Banner Corp Q1 FY2022 Earnings Call

Good morning, ladies and gentlemen. Thank you for joining and being present at the Banner Corporation's First Quarter 2022 conference call and webcast. My name is Irene, and I will be coordinating today's call. If you would like to ask a question during the presentation, you may do so by following the operator instructions. In case you have joined us online, you have the possibility to press the flag icon on your web browser to ask a question. I will now hand you over to your host, Mark Grescovich, President and CEO to begin. Mark, please go ahead.

Thank you, Irene. And good morning, everyone. I would also like to welcome you to the First Quarter 2022 earnings call for Banner Corporation. As is customary, joining me on the call today is Peter Conner, our Chief Financial Officer. Jill Rice, our Chief Credit Officer, and Rich Arnold, our Head of Investor Relations. Rich, would you please read our forward-looking safe harbor statement.

Sure, Mark. The presentation today discusses Banner's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures, and statements about Banner's general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management's discussion. Additionally, we provided an investor presentation that could be found in the Investor Relations section of our website, bannerbank.com. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ is available from the earnings press release that was released yesterday and a recently filed Form 10-K for the year ended December 31st, 2021. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligation to update information concerning its expectations. Back to you, Mark.

Our clients, our communities, and our shareholders are important. Jill Rice will provide comments on the current status of our loan portfolio. And finally, Peter Conner will provide more detail on our operating performance for the quarter and an update on our strategic initiative, which we are calling Banner Forward. As a reminder, the focus of Banner Forward is to accelerate growth in commercial banking, deepen relationships with retail clients, advance technology strategies, and streamline our back office. I want to begin by thanking all of my 2,000 colleagues in our company that have helped develop Banner Forward, and who are working extremely hard to assist our clients and communities. Banner Corporation has lived our core values summed up as doing the right thing. For 131 years, it is critically important that we continue to do the right thing for our clients, our communities, our colleagues, our company, and our shareholders, to provide a consistent and reliable source of commerce and capital, through all economic cycles and changing events. I am pleased to report that is exactly what we continue to do. I am very proud of the entire Banner team that are living our core values. Now let me turn to an overview of our performance. As announced, Banner Corporation reported a net profit available to common shareholders of $44 million or $1.27 per diluted share for the quarter ended March 31, 2022. This compared to a net profit to common shareholders of $1.33 per share for the first quarter of 2021 and $1.44 per share for the fourth quarter of 2021. The earnings comparison is impacted by the allowance for credit losses recaptured, a continued inflow of liquidity coupled with very low interest rates. Our strategy to maintain a moderate risk profile, continued good mortgage banking revenues, and the acceleration of deferred loan fee income associated with the SBA loan forgiveness of Paycheck Protection Program loans. Peter will discuss these items in more detail shortly. Directing your attention to pretax pre-provision earnings and excluding the impact of merger and acquisition expenses, COVID expenses, gains and losses on the sale of securities, Banner Forward expenses, and changes in fair value of financial instruments. Earnings were $49.7 million for the first quarter of 2022, in line with the first quarter of 2021 at $49.5 million. This measure, I believe is helpful for illustrating the core earnings power of Banner. Banner's first quarter 2022 revenue from core operations decreased 3% to $137.6 million compared to $141.4 million for the first quarter of 2021, primarily due to the increase in mortgage banking revenues, which were down $6.9 million when compared to the same period last year. We continue to benefit from a larger earning asset mix, a good net interest margin, solid mortgage banking revenue, and good core expense control. Overall, this resulted in a return on average assets of 1.06% for the first quarter of 2022. Once again, our core performance reflects continued execution on our super community bank strategy that is growing new client relationships, adding to our core funding position by growing core deposits, and promoting client loyalty and advocacy through our responsive service model. To that point, our core deposits increased 9% compared to March 31, 2021, and represent 94% of total deposits. Further, we continued our strong organic generation of new relationships and our loans outside of PPP loans increased 5% over the same period last year. Reflective of this solid performance, coupled with our strong tangible common equity ratio, we announced a poor dividend in the quarter of $0.44 per share. Our branches continue to be fully operational. And given the recent release of mask mandates in our region, we have reinstated our return-to-workplace policies. To provide support for our clients through this crisis, we made available several assistance programs. Banner has provided SBA Payroll Protection Program funds totaling more than $1.6 billion for approximately 13,000 clients. We made an important $1.5 million commitment to support minority-owned businesses in our footprint, a $1 million equity investment in City First Bank, the largest black-led depository financial institution in the United States, significant contributions to local and regional non-profits, and we have provided financial support for emergency and basic needs in our footprint. Finally, we continue to receive marketplace recognition and validation of our business model and our value proposition. JD Power and Associates announced this quarter that they've again ranked Banner the number one bank in the Northwest for client satisfaction for the sixth time. Banner has been named one of the top performing U.S. public banks of 2021 by S&P Global Market Intelligence. We have been recognized by Forbes as one of America's 100 best banks. And again, Banner recently was named one of the world's best banks in 2022 by Forbes. Additionally, Banner Bank has received an outstanding CRA rating. Let me now turn the call over to Jill to discuss the trends in our loan portfolio and her comments on Banner's credit quality.

