loans? So we should -- if we have 25 basis points of charge-offs, we should expect to see that overall allowance level grow in that 5 to 15 basis point range?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [40]

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Yes. That 30 to 40 basis points is over the average balance of loans for the year. So not new growth or funding, but on balance sheet, average loan balances. And the idea there is that it will exceed the net charge-off amount on that forecast, and that reserve level will build over the 3 years. Add to the sequel in 2020, which, of course, it'll build for everybody.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [41]

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Okay. So that's sort of the new way of -- we should be modeling out the provision growth.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [42]

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Yes.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [43]

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Okay. And then just shifting onto the expenses on the exit and disposal costs, the $8 million to $12 million that you're referencing, is that allocated to the 31 branches that we're looking at in first quarter? Or is that allocated to whatever the next round of branches would be?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [44]

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That's a good point. Actually, $3 million of it got pulled forward into Q4, so the balance, I guess, of, what, $5 million to $9 million, I'd expect that'd be on the low end of the range, and you'll see that being recognized in Q1 and Q2. It might be a bit lower, just given the expected gain on disposition on some of the properties.

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

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And as for the current, 31 stores.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [46]

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Right. Right.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [47]

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Okay. Okay. That -- can you just walk through what's included in that? I think as I look back over the last 2 years, the $5.6 million you took in '17, the $4.7 million in '16, just given the number of branches that declined, it seems like a big number for a branch. What's sort of wrapped up in that accounting?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [48]

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You bet. It'll include severance accruals. It'll include lease termination, if that's the case. It'll include gain or loss on sale or disposition of the property. Once the property is identified, if there's a loss, we recognize the loss that day. If there's a gain, it's not recognized until it's disposed of. So probably over the past year, the majority has been around lease exit.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [49]

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Okay. And then, I guess, as we go forward, most of that Next Gen cost, or a lot of that Next Gen cost, will be captured in this line item?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [50]

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Not in exit disposal costs. This is simply set around the store consolidations we have planned over the coming 3 years. So overall, Next Gen initiatives, be it compensation, staffing, training, digital marketing, digital product investment, that will all be throughout the expense categories but not identified separately as exit disposal cost. Apples and oranges.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [51]

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Okay. Great. And then in the past, you had stated looking for around $400,000 annual cost saves per branch closure. Is that just for the stuff that we've seen in the past? Or going forward, is that still a good level of cost saves to use?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [52]

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That's a good proxy on average across the 100 we're looking at over the next 3 years.

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Operator [53]

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We'll go next to Jeff Rulis with D.A. Davidson.

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Jeffrey Allen Rulis, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [54]

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I'd -- it's a follow-up on the expense detail. I just wanted to map through the -- certainly, the profit-sharing and donation that's running through the comp line. Is that correct?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [55]

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Jeff, sorry. I can barely hear you. The volume is a little low. I think you asked about Charitable Foundation contribution and profit sharing. So for Q4 2017, the $3.2 million profit sharing accrual was in compensation. The Charitable Foundation contribution was another expense.

(technical difficulty)

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Operator [56]

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We've lost connection with Jeff. We'll move next to David Chiaverini with Wedbush Securities.

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

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You mentioned that you're expecting deposit attrition in the first quarter and second quarter related to the branch closings. Could you first remind us how much attrition you had with the 6 branches closed in the third quarter?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [58]

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Yes. It's been 0.

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

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So given that it's 0 for those, can you kind of describe how much or give the magnitude for how much deposit attrition you're expecting for the upcoming branch closures and why you're assuming attrition for these closures when you had 0 attrition in the third quarter?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [60]

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Sure. No. Good question, good question. And again, following up on our conversation in October. To a certain extent, these 30 stores are a bit further apart. A couple of them are smaller market exits. In total, we're estimating anywhere from 20% to 30%. We hope to overachieve or come in much lower than that, but that's what we're factored into the 3-year forecast with initiatives, of course, on the side to grow more than that expected runoff. Specific to Q1 deposits, seasonally, we're always slower in Q1. I think banking, in general, it's coming off of Q4 and heading into tax time in April. Then we generally see it rebound late in Q2 through Q3 and Q4. So Q3 and Q4, generally the stronger quarters of the year for overall growth on deposits.

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

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Okay. And then you mentioned about how the deposit beta has been very, very low at 16%. What are you modeling for beta in the coming year? And also, can you provide some thoughts on the net interest margin outlook for the next couple of quarters?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [62]

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Yes, you bet. So just in terms of overall betas, again, on these -- on our 3-year financial goals, which we laid out on Page 5 of the slide presentation, we've modeled those margins in our historical 50% to 60% deposit beta range in total. So that's what's reflected in those margin estimates. Obviously, we're outperforming that here today, but this is 1 quarter with 3 years to go. In terms of near-term margin outlook, I'm going to assume here for the near term, betas are going to remain low, but expect that margin ex-credit discount to be in that, call it, 3.75% to 3.8% range, a bit higher than the prior guidance we hit.

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Operator [63]

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We'll go next to Jackie Bohlen with KBW.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [64]

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Following up on the margin question. That 3.75% to 3.80% range, does that include the impact of what's going to happen with the tax effect on munis' rates...

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [65]

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Yes. That's roughly 1 bp.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [66]

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Okay. Just 1 bp? Okay.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [67]

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Yes.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [68]

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And Ron, what was the linked quarter impact of the lower premium amortization?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [69]

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Premium amortization on bond income?

