Columbia Banking System, Inc. Q4 FY2023 Earnings Call

Welcome to the Columbia Banking System's Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. At this time, I would like to introduce Jacque Bohlen, Investor Relations Director, to begin the call. Please go ahead.

Thank you, Valerie. Good afternoon, everyone. Thank you for joining us as we review our fourth quarter 2023 results, which we released shortly after the market close today. The earnings release and corresponding presentation, which we will refer to during our remarks this afternoon, are available on our website at columbiabankingsystem.com. With me this afternoon are Clint Stein, President and CEO of Columbia Banking System, Chris Merrywell and Tory Nixon, the Presidents of Umpqua Bank, Ron Farnsworth, Chief Financial Officer, and Frank Namdar, Chief Credit Officer. After our prepared remarks, we will take your questions. During today's call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the Safe Harbor provisions of Federal Securities Law. For a list of factors that may cause actual results to differ materially from expectations, please refer to Slide 2 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 reconciliations provided in our earnings release and throughout the earnings presentation. I will now turn the call over to Clint.

Thank you, Jacque. Good afternoon, everyone. 2023 was a tremendous year for Columbia. We closed and integrated our transformational merger with Umpqua Bank, expanding our footprint to encompass eight Western states and creating one of the largest banks headquartered in the West. We achieved targeted net cost savings ahead of schedule and 6% above our original projection, even after taking franchise reinvestment into account. With the integration behind us, our priorities in 2024 and beyond have shifted to focus more fully on optimizing performance and driving shareholder value. The fourth quarter was noisy, and our results reflect that. The FDIC special assessment and other elevated expense items brought our quarterly expense run rate above prior guidance. Our cost of funds reflects the rate environment and the associated impacts of repricing CDs and higher-priced funding sources like public deposits and brokered funds. While these items matched the quality of our core deposit base, they do not dilute it. Relationship banking drives our franchise value, and it's the value proposition we bring to new and existing customers. Our fourth quarter results do not reflect this value, and we are focused on improving controllable variables to offset macro-driven headwinds. Looking to the year ahead, the competitive environment for deposits and the impact of higher rates is likely to persist, and the macro credit environment will likely normalize at minimum. We are well situated to benefit during times of stress, should they emerge. Our talented associates, skilled franchise, and offerings, and customer-focused business model provide us with the resources to win business and long-term drive consistent, repeatable performance. I'll now turn the call over to Ron.