Thank you, Mark. And good morning, everyone. I'm pleased to be able to once again report strong and improving credit metrics this morning. Banner's delinquent loans as of March 31st, remain nominal at 0.21% of total loans, flat when compared to the prior quarter, and down from 0.43% as of March 31st, 2021. Adversely classified loans total 1.96% of total loans, down from 2.18% compared to the linked quarter and 3.13% of total loans as of March 31, 2021. Non-performing assets remained low at $19.1 million and include non-performing loans of $18.6 million, and REO and other assets of $446,000. This represents 0.11% of total assets, down three basis points from the linked quarter and 12 basis points when compared to March 31, 2021. Gross loan losses in the quarter were nominal and were more than offset by recoveries of prior charge-offs, with a net recovery of $748,000 posted as of March 31. Based on the continued improvement in asset quality, we released an additional $7.4 million from our reserve for credit losses as of March 31. This was partially offset by an increase in our reserve for sound loan commitments of $428,000 for a net release of $7 million. After the release, our ACL reserve totaled $125.5 million or 1.38% of total loans as of March 31, down seven basis points from the linked quarter and compared to our reserve of 1.57% as of March 31, 2021. The reserve provides 674% coverage of our non-performing loans. Looking at the loan portfolio, we again reported strong loan origination. Our commercial and commercial real estate pipelines are solid and for the quarter, we reported core portfolio loan growth excluding PPP loans of $100 million or 1.12% for the quarter and 4.6% on an annualized basis. Looking at specific product lines, C&I activity was strong in the first quarter. While the utilization rate within this category remains approximately seven basis points lower than historical norms, C&I balance nonetheless increased by $68 million, 3.7% quarter-over-quarter, or 15% on an annualized basis, and are 5% higher than that reported as of March 31, 2021. This growth was spread across the footprint and looked diversified in product type, as well as by industry. In spite of solid originations, commercial real estate totals continued to be hampered by property sales, as well as refinancing, and are down $14 million in the quarter or 1% on an annualized basis. On a year-over-year basis, however, commercial real estate totals are up 5%. The majority of the decline in the quarter is located within the small balance CRE totals, down $120 million or 9%. Much of this decline was offset by increases in the multifamily portfolio, which grew by $68 million in the quarter, in part due to retaining a small number of the for-sale originations closed within our footprint. Additionally, our occupied CRE balances grew by $41 million in the first quarter. Construction and development loan balances also reflected strong production, especially when considered in light of the continued rapid payoff of our residential construction. Commercial construction balances grew by $12 million or 7% in the quarter, and multifamily construction balances grew by $15 million or 6% in the quarter. The residential construction outstanding declined by $12 million or 2% in the quarter. The year-over-year changes in these portfolio, detailed in the release, reflect anticipated payoffs and the expected conversion to permanent loan status upon construction completion, as well as the replenishment of land inventory within our residential builder portfolio. While we anticipate that the recent increase in mortgage rates will impact the velocity of home sales within our residential spec portfolio, I will reiterate what you've heard from me for the past several quarters. The markets in which we do business continue to be very strong, and the inventory of completed, unsold homes remains at all-time lows. Demand continues to outstrip supply in many areas, and affordable housing continues to be undersupplied across the footprint. Consistent with prior periods, our total residential construction exposure remains acceptable at 6.1% of the portfolio, and of that, nearly 40% is the balance outstanding within our custom one to four family residential mortgage loan portfolio. When you include multifamily, commercial construction, and land, the total construction exposure remains at 14.6% of total loans. The decline in agricultural loans, down $35 million quarter-to-quarter, or 12.4% is seasonal in nature and to be expected. When compared to the prior year, loan balances were up 11.5%, reflecting both new and expanding relationships. Consumer mortgage and home equity lines also added to the growth in the quarter, up $63 million or 6%, which reflects increased mortgage loan production held in the portfolio, as well as the result of a successful home equity campaign to replace those balances that were paid off with home refinances over the course of 2021. Looking at asset quality briefly, adversely classified loans declined $20 million in the quarter and are down $133 million or 43% year-over-year. This includes nearly $85 million in adversely classified loans that were paid off over the past 12 months. Overall, adversely classified loans are down 58% from the pandemic induced high reported in September of 2020 and continue to be centered in the recreation and hospitality industries. I noted last quarter that our clients have adjusted to the ever-changing operating conditions and are continuing to perform well. That remains true today. Still, I'm not yet ready to declare the credit cycle over. Rather, in addition to any lingering impacts from COVID variants that may impact our clients over the next several months, we are also closely monitoring the impact of sustained inflation, commodity price increases, supply chain disruption, and labor shortages, as well as the impact that the Ukraine crisis may have on the overall economy. Notwithstanding these uncertain economic drivers, our moderate risk profile remains intact. Our credit metrics continue to be strong. We have a solid reserve for loan losses, especially in light of the portfolio performance, and our capital levels continue to be well in excess of regulatory requirements. We remain well-positioned for the future. With that, I will turn the microphone over to Peter for his comments.

