Banner Corp Q4 FY2022 Earnings Call

Hello, everyone, and welcome to today's conference. This is the Banner Corporation Fourth Quarter 2022 Conference Call and Webcast. My name is Bruno, and I will be coordinating your call today. I will now hand over to your host, Mark Grescovich, President and CEO of Banner Corporation. Mark, please go ahead.

Thank you, Bruno, and good morning, and Happy New Year, everyone. I would also like to welcome you to the fourth quarter and full year 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. Good morning. Our presentation today discusses Banner's business outlook and will include forward-looking statements. So, statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecasts of financial or other performance measures and statements about Banner's general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and a recently filed Form 10-Q for the quarter ended September 30, 2022. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligation to update information concerning its expectations. Mark?

Thank you, Rich. Today, we will cover four primary items with you. First, I will provide you high-level comments on Banner's fourth quarter and full year 2022 performance; second, the actions Banner continues to take to support all of our stakeholders, including our Banner team, our clients, our communities and our shareholders; third, 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, as well as provide an update on our strategic initiative called 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. Before I get started, I want to again thank all of my 2,000 colleagues in our company that continue implementing our Banner Forward initiatives and who are working extremely hard to assist our clients and communities. Banner has lived our core values, summed up as doing the right thing, for the past 132 years. Our overarching goal continues to be, to do the right thing for our clients, our communities, our colleagues, our company and our shareholders, and to provide a consistent and reliable source of commerce and capital through all economic cycles and change events. I am pleased to report again to you that is exactly what we continue to do. I'm very proud of the entire Banner team that are living on 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 $54.4 million or $1.58 per diluted share for the quarter ended December 31, 2022. This compares to a net profit to common shareholders of $1.44 per share for the fourth quarter of 2021 and $1.43 per share for the third quarter of 2022. For the full year ended December 31, 2022, Banner Corporation reported a net income available to common shareholders of $195.4 million compared to $201 million for the full year 2021. The earnings comparison is impacted by: the provision or recapture of credit losses; excess liquidity, coupled with a rapid change in interest rates; our strategy to maintain a moderate risk profile; a gain on sale of four branches; and the acceleration of deferred loan fee income associated with the SBA loan forgiveness of Paycheck Protection loans. Peter will discuss these items in more detail shortly. To illustrate the core earnings power of Banner, I would direct your attention to pre-tax 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, changes in fair value of financial instruments and the gain on the sale of branches, full year 2022 earnings were $251.9 million compared to $223.1 million for the full year of 2021. Banner's fourth quarter 2022 revenue from core operations increased 9% to $175.7 million compared to $161.5 million for the third quarter of 2022, and $143.4 million in the fourth quarter a year ago. For the full year 2022, revenue from core operations increased 6% to $623.1 million when compared to the full year 2021. We continue to benefit from strong core deposit base and improving net interest margin and good core expense control. Overall, this resulted in a return-on-average assets of 1.34% for the fourth 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 represent 95% of total deposits. Further, we continued our strong organic generation of new relationships, and our loans outside of PPP loans increased 13% over the same period last year. Reflective of the solid performance, coupled with our strong regulatory capital ratios, we announced a core dividend of $0.48 per common share, up 9% from our last dividend. As noted in the release, Banner published our inaugural Environmental, Social and Governance Highlights Report in December. This report addresses many of the ways in which we are striving to do the right thing to support our clients, our communities and our colleagues. And while it covers many of the items I have mentioned before, including providing SBA payroll protection funds, totaling more than $1.6 billion for approximately 13,000 clients, as well as the $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. It goes much further in outlining the level of commitment Banner has to the many communities in which we serve. If you haven't yet, I encourage you to take a few moments to review it. Finally, I'm pleased to say that we continue to receive marketplace recognition and validation of our business model and our value proposition. J.D. Power and Associates ranked Banner the Number One bank in the Northwest for client satisfaction for the sixth time. Banner has been named one of America's 100 Best Banks by Forbes, and Banner Bank received an outstanding CRA rating in our most recent CRA examination. Let me now turn the call over to Jill to discuss trends in our loan portfolio, and her comments on Banner's credit quality. Jill?

