Columbia Banking System, Inc. Q3 FY2022 Earnings Call

Good morning and good afternoon, everyone. Thank you for joining us today on our third quarter 2022 earnings call. With me this morning are Cort O'Haver, the President and CEO of Umpqua Holdings Corporation; Tory Nixon, President of Umpqua Bank; Ron Farnsworth, our Chief Financial Officer; and Frank Namdar, our Chief Credit Officer. After our prepared remarks, we will take your questions. Yesterday afternoon, we issued an earnings release discussing our third quarter 2022 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both these materials can be found on our website at umpquabank.com in the Investor Relations section. During today’s call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the Safe Harbor provisions of federal securities. For a list of factors that may cause actual results to differ materially from expectations, please refer to slides two and three of our earnings presentation, as well as the disclosures contained within our SEC filings. We will also reference non-GAAP financial measures alongside our discussion of GAAP results. We encourage you to review the GAAP to non-GAAP reconciliation provided in the earnings presentation appendix. I will now turn the call over to Cort.

Thank you, Jacque. I will provide a brief recap of our performance and then pass to Ron to discuss financials. Frank will discuss credit, and then we will take your questions. For the third quarter, we reported earnings available to shareholders of $84 million, which represents EPS of $0.39 per share, compared to the $0.36 reported last quarter and the $0.49 reported in the third quarter of last year. On an operating basis, which excludes a number of interest rate-driven items and merger expenses that Ron will review, EPS was $0.47, compared to $0.37 last quarter and $0.49 in the third quarter of last year. The return of the provision for credit losses compared to 2021’s recapture was a driver of the annual variance. Operating pre-provision net revenue was up 30% on the quarter and 31% for the year as higher interest rates and loan growth have substantially offset declines in mortgage banking revenue and PPP-related fees. Loan balances grew $1.1 billion in the third quarter, representing a quarterly growth rate of 4.4%, as new generation was diversified across portfolios, business lines, and geographies. Deposit balances increased $685 million, representing a quarterly rate of 2.6%, while growth once again outpaced deposit balance increases. Our growth rates were more balanced than in the prior quarter, and we continue to target a balanced growth profile. Turning to other initiatives at the bank, we continue to add new digital and payment solutions to meet the evolving needs of our customers. In the third quarter, our teams implemented enhancements to product offerings and service capabilities. These include a new integrated receivable solution for businesses and commercial clients launched in partnership with a best-in-class fintech provider, as well as a digital healthcare payments and practice management solution that we will market to doctors, dentists, hospitals, and all healthcare providers. We have a robust roadmap planned for Q4 and into 2023 for continuous digital innovation and payments technology deployment. Just this week, we successfully launched real-time payments. Umpqua Bank is now registered with the Clearing House, and the real-time payments network enables our customers access to funds and the ability to review balance information within seconds, 24 hours a day, 365 days a year. Our ongoing advancements in payments technology continue to accelerate revenue growth in our core commercial fee categories, including 43% growth in commercial card revenue during the third quarter compared to the prior year. Our pipelines across all fee-based solutions, which includes treasury management, cards, merchant, and international remain very strong. As discussed on last quarter’s call, we continue to take necessary steps within the mortgage banking segment to manage our expenses and efficiently deploy capital in light of significant headwinds in the home lending industry. To that end, we further reduced headcount during the quarter and implemented additional business model adjustments to shift production towards salable volume, which is generally more profitable. We have achieved $3 billion in net loan portfolio growth through September, with $953 million of it, or one-third of the growth, coming from portfolio mortgages. Going forward, we expect our recent actions to result in lower growth in portfolio mortgages as we continue to target a balanced growth profile for our balance sheet. These actions take time to work their way through the financial statements, and we will continue to update you on our progress. We remain committed to serving our customers and will continue to invest resources in our low-to-moderate income communities. We are making investments to build and expand relationships in historically underserved markets with products and services provided by our retail, small business, and home lending teams. Regarding capital, earlier this month, we declared a $0.21 per share dividend payable on October 28 to our shareholders of record as of October 14. We once again accelerated our dividend declaration timing compared to our usual post-earnings cadence, as we continue to plan for our pending combination with Columbia Banking System. As we detail on slides six and seven of our deck, we continue to make headway with our integration planning, and our scheduled Q1 2023 core system conversion date remains achievable at this point, given our ability to separate conversion planning activities from the legal close date. Since we last spoke in July, we have signed a letter of agreement with the Department of Justice and received the required regulatory approval from the State of Oregon. We are pleased to have passed two additional milestones, and we are prepared to close the transaction after obtaining the remaining regulatory approvals and after Columbia executes purchase agreements to divest the ten Columbia State Bank branches identified by the DOJ. Before I pass to Ron, I would like to commend our teams. Umpqua’s loan portfolio is up 13% through September, and while favorable market conditions contributed to that growth, it is primarily reflective of the diligent focus of our associates and our ongoing investments in talent that have joined the bank since we announced our pending combination with Columbia. Our operating markets, pipelines, and top-tier banking teams support my expectations for continued net portfolio growth into 2023 outside significant economic deterioration, which we have not seen today. We remain acutely focused on the health of our new and existing borrowers, and our new loan production mirrors the high-quality metrics exhibited by our overall loan portfolio. I am excited about the activity at Umpqua and our forthcoming combination with Columbia. And with that, Ron, take it away.