Thank you, Jill. And good morning, everyone. As discussed previously, and as announced in our earnings release, we reported net income of $44 million or $1.27 for diluted share for the first quarter, compared to $49.9 million or $1.44 per diluted share for the fourth quarter. The $0.17 decline in earnings per share was due to a decline in net interest income and lower non-interest income, partially offset by a larger provision release this quarter. Core revenue excluding gains and losses on securities and changes in fair value of financial instruments, decreased $5.8 million from the prior quarter, due to the run-down of the PPP loan program, lower miscellaneous income from gains on branch sales in the prior quarter, write-downs on closed branches this quarter, along with lower mortgage gain on sale. Core non-interest expenses, which exclude Banner Forward, debt extinguishment, M&A, and COVID-related expenses, declined $300,000, due primarily to lower advertising and marketing costs. Turning to the balance sheet, total loans increased $30 million from the prior quarter end, as a result of increases in held-for-portfolio loans, partially offset by a $75 million decline in PPP loans. Excluding PPP loans and held-for-sale loans, portfolio loans increased $100 million or 4.6% on an annualized basis. Ending core deposits increased $235 million from the prior quarter end due to continued growth in the level of client deposit liquidity. Time deposit balances declined by $38 million in the prior quarter end, ending at $800 million as higher-cost CDs continue to roll over at lower retention rates. Turning to net interest income, net interest income declined by $2.9 million in the prior quarter due to fewer calendar days, a decline in SBA PPP loan forgiveness, which were partially offset by higher security income and lower funding costs. Compared to the prior quarter, loan yields decreased seven basis points due to a decline in PPP loan forgiveness processing fees. Excluding the impact of PPP loan forgiveness, prepayment penalties, interest recoveries, and acquired loan accretion, the average loan coupon increased three basis points from the prior quarter due to a smaller balance of low yielding 1% SBA PPP loans. The average interest-bearing cash and investment balances declined $44 million in the prior quarter, while the average yield on the combined cash and investment balances increased ten basis points due to a lower mix invested in overnight funds and higher yields on both the securities portfolio and organic funds. Total cost of funds declined one basis point to 12 basis points as a result of lower deposit and borrowing costs. The total cost of deposits declined from seven to six basis points in the first quarter due to declines in interest-bearing retail deposit rates, and ongoing re-pricing of the CD book. While borrowing costs declined due to the payoff of higher-cost junior subordinated debentures. The ratio of core deposits to total deposits was 94% in the first quarter, the same as the previous quarter. The net interest margin increased one basis point to 3.18% on a tax-equivalent basis. The increase was driven by better yields on securities and overnight cash and lower funding costs offsetting lower PPP loan forgiveness income. In the coming quarters, we anticipate the pace of margin expansion to increase, as a function of market interest rate increases, loan growth, and stabilization of excess deposit liquidity inflows. As we have guided in previous quarters, we anticipate laddering excess deposit liquidity into the securities portfolio at a measured pace, while remaining flexible to shifts in loan demand and the yield curve. Turning to non-interest income, total non-interest income declined $5 million from the prior quarter. The prior quarter benefited from a $2.6 million fair gain on a Fintech investment and an accounting adjustment related to an increase in the value of the company's SBA servicing asset, along with gains on branch sales. Core non-interest income, excluding gains on the sales of securities and changes in investments carried at fair value, decreased $2.9 million. Deposit fees increased modestly by $800,000, while mortgage banking income declined by $1.2 million due to lower production and gain on sales spreads. Residential mortgage loan spreads compressed in the current quarter with the steepening yield curve, while loan production was down 18% from the fourth quarter. Within residential mortgage production, the percentage of refinance volume remains steady at 36% of total production, the same as the prior quarter. Multifamily loan sales and gain on sale premiums were muted due to the steepening of the yield curve. Miscellaneous fee income declined $3 million due to gains on sale of closed branch locations and an accounting adjustment related to the increase in the value of the company's SBA servicing asset in the prior quarter, along with modest declines in swapped and SBA gain on sale fee income in the current quarter. Turning to non-interest expense, total non-interest expense decreased $600,000 from the prior quarter, primarily due to lower debt extinguishment costs and lower marketing expense. The loss on the redemption of certain junior subordinated debt liabilities carried at fair value declined by $1.5 million to $800,000 while Banner Forward implementation costs increased $1.3 million to $2.5 million in the current quarter. Excluding Banner Forward debt extinguishment M&A and pandemic-specific operating costs, core non-interest expense declined by $300,000. Compensation expense increased by $1.7 million due to higher severance costs, elevated payroll taxes, and medical claims expense, partially offset by lower salary driven by FDA deductions under Banner Forward. The credit for capitalized loan origination expense declined by $1.3 million, due to lower held-for-sale residential mortgage and multifamily loan production. Advertising and marketing expense declined due to seasonal declines in charitable contributions, direct mail, web-based advertising, and printed media expense. In addition, as part of ongoing capital management, the Company redeemed an additional $49 million of its outstanding TruPS junior subordinated debentures, increased its liquidity holdings by $50 million, and rolled off a $50 million long-term FHLB borrowing advance. I'm pleased to report continuing progress on Banner Forward. We've just completed the third quarter of implementation and are seeing evidence of the results in lower core operating expenses, improving deposit fee income, while setting the stage for continued improvement in core operating expense, and accelerating revenue growth in the coming quarters. Approximately 44% of the initiatives from a program value perspective have been executed and are reflected in the current quarter core run rate. With the majority of those now in place, driving expense efficiency. As we discussed previously, the remaining efficiency-related initiatives are anticipated to be implemented sequentially over the next few quarters with implementation of the revenue initiatives ramping up in the second half of the year and into 2023. We continue to guide toward the core expense quarterly run rate in the mid-to-high $80 million range before any effects of elevated wage or vendor costs inflation above historical norms. That said, our prospects for improved operating leverage remain strong as any elevated inflationary pressure on our reduced expense base will be more than offset by corresponding expansion to the bank's net interest margin. In closing, the company has begun to benefit from rising rates and we anticipate benefiting further from additional monetary tightening as we enter the current rate cycle. This concludes my prepared remarks. Mark?