Thank you, Mark, and good morning, everyone. As was detailed within our fourth quarter press release, Banner's credit metrics remain strong. Delinquent loans as of December 31 remained low at 0.32% of total loans, up 10 basis points when compared to the prior quarter and compared to 0.21% as of December 31, 2021. Adversely classified loans represent 1.35% of total loans, down from 1.39% as of the linked quarter and compared to 2.18% as of December 31, 2021. Nonperforming assets remained modest at 0.15% of total assets, but as noted in the press release, increased $7.8 million in the quarter and now total $23.4 million. Nonperforming assets are comprised primarily of nonperforming loans totaling $23 million. Given another quarter of strong loan growth and coupled with the continued negative economic sentiment, we posted a $6 million provision for loan losses and provided an additional $680,000 to the reserve for unfunded commitments. Net loan losses continued to be modest, and for the full year, Banner reported a net recovery of $1.2 million due to the strong collection work within our Special Assets department. After the provision, our ACL reserve totals $141.5 million or 1.39% of total loans as of December 31, an increase of 1 basis point from the linked quarter and compares to a reserve of 1.45% as of December 31, 2021. The reserve currently provides 615% coverage of our nonperforming loans. Looking at the loan portfolio. Origination volumes continue to be robust in the fourth quarter, with portfolio loan growth of $320 million in the quarter or 13% on an annualized basis. Excluding the growth in the one- to four-family portfolio, the annualized growth rate remained strong at 8%. C&I activity remained strong in the fourth quarter. For the full year, we reported commercial loan growth of $238 million plus an additional $155 million in the small business scored loans, which on a combined basis, equates to growth of 21% in the commercial lending arena. This growth is in spite of nearly $270 million in payoffs over the course of the past 12 months. The new loan originations continue to be modest in size, much of it to existing clients and is diversified both by industry and geographic location. C&I utilization is flat when compared to last quarter, however, it has increased 3% year-over-year. Commercial real estate balances declined $152 million or 4% year-over-year, a function of the significant CRE payoffs experienced this past year. Over the past four quarters, commercial real estate payoffs totaled nearly $500 million due to rate and term refinances, property sales and adversely classified relationship exits. As reported in prior quarters, the growth in the multifamily portfolio represents both new term loans as well as the conversion of completed multifamily construction projects, up 26% year-over-year. With the transfer of multifamily held-for-sale loans to the portfolio this quarter, the multifamily portfolio is now approximately 50% affordable housing and 50% market rate, and as noted before, remains granular in exposure and geographically diversified. Construction and development loan balances grew by 3% in the quarter due to draws on commercial and multifamily construction projects. As anticipated, the volume of one- to four-family residential construction projects has slowed significantly, which is reflected in the reduction in outstanding balances quarter-over-quarter. In total, construction and land development loans reflect an increase of 14% year-over-year, driven primarily by the multifamily construction portfolio. While the volume of residential construction starts has slowed, I am pleased to report that the portfolio continues to perform well and is diversified both in product mix and across our geography. Additionally, our underwriting standards have remained consistent and our land exposure is limited to our strongest sponsors. We expect that we will begin to carry completed homes longer as we move through this next year and anticipate seeing more builder concessions as clients work to keep their finished product moving. Still, our builders remain well capitalized and prepared to absorb the anticipated slower sales activity. Our total residential construction exposure remains acceptable at 6% of the portfolio. And consistent with prior reporting periods, nearly 40% of that is our custom one- to four-family residential mortgage loan products. When you include multifamily commercial construction and land, the total construction exposure remains at 15% of total loans, consistent with last quarter. And as noted in the earnings release, we again reported solid growth in the consumer mortgage portfolio. Again, a function of moving completed all-in-one custom construction loans on balance sheet. We reported a modest increase quarter-over-quarter in HELOC balances, up 4%, with solid growth of 24% year-over-year due to a very successful home equity campaign recorded in prior quarters. Lastly, the growth in other consumer loans year-over-year was the result of a small consumer pleasure boat portfolio located within footprint that was completed in the third quarter. I will wrap up my comments as I have the last few quarters noting that the continued overhang of pessimism as it relates to the economic environment we are facing. Still, Banner's credit culture is designed for success through all business cycles. Our consistent underwriting remains a source of strength, as does our solid reserve for loan losses and robust capital base. Banner's credit metrics remain strong and our moderate risk profile remains intact, positioning us well to navigate whatever the next phase of this economic cycle brings. With that, I'll turn the microphone over to Peter for his comments. Peter?