Thank you, Cort. I am going to follow along and will be referring to certain page numbers from our earnings presentation. Starting on page 11 of the slide presentation, which contains our performance ratios both on a GAAP and operating basis. The adjustments for our internal operating measures include various fair value changes from interest rate volatility along with merger and asset disposal costs, which are detailed in the appendix on slide 32. Our NIM continued to strengthen, up 47 basis points in Q3 to 3.88%. This drove improvement in our efficiency ratio and a continued increase in our PPNR and return metrics, both on a GAAP and operating basis. Our GAAP PPNR ROAA increased to 1.8%, while our operating PPNR ROAA increased to 2.1%, and operating ROE increased to 15.9%. Turning now to page 12, which contains our summary quarterly P&L, our GAAP earnings for Q3 were $84 million or $0.39 per share. On an operating basis, we earned $103 million or $0.47 per share. For the moving parts compared to Q2, net interest income increased $39.4 million or 16%, representing the power of our interest-bearing cash, skipping bonds, and waterfalling down in the loans in the last few quarters, combined with the recent Fed rate increases. We added a provision for credit loss of $27.6 million, driven primarily by the continued strong loan growth and a slight deterioration in the consensus economic forecast. Non-interest income declined $25.8 million, reflecting lower home lending gain on sale revenue, along with the fair value adjustments driven by the significant bond market sell-off and higher yields. Namely rate-driven fair value losses on bonds and loans held at fair value, partially offset by net MSR and swap CVA gains, as detailed later on the right side of slide 32. And non-interest expense declined $1.6 million or 1%, mainly from lower mortgage banking and payroll tax expense. As for the balance sheet on slide 13, loans were up $1.1 billion and deposits increased $0.7 billion. This difference along with a targeted increase in interest-bearing cash was funded with short-term borrowings that mature by year-end. The decline in investments AFS related primarily to the unrealized loss resulting from higher market yields this quarter. Our total available liquidity, including off-balance sheet sources, ended the quarter at $14.4 billion, representing 46% of total assets and 54% of total deposits. As noted on the bottom of slide 13, our tangible book value declined due to the AOCI rate mark on AFS investments. We also present measures for this and the TCE ratio, both including and excluding AOCI for reference. Slide 15 highlights net interest income, noting the increase to $288 million in Q3 resulted from the recent rate increases, along with continued strong loan growth. From a rate-volume standpoint, an increase in rates led to $29 million of the $39 million increase, with volume and mix making up the $10 million difference. Following that on slide 16, the trends for our net interest margin, noting again, our NIM increased 47 basis points in total to 3.88% in Q3. We represent a waterfall on the margin change on the right side of the page, indicating our loan and cash yields more than offset rising deposit costs. Key for me here is following the 150-basis-point increase in the federal funds rate during Q3. Our NIM for the month of September was 3.94%, reflecting another 6 basis points higher than the full Q3 amount, which bodes well for the remainder of the year. The next two slides include information which investors may find helpful on continued rate sensitivity. First, on slide 17, we provide the re-pricing and maturity characteristics of our loan portfolio. The first table in the upper left breaks down the pricing drivers on loans. Turning now to the quarter-end, 34% of the portfolio is fixed, 30% is in floating rate, and 36% are adjustable rates over time. The lower left table shows the maturity schedule by category. The upper right table shows the loan rate floor buckets for floating and adjustable rate loans, noting this has declined to less than 1% of the book. The lower right table breaks down the balances by rate change band along with the weighted average rate change required for these loans to move above their floor. Hopefully, investors and analysts will find this information useful in assessing the beneficial impact on net interest income of future potential rate hikes. And next on slide 18, on the left, we have included our projected net interest income sensitivity for future rate changes, in both ramp and shock scenarios over two years. This simulation we run in back test quarterly assumes a static balance sheet. The deposit beta used in this simulation is 51% on interest-bearing deposits and applies to future re-pricing, assuming future rate changes. The table on the right shows our deposit beta from the last rising rate cycle, starting Q3 2015 and running through Q3 2019 to capture the lag effect. Our beta then was 42% on interest-bearing deposits. Our cost of interest-bearing deposits increased from 11 basis points in Q2 to 23 basis points in Q3, a net increase of 12 basis points and an implied re-pricing beta of 8% based on quarterly