Banner Corp Q2 FY2025 Earnings Call

Hello, everyone, and welcome to the Banner Corporation Second Quarter 2025 Conference Call and Webcast. My name is Nadia, and I'll be coordinating the call today. I will now hand over to your host, Mark Grescovich, President and CEO, to begin. Mark, please go ahead.

Thank you, Nadia, and good morning, everyone. I would also like to welcome you to the second quarter earnings call for Banner Corporation. Joining me on the call today is Rob Butterfield, Banner Corporation's 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. These statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures and statements about Banner's general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and our recently filed Form 10-Q for the quarter ended March 31, 2025. 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. As is customary, today, we will cover four primary items with you. First, I will provide you high-level comments on Banner's second quarter 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, Rob Butterfield will provide more detail on our operating performance for the quarter as well as comments on our balance sheet. Before I get started, I want to thank all of my 2,000 colleagues in our company 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 135 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 changing events. I am pleased to report again to you 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 $45.5 million or $1.31 per diluted share for the quarter ended June 30, 2025. This compares to a net profit to common shareholders of $1.15 per share for the second quarter of 2024 and $1.30 per share for the first quarter of 2025. Our strategy to maintain a moderate risk profile and the investments we have made and continue to make in order to improve operating performance have positioned the company well for the future. The strength of our balance sheet, coupled with the strong reputation we maintain in our markets will allow us to manage through the current market uncertainty. Rob will discuss a number of these items in more detail shortly. To illustrate the core earnings power of Banner, I would direct your attention to pretax pre-provision earnings excluding gains and losses on the sale of securities, building and lease exit costs, and changes in the fair value of financial instruments. Our second quarter 2025 core earnings were $62 million compared to $52 million for the second quarter of 2024. Banner's second quarter 2025 revenue from core operations was $163 million compared to $150 million for the second quarter of 2024. We continue to benefit from a strong core deposit base that has proved to be resilient and loyal to Banner, a very good net interest margin and core expense control. Overall, this resulted in a return on average assets of 1.13% for the second quarter of 2025. Once again, our core performance reflects continued execution of our super community bank strategy. That is growing new client relationships, maintaining our core funding position, promoting client loyalty and advocacy through our responsive service model, and demonstrating our safety and soundness through all economic cycles and changing events. To that point, our core deposits continue to represent 89% of total deposits. Further, we continued our solid organic growth with loans increasing 5% and core deposits increasing 4% over the same period last year. Reflective of this performance, coupled with our strong regulatory capital ratios and the fact that we increased our tangible common equity per share by 13% from the same period last year, we announced a core dividend of $0.48 per common share. Finally, I'm pleased to say that we continue to receive marketplace recognition and validation of our business model and our value proposition. Banner was again named one of America's 100 Best Banks and one of the best banks in the world by Forbes. Newsweek named Banner one of the most trustworthy companies in America and the world again this year and just recently named Banner one of the best regional banks in the country. J.D. Power & Associates named Banner Bank the Best Bank in the Northwest for retail client satisfaction. Our company was recently certified by Great Place to Work, and S&P Global Market Intelligence ranked Banner's financial performance among the top 50 public banks with more than $10 billion in assets. Additionally, the Kroll Bond Rating Agency affirmed all of Banner's investment-grade debt and deposit ratings. And as we have noted previously, Banner Bank received an outstanding CRA rating. 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 reflected in our earnings release, loan originations were strong. We reported solid loan growth across multiple product lines, and Banner's credit metrics remained stable. Loan originations increased 80% when compared to the linked quarter, with commercial real estate up 484%, C&I originations up 96%, and construction and land development increasing 43%, respectively, all while commercial and commercial real estate pipelines continue to build. This level of activity reflects a certain amount of business confidence in spite of the continuing higher rate environment and yet to be finalized trade negotiations. Loan outstandings grew by $252 million in the quarter or 9% on an annualized basis and are up 5% year-over-year, in line with our year-to-date expectations. The primary drivers of the growth were owner-occupied commercial real estate up $104 million, C&I loans up $65 million and the construction and development book with one-to-four-family construction up $48 million, land development up $21 million, commercial construction up $13 million, partially offset by expected payoffs in the multifamily construction portfolio. The growth in owner-occupied commercial real estate is a mix of new middle market clients, expansion of existing relationships and continued solid performance in new small business generation. The C&I story is similar with growth coming from the expansion of existing relationships, increased land utilization, and meaningful small business origination. The residential construction portfolio at 5% of total loans continues to be diversified across market and product mix and the level of completed and unsold inventory remains below historical norms as builders have become more cautious with replacement starts in this extended high rate environment. The increase in land and land development reflects the builders' need to replenish finished lot inventory with land development financing reserves for the strongest vertically integrated clients within the portfolio, aggregating all business lines in the construction portfolio, the total remains balanced at 15% of total loans. Agricultural loans increased 3% in the quarter as both the size of operating lines and line utilization increased to cover higher operating costs and normal seasonal activity, and the growth in consumer one-to-four-family secured loans reflects the strong home equity promotion that occurred in the second quarter. Circling back to Banner's credit metrics, delinquent loans declined to 0.41% of total loans as compared to 0.63% last quarter and 0.29% as of June 30, 2024. Adversely classified loans also declined in quarter-over-quarter, down $8.3 million and represent 1.62% of total loans, an 11 basis point decrease when compared to March 31. In spite of the $7 million increase in the quarter, nonperforming assets remained modest at 0.30% of total assets. Nonperforming loans totaled $43 million, the majority of which are consumer-related primarily residential mortgage loans, which involve prolonged resolution timelines given consumer protection regulations. REO balances totaled $6.8 million, up $3.3 million in the quarter as we completed the foreclosure on an industrial property and two small single-family properties during the quarter. Loan losses in the quarter totaled $1.7 million and were offset in part by recoveries totaling $600,000. The net provision for credit losses for the quarter was $4.8 million, including a $4.2 million provision for loan losses and a $588,000 provision related to unfunded loan commitments. The provision was largely driven by the strong loan growth with the reserve for credit losses providing coverage of 1.37% of total loans, which compares to 1.38% as of the linked quarter and 1.37% as of June 30, 2024. Last quarter, I noted that the level of economic uncertainty, coupled with the myriad of policy changes that were being implemented created a potential headwind that could negatively impact our clients and communities. To date, that has largely not materialized, evidenced by the strong loan originations and growth in the quarter as the implementation of international tariffs were paused. With those policy changes again being suggested as imminent, I am compelled to reiterate that if adopted, they will almost certainly have a negative impact on the West Coast economies with the majority of the burden borne by the small business sector and further stressing the consumer. Still, in these uncertain times, Banner's super community delivery model, coupled with a consistent approach to underwriting credit has enabled us to expand existing and grow new relationships while maintaining our moderate risk profile. Our strong balance sheet, robust capital base and solid reserve for loan losses continue to serve us well. With that, I will hand the microphone over to Rob for his comments. Rob?