Thank you, Jill and Peter, for your comments. That concludes our prepared remarks. Irene, we'll now open the call and welcome your questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Jeff Rulis from D.A. Davidson. Jeff, your line is open. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Jeff.

Question on the remaining upfront Banner Forward costs, particularly in relation to the 2.5 we reported this quarter. I'm unsure of the original amount, but is there still something outstanding?

Yes. Hi, Jeff. Yeah, we're pretty much through the majority of the implementation costs and restructuring costs at this stage. I'd anticipate $1 million to $2 million more dollars of implementation costs spread out over the next two quarters. But it's going to continue to decline as we go forward into the rest of '22.

And Peter, your core expense, down $300,000. What is that exact level core rate?

Yes, in terms of the kind of what our expectations for core quarterly expense run rate, is that your question?

Well, for yeah. What was the core for this quarter and then I heard your commentary about turning to that mid-to-high $80 million range per quarter? But just what was the core this quarter?

A good reference point can be found on the last page of our earnings release, where we disclosed our adjusted core expense, excluding the Banner Forward and any other fair value or gain-related impacts. If you examine that schedule, excluding those items, we've been operating in the mid to high 80 range. We've reported $85.4 million as we define core expense, which also excludes B&O tax of 1.1 million and core deposit intangible amortization of another 1.4 million. If you add those two back, which total about 2.5 million, we are right around $88 million on a core basis, as we typically define it in Q1.

Great. Thanks. And maybe for Jill, I wanted to understand the thought payoff activity linked to the previous quarter, the challenges we're facing, and could you also discuss the pipeline or growth outlook? I believe there's some seasonality this quarter, but I would like more details to clarify the outlook, which seems fairly positive.