averages. The spot rate at September 30 was 38 basis points versus 10 basis points at June 30, indicating a net increase of 28 basis points during the quarter. We used the spot rates to help gauge movement and potential trajectory heading into the next quarter. This 28 basis points of spot rate increase translates to a deposit beta of 19% on the 150 basis points in Fed funds rate increases during Q3, and on a cumulative basis, we were at 9%. For comparison, the loan coupon, however, increased by 59 basis points between June 30 and September 30. Tying everything together, we expect our interest-bearing deposit costs to increase again in Q4, but stay well below our model level, which will bode well for our NIM assuming additional Fed moves in November and potentially December. Now to our segment disclosures, starting with the core banking segment on slide 21 of the presentation. Net interest income increased $39.5 million over Q2, given the higher rates and loan growth discussed previously. I will talk about CECL in the provision in detail here in a few minutes, but you will see here that we had a $27.6 million provision this quarter, again related to continued loan growth and slight deterioration in economic forecast variables. The next few rows show the fair value changes due to rising interest rates. As a group, we had a $25 million loss in Q3, compared to a $10 million fair value loss in Q2. Non-interest income of $36.8 million increased from Q2 due to continued growth in commercial fees. In the non-interest expense section, you will see the merger expense recognized to date on the combination, along with exit and disposal costs related to lease exits on recent store consolidations. The direct non-interest expense for the Core Banking segment was up slightly this quarter, primarily related to higher deferred loan costs from Q2 not repeating in Q3. The efficiency ratio for the segment improved to 52%, meaning this would be 48% excluding the non-operating fair value changes and merger exit costs. The operator disclosure for the core banking segment is back on page 34 in the appendix and also on page 24 of the release; it’s great to see the operating PPNR increased 45% year-over-year and 31% from Q2, which indicates the benefit of continued loan growth and rate increases. Turning now to slide 22 of the presentation, we show the mortgage banking segment five-quarter trends. The continued increase in longer-term yields has further depressed volumes and pipelines. We have $397 million in total held-for-sale volume this quarter, down 31% from Q2 due entirely to lower activity with higher rates. The gain on sale margin was 2.65%, up slightly from Q2. These two items resulted in the $10.5 million in origination and sale revenue noted towards the top left of the page. Our servicing revenue was stable; for the change in MSR fair value, the passage of time piece was stable, while the change due to valuation inputs was a gain of $16.4 million, due again to the increase in long-term rates during the quarter. We implemented the MSR hedge in August, offsetting $14 million of the MSR gain in line with expectations. Non-interest expense totaled $21.5 million for the quarter. This represents held-for-sale origination costs, servicing costs, along with administrative and allocated costs. The direct expense component of this was $10.5 million as noted on the right side of the page. As noted towards the bottom of the page, the MSRs reached a record high valuation of 1.51% as of quarter-end. A couple of final items before I turn it over to Frank: on slide 24, we have included the quarterly loan balance roll forward. Quarterly loan growth was driven by $1.9 billion in new originations and net advances, offset by $0.8 million of payoffs. Slides 25 and 26 provide additional statistics and composition of the portfolio. And next, let me take your attention to slide 27 on CECL and our allowance for credit loss. Our CECL process incorporates a life-of-loan reasonable and supportable period for the economic forecast for all portfolios, with the exception of C&I, which uses a 12-month reasonable and supportable period, reverting gradually to the output mean thereafter. We use the consensus economic forecast this quarter, updated in August. Overall, the forecast reflected higher expected inflation and interest rates, and a slight uptick in peak unemployment rates. With this, we recognized a $27.6 million provision for credit loss, with $12 million of that for the quarter’s strong loan growth and $15 million for slightly deteriorating economic variables. This page shows the commercial and leasing portfolio driving the majority of the increase, as they are the most sensitive to the unemployment rate forecast, which increased slightly from 3.7% to 4.1% over the horizon. The ACL increased to 1.16% at quarter-end, up from 1.12% in Q2. Lastly, I want to highlight capital on page 29, noting that all of our regulatory ratios remain in excess of well-capitalized levels. Our Tier 1 common ratio was 10.7%, and our total risk-based capital ratio was 13.2%. The Bank-level total risk-based capital ratio was 12.4%. With that, I will now turn the call over to Frank Namdar to discuss credit.