Thank you, Jill. And as discussed previously and as announced in our earnings release, we reported net income of $54 million or $1.58 per diluted share for the fourth quarter compared to $49 million or $1.43 per diluted share for the third quarter. The $0.15 increase in earnings per share was due to an increase in net interest income, partially offset by lower noninterest income, higher noninterest expense, and a larger provision for loan losses this quarter. Core revenue, excluding gains and losses on securities, changes in fair value of financial instruments carried at fair value and gains on the sale of sold branches increased $14.2 million from the prior quarter due to an increase in net interest income and noninterest income. Noninterest expenses, excluding Banner Forward, increased $3.6 million, due primarily to an accrual for a specific litigation matter, increases in occupancy expense and lower capitalized loan origination costs. Turning to the balance sheet. Total loans increased $292 million from the prior quarter-end as a result of increases in held-for-portfolio loans, partially offset by a $27 million decline in held-for-sale loans. Excluding PPP loans and held-for-sale loans, portfolio loans increased $325 million or 13.1% on an annualized basis. One- to four-family real estate loans grew $148 million in the current quarter as a result of directing potential custom construction mortgage loans on the portfolio. We anticipate a slower pace of on-balance sheet mortgage production in the coming quarters. Ending-core deposits decreased $616 million from the prior quarter-end due to outflows of rate-sensitive balances. The long-term decline in time deposit balances pivoted and increased $2 million from the prior quarter-end for the first time in this rate cycle, as existing clients transferred funds from their core deposit accounts to higher-yielding CDs. We anticipate further declines in core deposit balances, partially offset with growth in time deposits in coming quarters, albeit at a slower pace than we experienced in the fourth quarter, commensurate with the anticipated slowdown in the pace of Fed fund hikes. The loan-to-deposit ratio at the end of the quarter remained moderate at 74.5%. Net interest income increased $12.6 million from the prior quarter due to an expansion of the net interest margin, coupled with growth in average loan outstandings and lower balances of lower-yielding overnight interest-bearing cash. Compared to the prior quarter, loan yields increased 32 basis points, excluding the impact of PPP loan forgiveness, prepayment penalties, interest recoveries and acquired loan accretion. The average loan coupon increased 37 basis points from the prior quarter due to increases in floating and adjustable-rate loans and higher yields on new fixed-rate term loans. The average interest-bearing cash and investment balances declined $571 million from the prior quarter, while the average yield on the combined cash and interest balances increased 41 basis points due to higher yields on both the securities portfolio and overnight funds, driven by higher market rates. Total cost of funds increased 5 basis points to 18 basis points due to increases in deposit rates and borrowing costs. The total cost of deposits increased 3 basis points to 10 basis points, reflecting modest increases in money market rates and CDs. The ratio of core deposits to total deposits remained steady at 95%, the same as last quarter. The net interest margin increased 38 basis points to 4.23% on a tax-equivalent basis. The increase was driven by higher yield on loans, securities and overnight cash, coupled with a larger mix of loans and a lower mix of overnight cash within the earning asset base. In the coming quarters, we anticipate a slowdown in the pace of margin expansion as rate-sensitive deposits move off the balance sheet, the pace of loan yield increases slows, overnight interest-bearing cash levels decline and deposit rates increase. Going forward, we anticipate loan growth and deposit outflows will be funded primarily with security sales and secondarily with borrowings. Total noninterest income declined $2.5 million from the prior quarter. The current quarter was impacted by a $3.7 million loss on the sale of securities. Core noninterest income, excluding the gains on sales of the securities, gain on the sale of branches and changes in investments carried at fair value, increased $1.6 million. Total deposit fees decreased $628,000 while mortgage banking income increased $2.2 million due to an increase in the fair value of multifamily loans held for sale, partially offset by a decline in residential mortgage gain on sale income. Total residential mortgage production, including both loans held for investment and those held for sale, declined 49% from the prior quarter, reflecting the continued headwinds of higher rates and a slowdown in home sales. Within residential mortgage production, the percentage of refinance volume continued to decline as a function of rising rates, dropping to 10% of total production, down from 12% in the prior quarter. Multifamily loan production remained even with the prior quarter and the fair value of the held-for-sale portfolio improved as a function of higher yields on recently originated loans and a decline in market rates. Miscellaneous fee income decreased due to gains on nonperforming loans taken in the prior quarter. Total noninterest expense increased $4 million from the prior quarter, due to an accrual for an anticipated settlement of a previously disclosed litigation matter, lower deduction for capitalized loan origination costs and an increase in Banner Forward-related occupancy exit costs. Excluding the litigation settlement accrual and Banner Forward, noninterest expense was flat to the prior quarter. Capitalized loan origination costs decreased due to lower construction one- to four-residential mortgage and HELOC loan production compared to the prior quarter. Compensation expense declined by $1.3 million, due to declines in mortgage loan commission and medical claims expense. Occupancy and equipment costs increased $1.5 million due to Banner Forward-related facility exit costs and weather-related building maintenance expense. Professional and legal expense increased $3.7 million due to the aforementioned anticipated settlement of an outstanding litigation matter. Majority of the Banner Forward program initiatives were in place as of the current quarter. We anticipate the remaining run rate in Banner Forward-related performance improvements to occur over the course of 2023 as additional administrative building space is consolidated along with anticipated increases in selected deposit product service charges and the continued acquisition of small business and middle market relationships. In closing, the company continues to benefit from rising rates, along with the improved operating leverage put in place by Banner Forward as evidenced by the significant improvement in the company's core ROA and efficiency ratio. This concludes my prepared remarks. Mark?