Okay, thank you, Clint. And for those on the call who want to follow along, I will be referring to certain page numbers from our earnings presentation. Slide four lays out our Q4 performance ratios, knowing the decline in the quarter was driven primarily by the decline in non-interest-bearing demand deposits as customers continue to utilize cash, a higher provision for credit loss based on slightly worsening economic forecasts, and higher expense including the FDIC special assessment. These are five-quarter views and recall we closed the combination at the end of February. Slide five shows our summary balance sheet noting our deposits in total were flat from Q3, given seasonal inflows primarily on public deposits mostly offset customers' use of cash. Our tangible book value is up 13%, as our accumulated other comprehensive loss was halved during the quarter as bond markets rallied. On slide six, we highlight the income statement trends. GAAP earnings were $0.45 per share, impacted by declining merger expense as we completed the integration along with fair-value changes due to market yield changes. On an operating basis, we earned $0.44 per share in Q4, lower than expectations again driven by non-interest-bearing deposit flows, higher costs on interest-bearing deposits, and an increased provision with slightly worse economic forecasts, and higher expense driven primarily by the FDIC special assessment, which at $33 million reduced GAAP and operating EPS by $0.12 per share. Turning to slide seven, we break out Q4 GAAP earnings to help investors understand the non-operating and merger-related impacts on results. The first column represents our Q4 GAAP results with net income of $94 million or $0.45 per diluted share and return on tangible common equity of 12%. The second column includes our non-operating designation for income statement changes mostly related to fair-value swings along with merger and exit and disposal costs included in non-interest expense, which are detailed out in the appendix. These net $2 million of income in Q4 earnings resulted in the third column for operating income. Again, our operating income for Q4 was $91 million or $0.44 per share. And results were impacted by the FDIC special assessment and reserve build, given slightly worsening economic forecasts. The appendix shows trending on each of these columns, and the fourth column includes discount accretion and CDI amortization. Noting this discount accretion will be a steady and reliable source of interest income over time, as the majority is driven by rate not credit, providing us with a steady build of capital over time. And recall the CDI amortization does not impact tangible book value, so the $0.13 per share net for merger accounting was equivalent to $0.25 per share added to tangible book value in Q4. We'll continue to highlight and trend it here to aid investors in valuing all earning streams. And our tangible book value excluding AOCI increased $0.27 during the quarter, $17.35 per share. Moving to the next section on slide nine, we highlight net interest income in margin. Our NIM declined to 3.78% for the quarter, driven primarily by a higher cost of interest-bearing deposits more than offsetting increased loan yields and lower costs from term debt. Slide 10 breaks out the repricing and maturity characteristics of the loan portfolio, noting 41% is fixed, 30% is floating, and 29% are adjustable. On slide 11 provides an updated view of our interest-rate sensitivity under both ramp and shock scenarios. We've taken proactive measures to reduce the balance sheet sensitivity to a future declining rate environment. You can see here the trending over the past year, where our rates down risk has been reduced significantly. And noted below, we calculate our cycle-to-date funding betas, which are calculated on a combined company basis over the periods presented for comparability. As of the fourth quarter, our interest-bearing deposit portfolio has priced in 47% of the Fed funds rate increases. Notable here is the cost of interest-bearing deposits which was 2.54% for Q4 and 2.71% for the month of December. The lift this quarter was influenced by several factors. The decision in Q3 to replace maturing Federal Home Loan Bank advances for broker deposits was essentially neutral to the cost of interest-bearing liabilities but it drove nearly 30% of the increase in interest-bearing deposit costs between Q3 and Q4. Approximately 15% of the quarter's increase relates to an increase in the average balance and rate paid on public deposits and approximately $900 million in customer CDs with largely 12- and 13-month terms matured during the quarter, with many repricing upwards of 200 basis points higher. The cost of interest-bearing liabilities normalizes for balance sheet management decisions, and the quarter's 30 basis-point increase was significantly lower than the increase in interest-bearing deposit costs. Cost of interest-bearing liabilities was 3.02% in Q4, compared to 3.15% for the month of December and 3.19% as of December 31. Slide 12 breaks out non-interest income items knowing the largest changes in Q4 related to interest-rate driven line items. The changes in loans held at fair value at the bottom was a direct result of decrease in long-term yields this quarter. Next up on slide 13. We know we achieved $143 million in cost synergies guided last quarter, exceeding our original target of $135 million by 6%. This amount is net of re-investments made in various areas, while we will continue to target efficiency improvements with the integration now largely complete. We no longer consider future cost-saving opportunities to be merger-related. Q4 expense was above our previously guided range due to several elevated expense items. Noted on the right side is the waterfall from the prior quarter, with the increases driven by higher repairs and maintenance, equipment purchases, a branding campaign, and most notably, the $33 million FDIC special assessment. On slide 14, we introduced our outlook for 2024 on several key financial statement items. Our net interest margin remains sensitive to customer deposit balances, with growth driving margin stability and perhaps expansion as we replace wholesale funding and outflows driving contraction. Our interest-rate outlook, which incorporates three rate cuts in the back half of the year does not meaningfully impact prepayment assumptions related to purchase accounting. Our expense outlook incorporates a low-single-digit level of growth from Q4 adjusted run-rate. We see areas for efficiency improvement to offset the costs associated with franchise reinvestment and inflation. To that end, we consolidated five branches this month. Moving ahead to the next section on the balance sheet, on slide 16, we detailed out the investment portfolio. The table takes you from current par to amortized cost to fair value, knowing the difference between current par and amortized cost is the combined net discount, which will be accretive to interest income over time. The increase in market value this quarter, of course, resulted from lower market yields given the bond market rally, again with the unrealized loss halving. Just over half of the portfolio is now sitting with an unrealized gain at year end, which gives us significant flexibility to manage the balance sheet moving forward. As you can tell, I'm excited about this portfolio as it gives us a significantly higher and stable earnings stream with greater optionality. The overall book yield was 3.59% with an effective duration of 5.4 at quarter end. Slide 17 covers our liquidity including deposit flows during the quarter. Total deposits were essentially flat in the fourth quarter. Seasonal and targeted increases in public deposits nearly offset contraction in small-business balances, as other categories were relatively unchanged. The upper right table details our off-balance sheet liquidity with $11.7 billion available as of quarter end. Below that, we had cash and excess bond collateral not pledged for lines to arrive at total available liquidity of $18.7 billion. Slide 18 provides the driver of 3% annualized loan growth in Q4. Turning now to slide 19, we present the remaining balance of discount marks as compared to the prior quarter and at closing. For the AFS portfolio, the acquired discount was reduced to $21 million via accretion to interest income. In our earnings release detail, we include this $21 million along with $16 million of higher bond interest income from the portfolio restructure we completed post-close, to arrive at the $37 million of total accretion for bonds. On the loan side, we had $27 million of rate accretion and $5.4 million for credit. The total marks declined $69 million in Q4 through accretion to interest in Q4. And finally, in the back on slide 26, we highlight our regulatory capital position. Our risk-based capital ratios increased 20 basis points as expected in Q4. We do expect to quickly approach our long-term capital target of 12% on total risk-based capital, which will provide for enhanced flexibility to return excess capital to shareholders. With that, I will now turn the call over to Frank.