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [70]

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Yes.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [71]

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It actually was about $1 million. So the majority of that increase in the overall line was related to lower premium amortization. We didn't grow the portfolio.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [72]

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Okay. And then just lastly, on the agricultural loan that was put on nonperforming, the grower that you had mentioned, was that weather-related? Or was it something unique to the borrower?

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Cort L. O’Haver, Umpqua Holdings Corporation - CEO, President & Director [73]

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I would say, it was more operational issues.

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Jacquelynne Chimera Bohlen, Keefe, Bruyette, & Woods, Inc., Research Division - MD, Equity Research [74]

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Okay. And have you seen anything throughout your footprint given the severe weather that we've had going on? Has there been any weakness to any loans that you're seeing or anything that's concerning to you?

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Cort L. O’Haver, Umpqua Holdings Corporation - CEO, President & Director [75]

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No. No. And we monitor that, obviously, very closely on the ag portfolio, including water issues in the west. We have a pretty good handle on that. We're not seeing any emerging issues for our borrowers.

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Operator [76]

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And we'll go back to Michael Young of SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [77]

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I just wanted to kind of follow up on what you mentioned last quarter on evaluating the profitability and risk-adjusted returns across the organization, both by loan category and customer level. Any results or anything to kind of announce along that front? I know you exited auto -- or announced the exit of auto last time. But any other product types or customer types that you're kind of moving away from?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [78]

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Nothing to announce at this point. And again, we'll have follow-on discussions in April on the heels of the operational efficiency review. That could factor in based on the decisions we make company-wide, but nothing jumping out at this point.

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Operator [79]

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We'll go to Brian Zabora with Hovde Group.

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Brian James Zabora, Hovde Group, LLC, Research Division - Director [80]

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Just a clarification on the expense expectations, the quarterly ranges that you gave. Does that include or exclude those exits and disposal costs that you're expecting?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [81]

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Great question, Brian. That includes them. So the -- I announced it as the GAAP expense, which include the exit disposal. And again, Q1 of 2018, we're expecting in the range of $192 million to $197 million dropping over the course of the year. So for Q4, in that $178 million to $183 million range.

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Brian James Zabora, Hovde Group, LLC, Research Division - Director [82]

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Great. Okay. And then on the loss share that you just exited, how much of the loan book was still covered under the loss share?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [83]

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It's small. It's less than $100 million.

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Brian James Zabora, Hovde Group, LLC, Research Division - Director [84]

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Okay. Okay. And then just lastly, I think you mentioned on multifamily, your growth's been good. You said it's kind of a tight, straight box. Are there areas of your footprint that you're maybe more concerned about, that you're staying away from or types of properties that you may be also avoiding?

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Cort L. O’Haver, Umpqua Holdings Corporation - CEO, President & Director [85]

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We're looking carefully at higher-end product in all the major markets. I mean, that's the one space that we're probably being a little bit more conservative with, so that would be our focus.

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Operator [86]

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And we'll go next to Tyler Stafford with Stephens.

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Tyler Stafford, Stephens Inc., Research Division - MD [87]

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Just one last one from me, just on the 4Q expense page. And I appreciate you guys giving the 1Q '18 kind of run rate that we should expect to see, but I was a little surprised to see it up so much in the fourth quarter, especially with mortgage down, the $2.3 million. I know in the third quarter, you closed the 6 branches, and I believe the 10 non-stores that were expected -- expecting to drive $4 million cost saves. Did you guys end up recognizing that? Or is that -- I guess, getting to the puts and takes on the first quarter, is that left to come out in the fourth quarter and into the first quarter?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [88]

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It wasn't there for the whole fourth quarter, but it probably hit mid-fourth quarter. But I think the bigger moving parts in Q4, we talked about the little over $5 million between profit-sharing and the shareholder contribution. There's another, call it, net $6.5 million, $7 million increase. And majority of that we took in relation or in response to tax reform, and a lot of that was items that we were able to pull forward and deduct at a 35% tax rate. So they fall off, of course, in Q1 replaced with digital investments, a little bit higher exit costs, along with payroll taxes and the other items I talked about.

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Tyler Stafford, Stephens Inc., Research Division - MD [89]

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Did you hit on earlier what those 4Q items were that you pulled forward? I may have just missed it.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [90]

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Sorry. Yes, I did. There were a lot of small items, nothing individual to call out. But in total, I'd say in the range of $4 million to $5 million.

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Operator [91]

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And we'll take a question from Matthew Clark, Piper Jaffray.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [92]

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Just a quick follow-up. I'm curious. I know it's still early, but have you guys -- or will you kind of update kind of what you think you achieved in terms of revenue enhancements and cost saves to date for Next Gen?

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [93]

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We will do that over the course of the year. Obviously, a lot of discussion coming on in our April call specific to the operational efficiency review we have underway, along with plans for reducing the volatility of the fair value in MSR. So a lot more to come on that in April. And that's a big piece of Umpqua Next Gen.

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Operator [94]

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With no more questions in the queue, I'd like to turn the call back to management for additional comments or closing remarks.

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Ronald L. Farnsworth, Umpqua Holdings Corporation - CFO, Executive VP, CFO of Umpqua Bank and Executive VP of Umpqua Bank [95]

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

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Operator [96]

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Thank you, sir. And that does conclude the call today. Thank you for your participation. You may disconnect at this time.