Thank you, Peter and Jill, for your comments. That concludes our prepared remarks. And Bruno, we will now open the call and welcome your questions.

Thank you, Mark. Our first question is from Jeff Rulis from D.A. Davidson. Jeff, please go ahead. Your line is now open.

Thanks. Good morning.

Good morning, Jeff.

Could you provide insights on the increases in non-accruals for commercial and industrial loans and one to four family loans? Is this related to timing or any particular observations you've noticed? Additionally, Jill, while I value the statistics on delinquency, I'd like to hear your thoughts on the specific credits that were added, along with any general commentary you might have.

Yes, good morning, Jeff. So as to the change in the non-performing, you hit the categories, there isn't any one specific driver on the one to four family. Some of it is timing. December is month where people tend to put their cash into things other than their mortgage at times. But beyond that, we had a small modest SBA guaranteed loan put on non-accrual, while we work through the credit resolution process and then various small business loans, nothing that is tending to point to any one issue or any one industry or things like that at this point, Jeff?

Okay. And maybe, Peter, on the expenses, I guess, core expenses in the, call it, the mid-90s. You mentioned there can be some probably some Banner Forward exit costs potentially if there's more consolidation. But just kind of getting a sense for kind of growth rate off of maybe that 95-ish base for '23. And if you can touch on your expectation on additional Banner Forward expenses, that would be helpful.

Sure, Jeff. In terms of our guidance for 2023, we are projecting core expenses to be in the low to mid-90s. We expect some adjustments as we consolidate facilities throughout the year, which will lead to reductions in occupancy expense. We do not foresee any significant restructuring or exit costs, although there may be a few minor amounts. The compensation expenses are likely to remain consistent, though we anticipate some payroll tax increases in the first quarter, possibly keeping us at or slightly below the fourth quarter levels due to elevated bonus and incentive accruals from Q4. Overall, I expect expense levels to remain in that low to mid-90s range throughout 2023, with slightly higher compensation costs in the first quarter, but no significant increase in our expense base.