Great. Thank you, Jill. We reported $1.31 per diluted share for the second quarter compared to $1.30 per diluted share for the prior quarter. The $0.01 increase in earnings per share was primarily due to an increase in net interest income, partially offset by the current quarter, including costs associated with consolidating back office space as well as a higher provision for credit losses due to growth in the loan balances. We experienced strong positive operating leverage during the quarter compared to both the prior quarter and the quarter ended June 30, 2024, as core tax pre-provision income increased 6.6% or $3.9 million compared to the prior quarter and increased 19% or $10 million compared to the year-ago quarter. Total loans increased $265 million during the quarter with portfolio loans increasing $252 million or nearly 9% on an annualized basis, and held-for-sale loans increased $13 million. The loan-to-deposit ratio ended the quarter at 87%. Total securities decreased $55 million, primarily due to normal portfolio cash flows. Deposits decreased by $66 million during the quarter due to core deposits decreasing $40 million as a result of normal seasonal activity. Time deposits decreased $26 million due to a $25 million decrease in broker deposits. Core deposits ended the quarter at 89% of total deposits, same as the prior quarter. Total borrowings increased $309 million during the quarter as FHLB advances were used to temporarily fund loan growth. Banner's liquidity and capital profile continue to remain strong with a robust core funding base, a low reliance on wholesale borrowing, and significant off-balance sheet borrowing capacity. As a reflection of our robust capital and strong liquidity positions, Banner called and repaid $100 million of subordinated notes at the end of the quarter. Net interest income increased $3.3 million from the prior quarter due to average interest-earning assets increasing $188 million and one more interest earning day in the current quarter. The increase in average earning assets was due to average loan balances increasing $223 million, partially offset by total average interest-bearing cash and investment balances decreasing $36 million. The earning asset yield continues to benefit from a remixing out of securities and into loans. Tax equivalent net interest margin was 3.92%, same as the last quarter. Earning asset yields increased 5 basis points due to a 5 basis point increase in loan yields as adjustable rate loans continue to reprice higher and new loans are being originated at rates higher than the average yield on the loan portfolio. The average rate on new loan production for the quarter was 7.27% compared to 8.01% for the prior quarter. The reduction was due to a higher percentage of production coming from owner-occupied CRE and C&I in the current quarter. Funding costs increased 5 basis points as a result of using FHLB advances to temporarily fund loan growth and seasonal tax deposit declines. Deposit costs were 1.47% for the current quarter, which was consistent with the prior quarter. Noninterest-bearing deposits ended the quarter at 33% of total deposits. Total noninterest income decreased $1.4 million from the prior quarter, primarily due to a loss of $919,000 on the disposal of assets related to back office space consolidation and a $227,000 net difference in the fair value adjustments on financial instruments carried at fair value. Total noninterest expense was similar to the prior quarter with increases in salary and benefits, information technology, marketing, and REO expenses, which were offset by higher capitalized loan origination expense. The current quarter included $834,000 of lease termination and costs associated with back office space consolidation. Our strong capital and liquidity levels position us well to continue to execute on our super community bank business model. This concludes my prepared comments, and now I'll turn it back to Mark.