Yeah. Jeff, good morning. So our expectations for loan growth continue to feel good strong about reaching that upper single-digit growth rate by the end of the year. And as you called out some of the downward trend in that first-quarter is, seasonal in nature especially in the construction portfolio. The payoffs we would expect to slow down somewhat with the change in the rate environment. And the reasons we continue to feel positive about loan growth are that we're in strong markets, strong economic engines, the business model's working, the loan origination continue to be strong quarter-over-quarter had one of the best quarters this quarter in terms of production. Pipelines remain solid. The utilization will pick back up with the commercial real estate, the spec construction, and demand utilization is way low as well because of the rebuilding of that portfolio. So battle draw down over the quarter, I mean, over the year as well. So everything there bodes well for continued loan growth.

Jill, just to follow that up. The payoffs linked quarter were up or down from the fourth quarter. And then given that outlook of a return to growth, could you comment on the provision levels at all, do we expect to see a more modest. And then the reverse provision and eventually a positive provision or expense? Thanks.

So payoffs, quarter-to-quarter, Jeff, I'd have to get back to you. For sure I don't have that off the top of my head. They seem to be slowing, but I could be missing that. So let me shoot you a note on that to clear that up. As to the reserve, I'm going to start with what I say every time, we don't really guide to where we're going to end with our reserve. But our approach has been to be as measured as we can be within the bounds of credit standards in terms of releasing reserves as we've continued through what has been a good economic environment and continued improvement in asset quality. I would anticipate that as loan growth continues, we would begin to start provisioning again. And then what I would say in terms of coverage is that that ratio is going to really ultimately be dependent upon how the economic environment plays out now throughout 2022.

Okay. Thank you.

Thank you, Jeff.

Thank you. Ladies and gentlemen, our next question comes from Andrew Liesch from Piper Sandler. Andrew, your line is open. Please go ahead.

Thanks. Good morning, everyone. Jill, just to follow up on some of the loan growth questions and loan growth outlook here. I'm curious, what drove the owner-occupied CRE increase this quarter?

I can't say exactly what we've had new business activity, expansion of activity, new property purchases, but I can't tell you exactly where it was.

Got it. got it net disclosed along the lines of kind of next question just on the borrowers when, what are they saying about their demand, and CapEx, are they expanding? And clearly there is a lot of room for utilization to rise, but I'm just kind of get a sense of what they're telling you, and how they're feeling about their businesses.

They are certainly being impacted by the increased commodity prices, and so that is driving a little bit of increased utilization and demand. So while we've got that continued lower utilization rate, we have added lines of credit, we have increased line of credit that trended are seeing the needs for larger lines to carry more inventory. They're trying to get more inventory in as the prices are rising, to the best they can to counter the supply chain issues as well. So we are seeing existing borrowers borrow, and at the same time increase the size of the line keeping the utilization down.

Got it. Okay. I now understand.

Andrew, I want to expand on Jill's remarks. There are additional factors involved, as you know, such as rising energy prices, wage inflation, and labor shortages that are impacting businesses regarding inflation. Consequently, companies in the pipeline sector are contemplating capital expansion to enhance productivity in light of these challenges. However, a significant concern for them is the political uncertainty regarding the future of the economy. While there are encouraging signs for commercial and industrial sectors prompting further investments, the uncertainty will likely temper those efforts. I just wanted to share that.

Got it. That's very helpful. And then just a follow-up. Construction demand. It sounds like there was clearly some this quarter, more projects are going to start to fund up as we move into the summer months. What's the pipeline look there for new projects coming online or new opportunities to extend at least a construction line before those fund later this year?

The construction in line are refreshing and continuing, the demand is strong for that. I would say that we do anticipate that with the rising rates, it could slow the homebuilder sales as they're building out and affordability continues to be a concern. But the supply of available homes remains slow, so they're still coming in and building and we're not seeing any real disruption in terms of unsold inventory because it's really a low standing inventory and strong employment conditions that make the market conditions remain good to continue that product.

Got it. Okay. Yeah, that all makes sense. Thanks for taking the questions. I'll step back.

Thank you, Andrew.

The next question comes from David Feaster, from Raymond James. David, your line is open. Please go ahead.

Good morning, everybody.

Morning, David.

It's great to see you guys have made tremendous progress on the Banner Forward initiative. And it sounds like the majority of the next steps are really on the revenue improvement side. Could you just maybe talk to some of the initiatives that are on the docket and the roadmap for those? And then just how effective you've been in the growth as you generated this quarter, how much was from the new client growth and deepening relationships, and maybe moving upstream as part of this initiative that you guys laid out?