Okay, I will step back. Thank you.

Thanks, Jeff.

Perfect. Thank you, Jeff. Our next question is from David Feaster from Raymond James. David, your line is now open. Please go ahead.

Hey, good morning, everybody.

Good morning, David.

I wanted to get your thoughts on credit, given your conservative approach and insights. As you review your portfolio, especially concerning floating-rate borrowers whose borrowing costs have significantly risen over the past year, have you noticed any substantial changes in debt service coverage ratios? With the possibility of an additional 50 basis points increase or similar changes, how do you see cash flows and collateral values being affected? As these loans are up for renewal, what considerations are you making? Ultimately, what are your thoughts on the implications for credit quality? Do you anticipate an increase in restructurings? I'm interested in your perspective.

Thank you, David. That was a comprehensive question regarding credit. As we approach each of these loans, it's important to note that we evaluate them for a rising rate environment and potential changes in collateral value right from the start. We begin with solid collateral coverage that can withstand any fluctuations in collateral value. While debt service coverages for variable rate loans are certainly affected by rising rates, our portfolio is supported by strong guarantors and typically includes secondary sources to mitigate any business impacts. We are monitoring the situation closely and stress-testing the portfolio. However, we approach this with the understanding that we may enter a rising rate environment and that collateral values could be subject to change, acknowledging that the prolonged low interest rate environment couldn't continue indefinitely, even if it persisted for several years.

Okay. Okay. And then maybe just touching on the growth side. I mean you touched on some of the unique dynamics with mortgage and construction converting the perm and that potentially slowing or decelerating. If we look exclusive of that, loan growth was kind of in that 7% ballpark. I'm just curious how you think about loan growth going forward? You talked about slowing originations and some weaker demand in the market is kind of maybe a mid single-digit pace of growth realistic? Or I guess, even on the other side, what's your appetite for credit here, just given the market backdrop.

So I'll start with the second half of that question first. Our appetite for credit, the answer to that thinks with the fact that we want to be open for business through all credit cycles. So we want to make loans certainly. We want to make good loans, and we anticipate doing so through the cycle. As to overall loan growth expectations, certainly, they've moderated given the continued economic pessimism, the increased and increasing rate environment and the overall general uncertainty as to market conditions. Pipeline volumes were down as of year-end, and they're rebuilding, but it's at a more measured pace. So with that, I anticipate continued increases in line utilization, the headwinds of the refinance activity have slowed, which will help in terms of loan growth. And with our super community bank model, I anticipate loan growth in the low single-digit range for 2023.

Could you discuss some of the competitive dynamics regarding deposits and the trends you're observing? It seems like we might see ongoing outflows, so what are the factors influencing these flows? How much of this is related to the withdrawal of surge deposits or seasonal factors versus clients using cash to pay down debt or pursue projects without taking on more expensive debt? Are there also price-sensitive clients looking to switch for better rates? I'm interested in your perspective on the competitive landscape and how you balance the need to defend deposits and maintain them on your balance sheet versus allowing more outflows to occur.

Yes, David, it's Peter. To address the deposit outflow composition, in the fourth quarter, two-thirds of the decline came from business accounts. These clients were either reducing excess operating cash or paying down loans with their extra cash. We also observed that some of our more rate-sensitive consumer deposit accounts shifted to online high-rate offerings. We believe much of this initial decline was related to the excess balance surgery and that the most rate-sensitive clients moved quickly. As we progress through '23, we anticipate a decrease in the outflow pace as we reach the core of our deposit base, with many of the surge deposits already transitioned out. Our deposit base is highly diversified, touching both rural and metro markets, and is quite granular, featuring many accounts with relatively low average balances compared to our peers. This characteristic is expected to foster stability and stickiness in our core deposits throughout this rate cycle. Regarding pricing tactics, we aim to position ourselves at the median of our peer competition in each market and continue to do so. We also offer selective CD specials to attract more rate-sensitive balances with Banner. Lastly, we have a delegated exception pricing model that extends to our branch network, allowing certain clients to receive tailored pricing for retention without needing to adjust the entire portfolio. These strategies proved effective in the last rate cycle back in '17 or '18 and we believe they will be efficient again in this cycle. We forecast a low single-digit pace of core deposit outflow for the upcoming quarters, which is expected, while we may see an increase in our CD balances over the same period. We have ample liquidity to accommodate a moderate outflow of higher rate-sensitive balances as we navigate through this cycle, and we do foresee a continued slowdown in the pace of outflow as we delve deeper into the rate cycle.