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

Our first question goes to David Feaster of Raymond James.

I wanted to follow up on the impressive increase in origination that Jill mentioned. Could you elaborate on whether anything has changed from your perspective? Do you think your customers are feeling more comfortable with the broader economy, or was there any timing issue? I'm curious if there's anything significant to take from this and how the pipelines are holding up in light of the increase in originations.

So the increase in origination certainly pulled some of the pipeline out until they're rebuilding now. And if you look back historically, I think what you would see, David, is that Q1 and Q3 are generally slower than Q2 and Q4. So the tariff noise that happened at the end of Q1 certainly slowed things down there and the policy changes. That opened back up a little bit, pulled some of that through. So what was muted loan growth in Q1 came in, in Q2, and I guess at the end of the day, what I would say to you is that I'm still expecting us to hit that mid-single-digit growth rate for the year. I expect we'll see a little bit of a pullback in Q3 but we had a 5% annualized year-over-year in Q1. We had a 5% annualized year-over-year in Q2, and that's roughly what we're projecting for the year of 2025.

That's helpful. Regarding funding, we've noticed increased competition for deposits as growth has picked up in the industry. Can you share your observations on core deposits, any initiatives in place to boost them, and your strategy for funding additional loan growth during the latter half of the year?

Yes, David. This is Rob. From an overall perspective on deposits, we aren't seeing an increase in competition at this moment. There aren’t competitive banks raising rates significantly right now, and the situation appears quite stable. While deposits are typically competitive, the fierce competition we encountered a year ago is not what we see today. Our approach has always focused on relationship banking, and we anticipate that acquiring new clients will involve securing the entire relationship, including both loans and deposits. Additionally, we've noted that we are prioritizing small business clients, who often have strong deposit relationships, which is beneficial for us.

Given that loan growth continues to exceed deposit growth, do you anticipate finding a way to close that gap? First, could you remind us about the cash flows from the securities portfolio? Would you consider using FHLB advances to bridge the gap, or have you thought about repositioning securities or selling some assets to generate liquidity for the growth you are experiencing?

Yes. David, regarding the security portfolio, it's currently yielding about $60 million in cash flows each quarter. We do not have plans for any repositioning at this time, but we do have some flexibility depending on changes in market conditions. Could you remind me what the first part of your question was? I'm sorry, I'm trying to...