Hi David, this is Peter. I'll address those questions around Banner Forward. As we've guided to the sequential nature of how Banner Forward will be impacting our performance, as you mentioned, it was front-loaded around expense efficiencies first. We do and we have recognized the benefits of some of the initial expense efficiency initiatives. In the fourth and first quarter, as you know, we consolidated seven branch locations in the first quarter. That was mid-quarter, so we're not going to see the full benefit in the run rate of those consolidations until the second quarter due to severance and exit costs and so forth that we're still in the first quarter numbers. We also announced the sale of four more branches in the second quarter. That'll be executed towards the end of the second quarter. That will reduce expenses. All those branches are small relative to the rest of our portfolio branch locations and will be accretive to our return on assets when we execute them. In addition to that, there are a series of smaller incremental expense saves as we implement some efficiency initiatives across some of the support units and some of the spans and layer-related reductions across our retail and commercial functions. Again, those will continue to manifest into the second quarter and ultimately in the third quarter where we really see our core base of the run rate post Banner Forward on the expense side. On the revenue side, we began implementing some of the fee-related initiatives mid-first quarter. So we're not seeing the full carry of those deposit fee initiatives show up yet. We'll see them show up more in the second quarter and then even more in the third quarter, two or three initiatives that are being implemented over the course of the second quarter that we'll see the benefits from in the full third and fourth-quarter of the second half of this year. And then on the and then there's a series of marketing and digital marketing-related initiatives in terms of customer and account acquisition that we expect to result in an acceleration of loan growth. New client acquisition that will bring about perspective over the second half of this year. And then there's some additional loan growth on the commercial and CRE side that we're beginning to see just the very beginnings of in the first quarter related to some higher home mix, some focus on our metro and higher growth markets, middle market. When we expect those to really show up in the second half of this year and carry into 2023. So again, it's going to be expense efficiency first followed by revenue acceleration second, and we're right on track with where we expected to be in Banner Forward. And we'll continue to report our progress as we go quarter-to-quarter.

That's helpful, and I appreciate your commentary in the prepared remarks regarding rate sensitivity and expectations for margin expansion in light of the rising rates. Looking at the slide, you've mentioned before that about half of the impact is from floors, with half of your floors already at those levels. Can you remind us where those floors are and how long it will take to move through the majority of them to start seeing the full impact from rising rates?

So in terms of the as we disclosed in our investor deck, a little over 60% of our loan book is floating and adjustable, and about a little over 60% of those loans, floating adjustable have floors on them. If we look at the weighted average, strike to index spread on those loans with floors. We're down to about 30 basis points of remaining spread recapture, on a weighted balance basis. So there's still some additional short-end rate movement we need to fully reprice those loans going forward. That being said, based on our current balance sheet mix, and a kind of a static mix going forward. The way to think about our margin relationship to interest rates is about one third of the change in the yield curve, assuming a parallel shift shows up as an increase to our margins. So in other words, for each 25 basis points of Fed fund's hike, we expect about seven to eight basis points of margin improvement, right? All things equal, assuming our current balance sheet mix of securities cash and loans. So it kind of gives you a sense. Once we cross the 100-basis-point threshold with Fed funds, our loan yields improvement will accelerate because we'll have cleared all the floors, and we actually expect to see loan yields move up at a faster pace once all those floors are clear during the first 100-basis-points of tightening.

That's extremely helpful. Thank you for that. And then maybe just switching gears to touch on credit a bit more broadly. Asset quality, you guys do a phenomenal job. A very conservative approach to credit. Just hearing the commentary, it sounds like you're still a bit cautious on maybe the more macro economy. Just curious, what keeps you up at night, what you're watching closely as you manage credit, and whether the macro environment, the inflationary trends that you talked about, has that led to any tightening of the credit box at all?

It hasn't led to tightening of the credit box. I think the way I would summarize the way Banner has worked in my 20-year career here is to try to be as stable through all economic cycles as we can be. We don't try to shift with the wind necessarily and/or the broader economy, and it comes down to the found underwriting going in. So certainly we stress credits and anticipate in a rising rate environment. How we're stressing these credits to the origination is just with the higher rates to make sure that they can work through the cycle. In terms of what keeps me up at night, it isn't our loan portfolio, it is just what's going on in the world today and how that ultimately is going to impact all of us. But I feel good about our borrowers and our credit quality.

Okay. Thank you.

Thank you, David.

Our next question comes from Andrew Terrell from Stephens. Andrew, your line is open. Please go ahead.