Thank you, Ron. Slides 20 through 22 provide select characteristics of our loan portfolio, including composition of our commercial book and an overview of our office portfolio, which continues to perform well. Moving on, slide 23 highlights our reserve coverage by loan category. Also, the remaining credit discount on loans provides for an additional 21 basis points of loss absorbing capacity. The $55 million provision expense recorded in the quarter was primarily driven by a slight worsening in the economic forecast used in the credit models along with credit migration. Delinquency and non-performing loan movements over the past two quarters suggest a move toward a more standard credit environment following a phase of exceptional high quality. Slide 24 provides an overview of our consolidated credit trends. In general, our credit performance is and has remained causative, excluding the anticipated trend in FinPac. FinPac charge-offs remain elevated during the fourth quarter, still centered in the trucking portion of the portfolio. We continue to expect a slow recovery timeline over multiple quarters for this portfolio. Excluding FinPac, charge-off activity at the bank remains at a low level. I will now turn the call over to Tory.

Thank you, Frank. Turning to deposits, slide 25 highlights the quality of our granular deposit base. As Ron noted, small businesses' use of cash drove a reduction in customer deposits during the fourth quarter, as other commercial balances and consumer accounts were relatively stable in aggregate. The fourth quarter included normal course of business, use of cash, like distributions, dividends, and year-end tax payments, while public balances experienced a related increase. Public deposits were positively impacted by targeted efforts by our teams to grow public relationships in local communities as we work to reduce wholesale funding balances. Our teams remain focused on driving balanced growth in deposits, loans, and core fee income as they work to expand existing relationships throughout the bank, bringing new prospects into the bank. We see tremendous opportunity with our existing customer base to grow fee income. We launched Smart Leads in 2020 as a way to capture additional business with our existing customer base through predictive analytics. We generated an additional $11 million in revenue since 2020, with $5 million generated in 2023 alone, highlighting increased traction with our teams and the benefits of our scaled organization. We will continue to selectively invest in talent, technology, and locations that enable us to profitably expand our businesses as the efficiency opportunities Ron noted maintain our dedication to growing in a cost-effective manner. Lastly, our loan, deposit, and core fee income pipelines remain robust. I will now turn the call back over to Clint.

Hey, thanks, Tory. Our regulatory capital position is outlined on slide 26. As Ron discussed, we expect capital to continue to creep quickly in the coming quarters, providing us with ample flexibility for future shareholder return. This concludes our prepared comments, and our team is available to answer your questions. So, Valerie, please open the call for Q&A.

Thank you. Our first question comes from the line of David Feaster of Raymond James, your line is open.

Hey, good afternoon, everybody.

Hey, David.

I appreciate all the guidance and maybe just talking about starting on the margin and digging into some of the impacts of rate cuts. I'm curious how you think about the NIM trajectory. Obviously, you guys include three cuts in your forecast. How do you think about the impacts and cuts? You guys have done a great job managing the downside in the rate sensitivity scenarios. I'm just curious how you think about the trajectory of the margin and how quickly you'll be able to reprice some of those core deposits on the way down?

Yes, David, hey, this is Ron. Great question. You know, as I look into ‘24, I mean, if that were to come true, we see three rate cuts in the back half of the year or X number of rate changes, as the market's predicting. Really key with that is what happens to the deposit betas. In those rates down scenarios, I think we're pretty conservative in these numbers with betas in the low to mid-30% range. Whereas on the rates up side, we're now at 47%, and we model 53%, 54% on rates up. So something tells me you're going to see most banks probably be north of their model results on the rates downside, just given the nature and the fact that the deposit moved up so quickly. So with that, it would suggest that there could be potential upside on it. But again, under all of it is going to be what's going on with underlying customer deposit flows, right? So that's still the main driver versus beta, as I would suggest.

And hey, David, this is Chris. I'll add to the rate part of that discussion that between Tory and myself and our teams, we've already looking at the competitive market. We're looking at where rates are trending. I think they'll start to see us start moving potentially ahead of any sort of rate cut scenario and putting in place the long-term kind of more plan of if we get a rate cut and pick your month, what are we planning to do? So all of that's being laid out right now, and we should be launching that relatively soon here. But yes, just trying to get ahead of that aspect of it. I think you see the market is already kind of moving in that direction, so it'll just be a matter of historically can we follow or can we lead as we've done in the past, and that would be the ideal situation.