Thank you, Ron. Turning back to slide 28, our non-performing assets to total assets ratio of 0.16% was relatively steady with the prior quarter’s level, and our classified loans to total loans ratio of 0.74% was similarly stable. Our annualized net charge-off percentage to average loans and leases was 11 basis points in the quarter, reflective of the continued below-average net charge-off activity in the FinPac portfolio. FinPac’s ratio came in at 1.36%, still well below its historical 3% to 3.5% range, displaying the resiliency of its customer base and the impact of strategic credit adjustments continually and consistently being applied within that portfolio. My expectation continues to be for a gradual migration to historical norms over the coming quarters in this space. As expected, essentially all of the quarter’s charge-off activity was in the FinPac portfolio as the Bank’s activity was again nearly de minimis. We continue to be very pleased with our credit quality metrics; charge-off activity is minimal, and non-performing and classified loan ratios are low while delinquency migration is satisfactory. We remain confident in the quality of our loan book and look forward to high-quality growth balanced with effective and active risk management practices. Back to you, Cort.

Thank you, Frank and Ron, for your comments. We will now take your questions.

Thank you. Our first question comes from Jared Shaw with Wells Fargo. Your line is now open.

Hi. Good morning.

Hi, Jared.

Maybe just broadly, if you could share with us what you are hearing from your customers in terms of broader commercial sentiment with the economic backdrop that we are seeing, and does that change any of the longer-term assumptions with the COLB deal? How should we be thinking about that as we look at 2023 growth, maybe just the Umpqua part of growth going into 2023?

Hi, Jared. From the customers' perspective, we are continuing to see very active customers, certainly, on the borrowing side. Our C&I portfolio continues to grow with a lot of activity. I think changes in interest rates and the economic cycle make it a little too early to see anything material from their perspective yet. There’s somewhat of a slowdown in the pipeline on the real estate side. In our multifamily and commercial real estate division, they are a little more interest rate sensitive, and we are seeing a little bit of a slowdown there. However, overall, there is still really good activity from our existing customer base and our prospect community. We continue to prospect throughout the footprint and have success in bringing new relationships into the bank.

And Jared, here Cort, one last thing relative to the product sets of both companies—like you heard Clint and I say a year ago now—our respective banks independently are very complementary to one another. We each have products and services potentially the other one does not have, and there's a tremendous opportunity to leverage those opportunities. As it relates to the combination, I am extremely excited about the momentum we have created. The opportunity to combine products and services, portfolios, markets, and teams together is a huge opportunity that we have before us.

So when we look at the sort of $1 billion of growth this quarter, do you feel that that’s a sustainable rate as we go through the next few quarters barring any major economic change from these levels?

Yeah. This is Tory. Based on our pipeline and activity, Q4 and into Q1 will be less from a loan growth perspective than we saw in Q3. Pipelines are still healthy, but they are down from their peak about 15% to 20%. Most of that is in the real estate space, which is a little more sensitive to the interest rate side. We will just see less growth on the real estate piece over the next couple of quarters. I think we will see decent growth on the C&I side, so expect less in Q4 and Q1 at this point but still healthy.

Okay. That’s good color. Thanks. Lastly, on the RTP real-time payments rollout, how do you see that playing with the broader FedNow rollout expected in 2023? Is that complementary or do you expect to see more of a shift over to FedNow from that volume as we look out into 2023?