Thank you. Good morning.

Good morning, Andrew.

Peter, I would like to revisit the discussion on rate sensitivity, specifically regarding Slide 17 of the presentation. For the first 100 basis points, you indicated a 7% increase in net interest income, and for the second 100 basis points, the increase was noted at 11.6%. I understood your comments about moving past the loan floors, suggesting that you might become more asset sensitive with the second increase. However, the disclosure doesn’t seem to support that, so I would like to know if you anticipate a higher deposit base for the second 100 basis points scenario. Any clarification on this would be appreciated.

Your intuition is correct; my comments focus on the loan yield itself. On the funding side, we have seen our betas increase as rates rise further up the curve. Our expectation is that deposit betas will remain very low during the first 100 basis points of tightening, but will start to pick up in the second 100. This means our funding costs will increase at a much faster pace compared to the first 100 as rates tighten. Historically, during the last tightening cycle in 2017 and '18, Banner did not raise its deposit rates until after the initial 100 basis points. We believe this is a reliable indicator for what we might see in the current cycle. Based on our experience last time and the fact that we are entering this cycle with significantly more deposit liquidity, we expect a similar pattern to emerge. In the last cycle, we noticed deposit rates began to rise more sharply during the second 100 of tightening, and we anticipate this relationship will hold true again. Therefore, this is driving the limited growth in net interest income as we progress through the 200 and 300 basis points, with accelerating betas affecting our models. This explains some of the constrained growth in NNI.

Okay. Very good, that's really helpful, I appreciate it. And then I heard your comments on kind of continuing to take a measured pace to laddering the liquidity into the bond book. I know you obviously mentioned you monitor kind of the yield curve level, and just overall loan demand at the bank as well when you're kind of making the consideration. I'm putting liquidity to work. I guess just with the improvement we've seen over the past few months in yields. Does that make you more apt to get a bit more aggressive in terms of putting some liquidities work, or is it more about considering maybe the acceleration of loan demand that you might be expecting?

Look, all things equal, given we still have an ample amount of cash sitting with the Fed. And last quarter, we laddered in about $160 million of cash into the securities portfolio. This quarter, we expect to have a higher number given the sharp increase in the long end of the yield curve. And we want to take advantage of that so you could anticipate we'll be somewhat more aggressive this quarter than we were last quarter, in laddering some additional cash into the securities book. We have ample cash to support accelerated loan demand, and potential deposit liquidity runoff. Although we're not seeing any signs of deposit outflow yet with increased rates, but all things equal, we expect to be a bit more aggressive and laddering cash into the securities book this quarter.

Got it. Okay. And then relative to that two and a quarter yield, I think is around two and a quarter, maybe 2.22. You're buying at in the first quarter, where are you buying at today just from a yield perspective?

We're closer to three now. So we're seeing, we're looking at the securities on a basket average basis in the right high-twos, maybe 3% of stage.

And if I can just sneak one more and I might have missed it. But did you have the net dollars of expenses you would expect from the announced branch sale.

We didn't disclose the amount of expenses. We just for reference, those branches hold a little over $200 million in deposits. So we will expect that balance to go out and said earlier, these are smaller branches relative to the rest of our footprint. And so from an ROA, PD, ROA accretion perspective, these will be a net benefit to the go-forward profitability metrics for the company once they're executed.

Okay understood, I appreciate you taking my questions.

Thank you, Andrew.

Next question comes from Kelly Motta, from KBW. Kelly, your line is open. Please go ahead.

Thank you. Good morning. What's my questions have been answered, but I did want to touch on loan yields, and wanted to ask how new origination yields were coming in. If you've seen a nice pickup there. And we've seen loan growth across your footprint pick up. Are you seeing any competitors getting a bit more aggressive or extending a bit more on terms and standards in order to get the liquidity to work? Just interested in kind of the competitive dynamics of what you're seeing there. Thanks.

Peter, I'll start with the competition and then I'll let you come back with the loan yields. Competition, Kelly is as crazy as it has ever been in terms of pricing and structure. Yes, competition is stretching. The amortization period longer interest only period, low rate, and it comes from everyone is community banks with credit unions. It's insurance companies, non-bank lenders. Everyone out there is looking to put quality assets on their balance sheet. As to yields, I'm going to throw it to Peter and I'm not sure if there was something else in there that I forgot, but we'll circle back if I did.