Okay that's helpful and maybe kind of just a follow-up to some of this just staying on the deposit side; in the prepared remarks it was alluded to some of the declines being attributed to small business declines. I'm curious maybe, what are some of the drivers of that from your standpoint? Obviously, there's some seasonality, but how much of it's activating deposits versus paying down debt, using cash to fund growth, or just less profitability at this point for some of the small businesses? And just curious, it's early in the first quarter, just curious, are you seeing things stabilize? And how do you think about core deposit growth going forward?

Yes, you got a lot in there, David. I would say the uses that you mentioned, absolutely, you’re seeing that completely across the board. You are seeing some small businesses that good operators have the ability to increase their prices and things of that nature, but for many of them, inflation is certainly taking a big impact and that goes across all items from products, service, to the employment inputs and things of that nature. We move into really kind of more of a seasonality type of situation in the first quarter as well. I would say we're in contact with the small business customers through our local presence, mainly through the branches. People are positive, but they're also, let's say, looking down the road for when something's going to take place that's going to provide them some relief. We haven't seen that quite yet. And I think Tory can speak to a little bit more onto the commercial side there.

Yes, David, this is Tory. On the commercial side, it's typical for the end of the year and the fourth quarter. One difference we've noticed is that some businesses are taking extra cash from their operating accounts and wanting to move it into interest-bearing accounts, which makes sense from their perspective. It's a usual way to use cash, such as for dividends, distributions, and tax payments. Some customers are also choosing to make investments using cash instead of borrowing. Overall, we've observed these typical behaviors over the past year.

Yes, and David I’d say Tory and I talked quite a bit about the momentum that's building and our team's getting excited about being out in the market, integrations behind them, and we're seeing new business start to come on with some of the other things that are going on out there. Now it's coming on at a higher cost than we've seen in the past, but we're driving those operating accounts, we're getting the full relationships with the focus and like I say Tory and myself see stories almost every day about somebody somewhere in the footprint bringing in a new name into the bank.

That's great. That's great. And I guess to that point, I'm curious on the C&I growth. Curious, where are you having success driving growth? How much of it's from client acquisition versus increased utilization or deeper relationships, or even the new hires that you've made. I'm just curious your appetite for growth and whether you'd expect C&I to be the key driver of loan growth going forward?

Yes, David, it's Tory again. Definitely C&I growth as the place that we will grow the lending side of the house with full relationship banking. So like we said, I think in very consistently, we're in eight Western states, great markets. We've got great people. They have very strong pipelines. We saw C&I growth, kind of, a mixture between new client acquisition, as Chris was talking about, plus lending to existing customers doing their normal course of business. So it was spread throughout the footprint. So there's not one place where I can say we got most of our growth. It was kind of spread throughout our footprint. And as Chris said, I mean, I feel very good about the pipelines and the activity that's occurring out in the field.

Okay, that's great. Thanks everybody.

Thank you, David.

Thanks, David.

Thank you. One moment please. Our next question comes from Timur Braziler of Wells Fargo. Your line is open.

Hi, good afternoon. Following up on the net interest income, net interest margin commentary, just with the expectation for deposits and funding to remain a source of pressure here in the near-term, and then the expectation for rate cuts in the back end of the year. Is there an outcome where NII inflects and grows in 2024 or is that more likely a 2025 event?

Well, Tim, this is Ron. Good question, and again, it's going to be really a function of the cost of that deposit growth. I could definitely see a scenario where you see a little on the lower end of the front end if we do continue to see pressure on non-sparing demand specifically within that guide range. But then once they start moving, again, I talked about earlier that deposit beta, I think that's pretty conservative. I would suggest most of the regional banks think their model betas on the rates down side, they're going to be closer to what they were on the upside. So you could see that scenario exactly where you get some pickup in the second half.

Okay. And then I guess, looking at the deposit costs and some of the December 31 spot rates. Is that a good ceiling here? Is that kind of where we expect the funding base to stall out, or is there going to be some more mix shift in the first half of the year to some of these higher cost categories, which could keep that lag around and costs for a little bit longer?

Yes. Obviously, it's an estimate, but we'd expect the lag to continue there. And that's probably why we showed the 47% beta to date, but we model the 53% on the rates up side. So you got that additional piece. We also have, in the past quarter, we had about $900 million of CDs repricing that were in that 12- to 13-month tenors. So they have been sitting there for a year. And those all repriced up close to 200 basis points. In the first quarter, I want to say it's around $650 million to $700 million of CDs maturing, which will reprice, but it will be less than $200 million, just given the timing of those compared to when the average raising rates earlier in '23.