Yeah. This is Tory again. I think it is complementary at this point. For us, the products that Cort mentioned, our integrated receivables, our healthcare product, and then real-time payments, are about us creating and partnering on the technology front for working capital solutions for our customers. These essentially bring money into companies faster and easier, and I think that it serves the customer well and serves the bank really well. We are well-positioned to be a significant payments provider and are excited about that for the company going forward.

Great. Finally, just as we look at the Umpqua balance sheet, you have done a great job of growing DDA as a percentage of overall deposit funding during COVID. Do you think this has been a systemic or a structural change in your relationship with those depositors where we should expect to see that stay closer to this 40% level, or should it start dipping back and reverting closer to the 30% as we move through the cycle?

Absolutely, there has been a shift over the last couple of years in relationship banking within the company. Our desire and necessity to ensure that we are garnering deposits and operating accounts from the companies we bank, if we are to make loans to them, is very deliberate. My expectation, I believe all of our expectations are that this trend will continue. We are a full-service company, a full-service bank, and will continue to pursue non-interest-bearing deposits strongly as we move forward.

Thank you. Good morning.

Good morning, Brandon.

I wanted to touch on deposit growth. It’s pretty solid, and Cort, a lot of your competitors are seeing deposit declines. So I wanted to get more color on the deposit growth outlook, near-term, and any seasonality that you are expecting?

Well, this is Tory. We feel very confident in our ability to generate deposits at the company. As I said earlier, there’s a big emphasis on relationship banking and full-service banking, and that will continue into Q4 and beyond. The market is shifting, and there’s certainly liquidity leaving the system. Some of our customers are more rate-sensitive than others, and we need to pay close attention to our current customers and the prospects we are looking to bank. We will continue to work hard to bring deposits into the company at the lowest cost possible, and I feel very confident in our commercial banking teams and all departments in retail to do that.

Got it. And then on the balance sheet side, I know the merger is pending. Are there thoughts to hedge against the downside of rates potentially in the future? Is that a strategy being contemplated?

Hey, Brandon. We just discussed implementing a hedge on the MSR. We have also faced a pretty negative debit impact this quarter from the fair value of loans held at fair value for that mark. Obviously, when we think about down rates in the future, those two elements will take care of themselves. Considering the overall balance sheet and the NIM, it is something we do evaluate. Key will be opportunities we have on a post-combination basis, but nothing definitive at this point regarding hedging strategies for NIM. We always evaluate that before, striving to maintain a relatively asset-sensitive position, balancing upside and downside risks. That is a risk long-term if rates drop, which could put pressure on margins.

Got it. Thanks. And lastly, on loan growth, I appreciate the comments on having more balanced growth going forward, but considering the expected economic slowdown, are there any loan categories that you are shying away from relative to the last couple of quarters?

This is Tory again. We have been cautious in places like office and hospitality for a while, so that hasn’t changed. We continue to underwrite and manage risk responsibly at the company, so we will remain opportunistic about loan opportunities and relationships for the Bank, for our existing customer base, and for prospecting. I believe we should and will lend throughout the cycle and feel good about that. There’s nothing we’re steering away from, other than what we’ve been cautious about previously in hospitality, office, and some retail space.

Yeah. Brandon, this is Frank. We practice underwriting through the credit cycles. Our portfolio is designed with that in mind, and we will continue to do that, which supports what Tory was referencing.

Hey. Good morning. This is Adam calling in for Matthew Clark.

Good morning.

I believe I heard earlier in the call that you plan on reducing headcount within the mortgage business. Is that reflected in that decrease in the salary line?

In our comments, we reduced 60 headcount in our mortgage group in the third quarter and year-to-date, that’s 100 in the mortgage group.

No, it’s not fully reflected because that occurred throughout the quarter.

We will continue to assess that segment of the business. While mortgage finance is important for our customer base, we will evaluate it as rates fluctuate.

Definitely seeing opportunities for hiring. We have hired folks in Phoenix and in the Denver market, and we continue to look at other places throughout our footprint. We are always looking for strong banker talent and feel confident we will continue that effort.

Great. Those are all my questions. Thank you.

Thank you.

Thank you for your interest in Umpqua Holdings Corporation and participation in our third quarter 2022 earnings call. Please contact me if you would like clarification on any of the items discussed today or provided in our presentation materials. This will conclude our call. Goodbye.

This concludes today’s conference call. Thank you for your participation. You may now disconnect.