Yeah. Kelly, in terms of loan yields, we're seeing some modest improvements in the average loan yields in new production, and it's running in the low fours right now, and we expect that to continue to improve, right as the yield curve continues to move up. The loan yields that we're putting on now are accretive to the average portfolio yield. So we've remained disciplined in the past and we're going to remain disciplined on not just credit structure, but also pricing. And so we have turned away deals for price and remain disciplined around that. But we are seeing yields coming on that are accretive to the portfolio now.

That's super helpful. And maybe just a high-level question about Banner Forward. I know you're working on expanding your customer base and penetration of existing customers, and I was just wondering if that's led mostly with the credit side or it's the loan side, or if we should expect increases in deposits from that as well, which could potentially help mitigate the slower deposit growth that we're all expecting with liquidity getting put to work?

I'll take a response there. Kelly, as we talked about, there's a number of initiatives that comprise Banner Forward, and you've heard us discuss several of those are in the commercial banking and small business banking arena, with an emphasis on accelerating new client acquisition and deepening our relationships in that line of business. And as part of that, we expect to bring in the entire relationship with the client, which would be not just the loan, but their operating accounts and including treasury management needs, which would bring with it some additional deposits and funding. So those initiatives that are focused on accelerating revenue and production in the commercial side and small business banking will bring with them deposits, although I would tell you overall there's going to be more of a loan focus overall. So would characterize that the loan to deposit ratio of that new business has a more balanced loan to deposit mix than our existing portfolio. So we expect that the overall benefit will be to improve our earning asset mix across those initiatives. And then there's a series of other initiatives on the retail and consumer side that also contemplate bringing in additional accounts and clients that will bring both loans and deposits, right through many of our digital and marketing initiatives. This will bring up for a relationship as well. But again, those are again focused on the loan side. And we expect the mix of the overall business to be very balanced between loan and deposit growth across those new clients.

That's so helpful. Thank you so much.

Thank you, Kelly.

Ladies and gentlemen, we will now open the floor for additional questions. We have a follow-up question from Andrew Terrell from Stephens. Andrew, your line is open. Please go ahead.

Hey, thanks for taking the follow-up. I just wanted to ask there's been a lot of M&A, really across your footprint over the past year or so, both completed and just announced. Are you starting to see any kind of accelerated ability to attract either customers or new talent to the bank just as a result of maybe some of the M&A disruption?

Yes, Andrew. This is Mark. I'll address that question and invite others to join in. Ultimately, there has been significant uncertainty among institutions that are merging, which has sparked many discussions about the next steps for bankers. Clients are aware of potential changes in decision-makers and relationship managers. We are in the early stages and I believe we can capitalize on this situation. We are currently working on building our talent and client pipelines. However, the real opportunity to benefit will depend on conversion dates. As new structures are implemented and decision-making teams change, those will be key moments for us. As expected, institutions involved in mergers have secured key personnel with retention bonuses, waiting for the conversions or new structures to take effect. I anticipate that our benefits will ramp up at just the right moment, aligning with the launch of our Banner Forward initiatives, which will be happening in the second half of this year.

Understand. Okay. And then maybe just one last one as well, just kind of given some of those comments, maybe does the organic kind of opportunity both from Banner Forward and then some maybe potential hiring or talent acquisition as well. Does that lead you to be I guess, more inclined to focus organically at the franchise as opposed to looking to do M&A yourself or are you still storming kind of open to M&A?

Our M&A strategy has remained consistent; it has not changed since the pandemic. We approach M&A opportunistically and maintain a disciplined view on how it aligns with our business model, which has been validated by external recognition that you can find in our investor deck. The business model is performing well, and we are cautious not to engage in actions that could introduce execution risks and undermine that momentum. Currently, we are capitalizing on growth opportunities and disruptions in our market. We have also onboarded great talent from larger financial institutions, particularly in California. Overall, we are focusing on a dual strategy of organic growth by bringing in additional talent to enhance our Banner Forward initiative, while also remaining open to strategic M&A opportunities. Our skilled integration team, led by our Executive Vice President Cindy Purcell, is prepared to act should the right opportunity present itself.

Okay. Very good, I really appreciate the color and thank you all for taking my questions.

We're glad, Andrew. Thank you.

We have no further questions. Therefore I will now hand back to your host, Mark Grescovich for any closing remarks. Mark, please go ahead.

Thank you, Irene. And as I've stated, we're very pleased and proud of the Banner team and our solid first quarter performance. Thank you very much for your interest in Banner and joining us on our call today. We look forward to reporting our results to you again in the future. Thank you, everyone, and have a wonderful day.

Ladies and gentlemen, this concludes today's conference call. Thank you for being with us today. Have a lovely day ahead. You may disconnect your lines now.