Okay. And I guess what's the thought process of the rationale for maintaining all of those balances rather than being more aggressive with rates here and letting some of that money walk?

Just overall liquidity levels, where we feel comfortable sitting with cash on the balance sheet, just bringing cash at the Fed. And keep in mind, too, I mean, we've got an incredible amount of optionality, again, compared to the average regional bank with a little over half of our bond portfolio sitting on an unrealized gain. But then again, too, the goal will be to accrete that remaining discount up to par over the life of that book because that's all the government rate from that standpoint. So we've taken the approach of maintaining that flexibility, so we earn back that discount, which reduced capital a year back at the combination closing. By utilizing that, we utilize overnight or wholesale funding in that two to four month tenor to maintain that overall level of liquidity. We have reduced the overall level of on-balance sheet liquidity, where we were sitting up closer to $3 billion, early mid-'23, of in-spring cash. We've now taken that down into the, call it, 1.5 to 2 range. I can see that probably dropping a little bit more into '25, but probably not too much more.

Okay, great. Thank you. I'll step back.

Thanks.

Thank you. One moment, please. Our next question comes from the line of Brandon King at Truist. Your line is open.

Hey, good afternoon.

Good afternoon.

So I wanted to talk about leaning into those public deposits, could you just elaborate on the thought process behind that? And if you're able to achieve that just based off of rate or primary relationships? Just give the puts and takes there.

Hey Brandon, this is Tory. So we have a lot of existing customers in the bank that are municipalities spread throughout the footprint. Most of them are smaller rural communities, and we have strong relationships with them and just made a very significant effort to go out and call on that group and ask for more deposits in the bank. It says a lot about the capability of the teams, both in the branches and in commercial banking to have those relationships and to call on them to further deepen and strengthen those relationships. And that was the effort. It's that time of year as tax payments come in so they have more money in distributing it to us; we thought it was a really good idea.

And Brandon, I want to add that, as Tory mentioned, our local presence and collaboration is not solely about existing customers or minor price increases on some reserve funds. We are building full relationships. We're engaging with them regarding their operating accounts, which may lengthen the sales cycle, but we are already experiencing positive momentum with new clients, such as those seeking money market accounts who want to explore their operating accounts with us. That is when the relationship truly solidifies. As Tory mentioned, this is because our teams live and work in these communities, knowing individuals within public entities, building relationships, and actively seeking their business. With our capabilities and the new treasury management tools that have been implemented across our footprint, we are gaining attention and winning business, and that momentum is growing.

It's an excellent funding alternative that complements our operating account. With their surplus liquidity, we offer a different option to local government pools. This approach allows us to increase deposit balances without harming our core deposit base or affecting the overall pricing of our deposits. It’s a unique option we can utilize. However, it can create some confusion. In my earlier comments, I mentioned that this quarter's results don't fully indicate the strength of our deposit base. What I meant is that this is just a strategy we can employ, and the period when tax revenues are coming in for municipalities is an ideal time to utilize this strategy.

Got it. And just to follow up, could you quantify the amount of public funds deposits you have? Would you consider these deposits to be higher beta compared to some of your more core deposits?

I think we need to separate it because we have an operating relationship with almost all of these public entities. This will function more like a traditional part of our portfolio. Then there’s the alternative to the local government pools, and I believe Ron has the details you need.

Yes, we emphasize the trends on Page 17 of the earnings presentation. In total, we have $2.9 billion in public deposits, which is an increase of nearly $0.5 billion for the quarter. Of this amount, core operating accounts likely account for about 10% to 15%, with a maximum of around 20%, indicating a strong stable base.

Okay. Okay. And just lastly, Ron, I know you're working to kind of reduce asset sensitivity just given the potential for rates to come down. Are there any actions that you're considering or looking at that would make sense at this point to achieve that?

Yes, great question. It's really difficult on the derivative side just given pricing and expectations, but we took that shot, and we did that. You can see the trending there, too, on page 11 of the presentation, with how we reposition the portion of the bond portfolio in that first week post close back in Q1. Also, utilization of shorter-term wholesale funding, be it the broker deposits or Home Loan Bank advances, to help offset the deposit flows during the year. Those two items in and of themselves basically act as like a swap benefiting rate down because you're locked out cash flows on the portfolio, and you'll have fully floating cash flows on the right side of the balance sheet. That was really the majority of the change from a year back to now where in the past year back, we had a more traditional asset sensitive profile, and today, we're relatively neutral.