As growth surpasses core deposit growth, are FHLB advances just a temporary solution, or how do you view funding your growth moving forward?

Yes, it was a plug for this quarter certainly. And I think that's why we saw that increase in funding costs during the quarter was deposit costs were flat, but funding costs were up because of the combination of two, both the really strong loan growth that we had for the quarter, but then also just normal seasonal deposit outflows that we experienced during the first two months of the quarter. And so that's why you saw FHLB advances increase. If normal seasonality returns, we would expect that we would see deposit growth happen in the third quarter, and deposit growth could very well outpace loan growth in the third quarter if historical trends come in line. And so I mean, usually, during the third quarter, that's when we see our ag clients their crops come in, cash comes in from that. So historically, we've already seen increases in deposits during the third quarter.

The next question goes to Andrew Terrell of Stephens.

If I could just finish up kind of on the margin of the funding there. The sub debt that was redeemed or paid off this quarter. Do you have the rate on that or the cost of it? Just trying to get a sense for the rate of what's remaining.

Yes. The cost at that time was 5%, but there was also amortization of some original debt issuance costs. The total cost on that subordinate debt was about $550 million. We expect some reduction in funding costs because if we transition from the $550 million to FHLB advances, even if just temporarily, they are in the $450 million range. So we might gain about 100 basis points from that.

Yes. Got it. Okay. I appreciate it. And then maybe sticking with you, Rob, on just the expense base. You definitely had maybe a little bit of a benefit this quarter from the deferred origination costs. It sounds like maybe loan growth is a little bit slower in the 3Q. Just hoping to get a sense of kind of the puts and takes of the expense base into the back half of the year and if you have kind of an expected quarterly run rate?

Yes. So Andrew, on the expense side of the equation, we continue to go live with some of the different modules on the new deposit and loan origination system. So in the second half of the year, we would expect IT expenses to increase. And what we're looking at is we're looking at kind of over the longer term offsetting a portion of that with the consolidation of some additional back office space, I think you saw some of those non-recurring expenses come through during the current quarter, but we would probably expect that we continue to see some non-recurring expenses come through probably over the next three or four quarters related to that specific initiative. And if you think about our run rate, what we talked about is the first quarter was probably a decent run rate that we would expect and then if you kind of layer in just normal inflationary changes as you go forward from there. As you mentioned, the second quarter was down, and that was partially driven really by the higher capitalized loan costs, higher origination just due to the higher originations. But if you think about Q1 was really low originations historically as well. So we would expect capitalized loan costs probably to be somewhere in between those two.

Got it. Okay. And then I just wanted to ask maybe for Mark, the M&A environment, it seems like it's maybe a little more amicable today. And we've seen quite a few deals announced. Just curious if anything has changed in terms of your view on M&A how palatable you see it being today? And then just any update on kind of the status of discussions or how M&A kind of fits into the Banner strategy over the kind of near to medium term?

Thank you, Andrew, for the question. Clearly, there's been a number of transactions that have been announced. I think certainly, the M&A environment has picked up and conversations have picked up. But what I would remind you is that our organization is totally focused on our organic business operation. And as you can see by the numbers that we put up quarter-over-quarter and year-over-year, the organic business model and our execution, we're very focused on it and it's very successful. So opportunistic M&A is something we will continue to look at. But I don't feel compelled that we have to do anything. It is simply something that I think the entire industry is going to continue to look to some consolidation to get additional efficiencies, but we remain very focused on our organic business model.

The next question goes to Jeff Rulis of D.A. Davidson.

Jill, I had a question about that. Mark, the loan growth comment you made about a pullback in the third quarter. Was that a pullback from the 9% pace from 2Q or a net runoff? My guess is it still positive, correct?

Yes. It's a pullback from the 9% growth rate. And if you look in our disclosures, right, if you just quarter-over-quarter, third quarter is generally a little slower than second quarter.

Got it. And Rob, regarding the margin, you mentioned the impact from the sub debt movement, as well as the possibility that if loan growth levels off or slows down a bit and FHLB needs decrease, the seasonal increase in deposits could create a favorable margin outlook. Looking at the second half of the year, without any changes in Fed expectations, it seems that there are more positive factors than negative ones affecting the margin.