Okay. That's helpful. Thanks, everybody.

Thank you, David.

Perfect. Thank you, David. Our next question is from Andrew Liesch from Piper Sandler. Andrew, please go ahead. Your line is now open.

Thanks. Hi, good morning, everyone. So just given where liquidity now sits and some of these balance sheet trends that you're noting, do you think the margin has now peaked?

Hi, Andrew, it's Peter. There are still some opportunities for growth, although it will occur at a slower pace. We are confident in the loan yield repricing and, to a lesser extent, in the growth of our securities portfolio in line with the Federal Reserve's interest rate hikes. The adjustment in our loan mix shows this trend with our adjustable and floating rate loans, as well as increased yields on fixed-rate loans. We included a chart in our investor presentation this quarter that highlights both our production and the average yield on new production. In the fourth quarter, the average yield on new loan originations was approximately 6.4%, which is beneficial to our existing portfolio yield. There is a carry lag effect that will positively impact average loan yields quarter over quarter for the next several periods. Meanwhile, funding costs will continue to rise at a slower rate compared to the increase in the yield of earning assets. Although we won’t see the rapid growth we experienced in the previous quarters, we believe there is still potential for improvement before it levels off, likely in the second half of 2023, especially if the Federal Reserve implements another 50 basis points increase in short-term rates.

That's really helpful. It's a bit longer than I expected. You also mentioned that you're funding some of the deposit outflows or loan growth through security sales or borrowings. How do you manage that? I would think many of the securities sales could lead to additional losses, while the funding might come at a higher rate on the borrowing side. How do you strike that balance?

We've described our securities portfolio as a barbell, consisting of short-duration securities alongside traditional long-duration MBS and CMO securities. There is sufficient liquidity in the securities portfolio, with only modest fair value losses. We plan to utilize this liquidity to support both loan growth and deposit outflows while avoiding significant realized losses during sales. Therefore, securities will be our main source of liquidity. We will also consider the FHLB as a secondary option, but we do not anticipate extensive leverage or FHLB borrowings to manage additional deposit outflows or loan funding. We expect to incur very limited losses from any necessary security sales to facilitate this.

Got you. And then can you just remind us what the monthly or quarterly cash flows off the securities book are?

Yes. I think we've said in the past that the run rate amortization on the securities book is about $25 million a month. So, I think about $75 million to maybe $80 million a quarter and just natural amortization and prepayment activity on the securities book.

Got it. Got it. All right. Thank you for taking the questions. I'll step back.

Thank you, Andrew.

Perfect. Thank you, Andrew. Our next question is from Andrew Terrell from Stephens. Andrew, your line is now open. Please go ahead.

Hey, good morning.

Good morning, Andrew.

I wanted to go back to some of the discussion on just like the fixed and adjustable loans. I think both are 36% of total and just the repricing dynamics there and maybe some margin tailwinds longer term there. I was hoping, I guess, do you have a breakout of roughly per year, how much in fixed and adjustable rate loans either reprice or mature?