Got it. Thanks for taking my questions.

Yes, thank you.

Thanks.

Thank you. One moment, please. Our next question comes from the line of Chris McGratty of KBW. Your line is open.

Thank you for the question. Ron, regarding your expense guidance of $1 billion to $1.1 billion, could you share your thoughts on how the revenue environment might look at various points within that range?

Good question, Chris. Historically, the expenses that are directly linked to revenue would have been related to home lending in a different, much lower interest rate environment. You can observe seasonality throughout the year which leads to higher revenue in the second and third quarters, while the first and fourth quarters typically see lower revenue. Corresponding expense trends follow this pattern. Our outlook suggests that we do not expect significant decreases in rates that would lead to a substantial increase in home lending volume. Therefore, we anticipate that our net interest margin will remain relatively stable and be the main driver of revenue. Throughout the year, aside from any legacy home lending seasonality, we generally expect to see higher payroll tax-related expenses in the first two quarters, which will taper off in the latter half of the year. Additionally, we typically experience annual merit cycles at the beginning of the second quarter, which align with inflation rates, causing a slight increase followed by stabilization as the year progresses.

Okay. That's helpful. Clint, regarding capital, you noted that the CET1 ratio is 9.6%, which exceeds your 9% target, and the total is within 20 basis points. Can you clarify when the buyback might be discussed or announced? Is it contingent on reaching 12%, or do you need to build a buffer to that level? What are your thoughts on the buyback in light of the outlook?

Yes, achieving 12% is similar to the Fed trying to stabilize the economy; it's challenging to reach that level and maintain it. We would prefer to have a slight buffer before initiating the buyback, not a large one, but enough to ensure we can engage in a substantial buyback while still being above 12% after accounting for it. While I can't provide a specific timeline or figure, we have observed the brand's capital build over the past three quarters. The current interest rate environment, particularly with three rate cuts, offers us extra options beyond our current balance sheet and gives us flexibility, which could allow us to pursue a buyback sooner rather than later. However, we are likely discussing a timeframe of one to two quarters for this to occur naturally, considering a steady increase of 20 to 25 basis points in capital each quarter.

Okay. That's helpful. And then just a follow-up. Would that be the top use of capital beyond growing your business that you've talked about? Or is there an alternative use? I know you have the dividend that's pretty competitive, but inorganic growth at all on the table?

We are committed to maintaining our regular dividend, which is an important aspect for many of our investors. Tory mentioned the organic growth opportunities within our pipelines, and I’ve had the chance to talk with some of our market leaders recently about their prospects. The enthusiasm from our bankers regarding these opportunities is palpable. Even with strong capital generation, reasonable organic growth won’t surpass the ratios of regular dividends to organic growth. This provides us potential options for buybacks, or possibly considering a special dividend if necessary. Regarding inorganic growth, we seem to be in a period similar to mid-2020, where the M&A markets are quite stagnant. While some announcements have been made, they do not involve healthy businesses that would enhance our long-term value. However, we expect things to evolve over time, and we will look for opportunities. Given our company size and the eight states in which we operate, we don't see a lot of opportunities that would significantly impact us, so we will be very selective and disciplined in pursuing any inorganic growth options.

Great. Thanks for all the color. Appreciate it.

Thank you. One moment, please. Our next question comes from the line of Jeff Rulis of D.A. Davidson. Your line is open.

Thanks. Good afternoon. I wanted to clarify, is it safe to assume a loan growth expectation would mirror your balance sheet growth expectation of no growth to 3% or possibly outstrip that?

Jeff, this is Ron. Good question. Yes, ideally, over time, you want the deposit growth to match the loan growth. And that's our goal here over the course of 2024.

Okay. So loan growth at maybe no growth, I just want to kind of pare that up, Clint, with kind of the field and that getting us out there. Is there a point where you're kind of tamping down your loan officers on, hey, we got to true it up with deposit growth. I'm just trying to get the assumptions underlying pretty limited growth and kind of meet that with kind of the team and you're going on the anniversary of the merger close. I just want to kind of get the sense for feed under those folks and starting to produce pretty significant net growth.

Yes, it's a great question. It relates back to my comments on inorganic growth. We've emphasized being relationship-centric over the past few quarters. In the current environment, we are cautious about transactional real estate. Our commercial and industrial teams and small business bankers have the freedom to pursue opportunities, but every banker in the company understands the importance of building full relationships that include deposits. They won't fund dollar for dollar; that's not how it works. This is why we have a strong retail network with 300 branches to support funding. That's where I see the optimism. The integration is completed, the integration management office is closed, and the teams are ready to move forward aggressively. Tory, do you have anything to add?