Yes, I think that's accurate, Jeff. As long as the Fed stays on pause, according to Moody's last forecast, it seems we won't see any rate cuts until September, which is quite a ways off. We'll have to wait and see what unfolds, with another potential cut in December. In this scenario, we anticipate loan yields to continue rising by 4 to 5 basis points in the upcoming quarter. Therefore, in the third quarter, we expect loan yield expansion to follow the same pace we observed in the second quarter. On the funding side, there's a bit more uncertainty, but if we assume deposit costs remain stable, we could improve our funding costs through typical seasonal activity. If we experience a seasonal increase in deposits during the third quarter, this could lead to lower reliance on FHLB advances, ultimately reducing funding costs.

Got it. Last one for me was maybe on the credit side, where the risk rating downgrades or additions not we assume, Jill, you're cautious on the small business and consumer are those the areas that added to the balance for this quarter?

So you kind of faded out on me, Jeff, but the decrease in substandard this quarter was really a mix. We had several upgrades, a couple of payoffs, and then a handful of downgrades into substandard for that net change of $8.3 million. The agricultural sector has experienced more downgrades due to the pressure on commodities prices and input costs. So we are seeing some continued pain in the ag sector. So I'll remind you it's 3% of the loan portfolio, 50% operating lines and 50% real estate secured. I continue to watch the small business sector. Looking forward, we haven't seen real change in it yet. The delinquencies are pretty static in that as well. So it's just where I think the pain of the tariffs will ultimately land before they get pushed to the final consumer. Hopefully, that answered your question as you were fading out on me, Jeff, if I didn't hit it all.

And the next question goes to Kelly Motta of KBW.

I thought maybe I would start off by circling back on the margin. There's been a lot of moving parts, and I appreciate all the color thus far. But wondering, particularly in light of the really strong loan growth, I know one of the drivers of margin ahead has been just the back book repricing of the loan book. So wondering how spreads are holding up, where new pricing is coming in? And if there's a lot of color on the deposit competition, but wondering how things are holding up on the loan side in terms of pricing and spreads.

So Kelly, on the loan side, pricing on the term pieces is holding steady, with not much change expected. The real change will be in the variable rate portfolio when the rates reset. If you examine the originations, you'll notice a decline in the yields from quarter to quarter, which is mainly due to a different mix of product types, with less construction lending and more commercial and industrial loans and owner-occupied commercial real estate. Overall, the yields are stable.

Got it. I think, Rob, the commentary on prior calls have been like roughly a 5 basis point increase in loan yields absent Fed cut which would cut into that. I'm wondering if that kind of rough rule of thumb still holds in terms of modeling from the NIM perspective.

Yes. I think that's right. I would say 4 to 5 basis points is what I would expect. And I think the modeling is showing that, that would continue as long as the Fed is on pause for the next handful of quarters. But over time, that backlog of adjustable rate loans that haven't repriced through the cycle continues to dwindle. So over time, we would expect that to trend down over time. But in the near term, we would expect in that 4 to 5 basis point range.

Got it. That's helpful. Maybe my last question on loan growth. It was a really good quarter. Jill, are you seeing any particular markets with better opportunities or where activity is holding up a bit better? Just wondering if there are any regional differences or insights on that front you could share.

Yes, Kelly, I would say that in the past quarter, the middle market space was primarily driven by the Pacific Northwest rather than California. When looking at small business originations, both commercial and industrial and owner-occupied commercial real estate, that activity is widespread across our footprint. Additionally, I expect to see solid growth in California since we have recently added several experienced relationship managers to that market. So, I anticipate more growth in California in the near term.

It appears we have no further questions. I'll hand back to Mark for any closing comments.

Thank you, Nadia. As I stated, we're very proud of the Banner team and our second quarter 2025 performance. Thank you for your interest in Banner and joining our call today. We look forward to reporting our results again to you in the future. Have a great day, everyone.

Thank you. This now concludes today's call. Thank you all for joining. You may now disconnect your lines.