I don't have an exact number for you, Andrew. The average duration of our fixed-rate loan portfolio is between 12 and 18 months. You can expect those loans to reprice at that frequency. We are intentionally taking on longer durations overall and encouraging our bankers to do the same. This has been our approach since the start of the rate cycle to increase duration as we approach the peak. We are noticing this impact in the extended duration of our loan portfolio as we progress further into the rate cycle. The loans we are targeting are generally FHLB or treasury index loans that reprice every three months to five years. There is still potential for an increase as we base our pricing on higher indices that have not yet undergone the repricing process. Additionally, all our floating and adjustable-rate loans have a floor mandate, and I would say that around 80% of our floating-rate loans that are linked to LIBOR or SOFR have floors within a reasonable range of the actual loan yield. We are confident in the embedded optionality in our loan portfolio without needing to implement a large portfolio of floors. This setup will provide us with favorable conditions when rates decrease in the future, thanks to the floors we've established as rates have risen.

Okay, I appreciate it. And maybe one for Jill on the construction portfolio. I think a lot of investors kind of focused on dynamics within construction books right now. I was hoping maybe you could just spend a little bit of time talking about, kind of, specific credit metrics that you underwrite to in this book of business? And then maybe any trends you're seeing within the permanent financing market?

Yes, Andrew. Regarding the construction portfolio, I prefer not to go into too much detail about our credit underwriting metrics, but we do require cash equity for those projects. We have a solid group of builders involved. As we've noted, the market continues to experience a shortage of available homes, so we are still observing strong demand for that product. Regarding the underwriting and permanent mortgage loans, was that the first part of your question, Andrew?

Yes, that's right. Just as those construction loans go to the perm market.

Yes. So the permanent loans, we're underwriting to the secondary market generally and then determining whether we want to keep it on balance sheet or not for loan growth. The custom all-in-one, we price that a little higher than the standard market rate so that theoretically, you would be able to float that down and sell it into the secondary market. The fact we would expect from the loans originated late '21 and into early '22, because of the rate environment at that time, those will still come on to balance sheet as the construction continues because of the low rate at that time. But the underwriting is generally set in that so that we will sell it in the secondary market upon completion.

Okay, I appreciate you taking the questions.

Thank you.

Hi, good morning. Thanks for the questions. Congrats on a great quarter. Most of my questions have been asked and answered at this point. But just wondering, given the position you're in, in that you have a lot more liquidity than some other banks that may be having more issues. Just wondering if the pace or consistency of M&A discussions has picked up at all or any changes there in the last couple of months?

Well, good morning, Kelly, this is Mark, and thank you for the question, and thank you for your compliment. We thought it was a very strong quarter as well. Look, I think the bank M&A environment right now is pretty stagnant just because of various things, not just interest rate sensitivity and a lot of institutions, but also the uncertainty with the credit environment or what you may potentially buy, be buying, along with accounting rules associated with an M&A transaction, so it's going to be fairly muted here. But our philosophy hasn't changed, our policies haven't changed. We continue to have a select group of companies that we admire and that we think would be great partners with Banner, and we continue to have that dialogue. And it's more important to have that dialogue now more than ever as we get through this cycle as to where the opportunities might exist for combinations. If you think about our acquisition strategy and our combination strategy, it has always been opportunistic. And it has been transactions that have been nurtured over several years of understanding their company and their management team and our company and our management team. So I see that process continuing right now.

Thanks for the insights, Mark, I appreciate it. My next question is for Jill. We're taking a closer look at the office space, which has been receiving a lot of attention. Could you provide an update on your exposures in that area? Additionally, can you share any details on loan-to-value ratios or debt service coverage ratios for that portfolio, as well as the overall nature of that book?

Sure, Kelly. We are closely monitoring the office market, and our portfolio is performing well. Our total exposure is limited to 7% of the loan book, and importantly, we have very limited exposure to core business districts. Our office portfolio, as I mentioned, is 7% of the loan book, with 50% being owner-occupied. The details help in managing our exposure, with the average individual loan size for the investor portion being about $2 million. When we include the owner-occupied portfolio, that average drops significantly. We have maintained consistent underwriting standards. Since the post-pandemic period, our office portfolio has had an average loan-to-value of approximately 60% and a debt service coverage ratio of over 150%.