Yes, Jeff, it's Tory. I would just maybe reiterate a little bit of Clint's comments around just the sales force and the bankers in the footprint. Their strong desire to grow market share to really manage what we have and keep what we have and continue to expand with what we have, but to grow market share. Sometimes it's a relationship that includes a loan and sometimes it's a relationship where there's no lending activity. With deposit only or deposit and core fee income, a relationship is very valuable and supports this local presence that Chris always talks about and this ability to grow their book of business. Our focus is definitely on the C&I side of the house. As you can see in the growth in real estate, it’s been flat and on purpose, and we're pushing on the C&I front. We've got a lot of great bankers and great markets that are out pounding the pavement and looking to bring in new names into the bank.

I appreciate it. I wanted to switch over to the credit aspect and specifically look at our expectations for FinPac. Reflecting on mid last year, we seemed to have some hopeful indications that trucking losses might decrease. However, it appears that those losses are on the rise again. Looking ahead to 2024, can we expect losses to remain in the 5% to 6% range for the year? Or do you foresee any trends that might lead to a significant decline?

Jeff, yes, I do not expect that this trend goes all through '24. If we look at the loss curves and really the vintages that have caused this pain, the vintages were really the last half of '21 and all of 2022. From a loss curve perspective, we're through all of '21, and we're about halfway through '22. I believe we will see at the end of the second quarter, those losses start to tail off at a more rapid way than they have historically. Don't forget, the fourth quarter is a tough barometer for collecting because of all the holidays that are during that quarter. FinPac is maybe a subsidiary of the bank and provides a valuable product set for the bank. But at its core, it's still a finance company, and a finance company, this type of activity and what we're seeing currently is not is not abnormal. If you go out there and survey our competitors, they're experiencing the exact same thing, even at a worse clip than we are. What is encouraging is that it is isolated to the trucking portfolio, and we do see the light through the data that we have, that there is an end in sight, and I do believe it will be halfway through this year.

Got it. Just to kind of get into that vintage, I appreciate the color there. That's the thought that as we moved into the back half of '23 and hopeful of a decline, was it that you got into some of those ‘22 vintages that were like, wow, this is also troublesome? Is that why sort of the extended?

Yes. As we came out of 2021, we noticed that 2022 showed some ongoing elevated loss characteristics. We had a sense that it would be a lengthy process to return to a 3.5% level. However, I can share that the early returns for the 2023 vintage are very positive, which is encouraging. The adjustments we've made to our model and criteria, particularly in the trucking portfolio, appear to be paying off in the 2023 vintage.

Great. And then one last one. Ron, I'll take another crack. I didn't really hear a response on the margin trajectory. I know it resides with deposit success. But I guess, put it more clearly, do you expect more compression in the first half of ‘24 versus the second half when you layer on potential rate cuts, your 3 basis points of cuts?

That's correct. Given our conservative estimate for the deposit betas, this will significantly influence our performance in a declining rate environment. I anticipate that our betas will exceed 30% on the downside, while they are closer to 50% on the upside. Ultimately, the basic customer deposit flows will play a crucial role, and we've had enough discussions on that topic so far. We'll see how it develops.

If we're talking $350 million, $360 million for the full-year, you may shoot to that midyear and then kind of coming up is sort of how you would trend on that?

If in that view over the course of the year, you saw a couple of rate cuts in the second half of the year, and we, like most banks expect that, that will perform on our deposit betas to the rates down side, yes, that's a true statement.

Thank you. One moment, please. Our next question comes from the line of Brody Preston of UBS. Your line is open.

Hey, good evening, everyone. Ron, I just wondered ask a few questions on NII. The $4.3 billion of loans that you have above floors, do you happen to know where those floor rates are?

They're sitting more than three cuts down. We'll have that detail into the next quarter's release, but they're definitely more than 3 cuts down.

All right. Would they be more than the forward curve down, the five or maybe six depending on the day?

I don't have that in front of my hands. But again, recall, going back over the last 1.5 years, 2 years, as rates were increasing, it was easily more than what, six cuts would be 100, 150 bps, is easily more than 150 bps ago that we started to slow down talking about loans going above their floors.

Yes, okay. I noticed that you shifted some of the borrowing base to BTFP this quarter. I think it was maybe $200 million of utilization. You still got a lot of FHLB lines. If I'm remembering correctly, those are pretty short from a duration perspective. I think there's like an 80-something basis point gap between the cost of your borrowings right now and what BTFP is. Would you consider shifting the rest of the borrowings to BTFP to help with the margin? And if so, is that contemplated in your guidance at all?