I appreciate the information you provided, Jill. It's really helpful. My last question for you today is, I apologize if I missed it, but did you give any guidance or outlook regarding fees for 2023?

Or non-interest income, Kelly?

Correct. Yes.

Yes, we didn't provide any guidance, but we think the fourth quarter is representative. It's a good baseline. It reflects the muted mortgage environment. We're seeing some green shoots in mortgage, given the drop in the 10-year, but our expectation is we're going to run at the lower levels we've seen in the last quarter or two in residential mortgage for the bulk of 2023. And we'll see some the deposit fees, while we have some selected deposit product fee changes coming in the second half of '23 as part of Banner Forward. We're seeing a little bit of offset with the ECR rate going up on our analysis fees as we hold those analysis deposits, we're giving more compensating credit in the ECR rates. So, our deposit fees are going to generally kind of trend neutral to what we've seen in the last quarter. So, all that being said, in multifamily, we think we'll have a better year than we did in '22. So, we should see some upside in multifamily given the marks that we took on it in '22. But overall, we think it will be very similar to '22 in terms of the aggregate core fee income trend in '23.

Thank you, Peter. I appreciate the color. I'll step back.

Thank you, Kelly.

Great. Thanks. Good morning, everybody, and I appreciate the opportunity to ask a question here. Peter, as you prepare to sell securities this coming year, have you estimated what the costs might be? Will it resemble what you experienced in the fourth quarter?

Yes. I believe there is a slight single-digit loss on sales related to liquidating securities needed to address fund loan growth or deposit outflows. However, the securities portfolio is divided into categories based on their QSIPs, ranging from those with no loss to those experiencing a more considerable decline due to their duration. We will prioritize the sale of securities based on their balance, risk return, and potential yield dilution. It's important to note that there are currently $300 million in overnight repos maturing in the first and second quarter with no associated losses. The rest of the portfolio has relatively low marks, providing us with adequate liquidity without significant losses on sales to support the company throughout '23, so we anticipate that it will not have a material impact.

Great. That's great insight. Mark, you have one of the best footprints of any West Coast bank. As you assess your geography, are you observing certain markets performing better than others?

Thank you for the question, Tim. We continue to see strong long-term economic drivers in the Pacific Northwest. Northern California is a stable market, while Southern California is experiencing some outmigration and challenges related to political and tax issues. Overall, however, we believe that as we move through the business cycle, all these regions will benefit significantly from an economic rebound. Most markets in the Northwest are still seeing population growth and per capita income increases, and we expect this trend to persist. Despite headlines about technology and aerospace layoffs, the markets we operate in are not likely to be as adversely affected. Therefore, we remain optimistic about these markets and the long-term trends continuing to be favorable for us.

Okay. Can you share a general comment on what you’re observing from your competition? Are there still some irrational players in the marketplace, or are you noticing a slight pullback from them?

Yes, Tim, you set me up well. While people often mention irrational behavior from other institutions, our management team views it differently. We don’t believe competitors act irrationally; we just don't always grasp their reasons for their actions. Some competitors have been more aggressive than we would have expected, but I think that has now normalized due to liquidity constraints they are facing. The marketplace is adjusting because of the uncertainty present. As a result, things have stabilized to more fundamental underwriting and pricing behavior. However, on the deposit side, we have competitors, like credit unions and certain financial institutions, with loan-to-deposit ratios exceeding 100% that are offering deposit rates and CD campaigns significantly higher than ours. We will not chase or compete against that. While it may not be entirely rational, it aligns with their business models. Hopefully, that clarifies things. Jill, if you have anything to add, please do.

No, I think you covered that one.

Great. All right, that's was all my questions. I appreciate it. Thank you.

Thanks, Tim.

All right. Thank you, Tim. We currently have no further questions. I will now hand back to our speaker for final comments. Mark, please go ahead.

Thank you, Bruno. As I stated, we are very proud of the Banner team and our fourth quarter and full-year 2022 performance. Thank you for your interest in Banner and joining us on the call today. We look forward to reporting our results to you again in the future. Have a wonderful day, everyone.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. Thank you.