We are looking at that. It's not the full amount of the Home Loan Bank advances, just given the capacity at the BTFP, but we are looking at that here over the course of the first quarter.

Okay. Great. So if I look at the NII sensitivity slide that you all provide, it looks like in either up 100 to 200 down, 100, 200 kind of scenario, it's negative for NII and all but a couple of them as of December 31. I don't think you have a lot in fixed asset repricing. So if we got no cuts, maybe that kind of incremental deposit beta creep and lag that you've talked about would continue. I'm just struggling a little bit, Ron, to think about holistically, like what's the best rate environment that you could proceed just kind of looking at those pieces of the puzzle?

Yes, that's an interesting question. I would suggest that in anyone's interest rate risk modeling, if they are examining the difference between 0.7% and 1.1% and claiming there is exact precision in that, they are not being truthful. There are so many assumptions involved, including customer deposit flows and timing lags. Therefore, I consider those differences relatively neutral as long as they are within a point or two of each other, as I know that is generally the range you will encounter throughout the year.

Got it. And what is the NIB mix that's contemplated within your NII guidance? I'm sorry if I missed that?

Within the traditional NII guidance or interest rate sensitivity analysis, which is what this is, you generally assume a static balance sheet and then things repricing into themselves. Again, that's where I got to earlier, talking about within the range of the guide, if we're better on the deposit side then we're going to be on the upper end. If we're not, we're going to be on the lower end.

Okay. And then last one for me. Just if I take the pieces of your guidance, $48.5 billion of average earning assets, 3.55% on the margin and then factor in the expenses. If I do something just like last three quarters, average fee income assume that the run rate annualize it and grow it by low to mid-single-digit. It kind of implies like mid-780s on PPNR. Am I far off the mark there?

Brody, I don't have the calculator out in front of me to run through that math with you. I'd just ask, we're not providing inputs in the guidance on EPS. We're not giving an EPS guide, but there's other maybe specific questions that might help you on the modeling side. I highly suggest contacting Jacque. She's great and she'll set you straight.

Got it, thank you very much for taking my questions everyone.

You bet. Thank you.

One moment please. Our next question comes from the line of Matthew Clark of Piper Sandler. Your line is open.

Thank you for the questions. Brody, 780 is about where I am right now. My first question is regarding expenses in relation to the size of the balance sheet. If we reach the lower end of the average earning asset range at $48 billion, would it be reasonable to assume that noninterest expenses will also be at the lower end, around $1 billion instead of $1.1 billion?

There's potential for that. Obviously, we have efficiency improvements that we're working through as well. But there's also just enough uncertainty when you look into the year inclusive of inflation rates to say our target is going to be somewhere relatively in the middle of that, and there is downside, there's upside and see which way it plays over the year. But we wanted to just make sure we recognize that there is some level of uncertainty to timing and flow over the course of the year. So not giving a specific guide on that by quarter or the trajectory.

I'm just trying to maintain consistency between the balance sheet size and expenses. Should we strive for consistency?

There is a little bit of movement with the balance sheet size. But again, you also have changes in, say, for example, deferred loan costs, which are influenced by the balance sheet size or we get leverage within deposits per branch, which doesn't necessarily have an impact on expenses other than incentives. So it's just difficult to say with precision at this point.

Understood. Okay. And then regarding the increase in other noninterest expenses, it appears to have risen from around $38 million last quarter to approximately $45 million or $46 million, not counting merger charges. Is there anything unusual in that figure that we should exclude moving forward? I'm trying to get a better understanding of…

Yes, no. Good question. I take a look at Slide 13. Again, Jacque did a great job showing the movement in the bridge and a good chunk of those items inclusive of the FDIC special assessment, but a good chunk of those items are elevated and not expected to continue at those levels.

Yes, I know the FDIC, that's obvious. But I'm talking about in the merger. We're stripping all that out, I'm just talking about anything else beyond FDIC and merger charges?

Yes. If you look at Slide 13, you'll notice some items related to small equipment repairs and maintenance, particularly in the occupancy and equipment area. Additionally, there are items related to legal title and other categories, which we should highlight on the bridge.

Okay. Got it. Okay. Fair enough. And then back on the deposit beta outlook for kind of the remainder of the cycle. Did I hear you correctly that you're expecting the cumulative interest-bearing deposit beta to get to 53% at the peak? Is that what I heard?

That is what our models would suggest, but then again, recognize that those are models.

Understood. I want to clarify what I heard. Regarding the provision, I know it's a fluctuating figure each quarter, but it seems there's been a significant increase in reserve building. I see that classifications have risen slightly, but not significantly. Most macro models showed improvement this quarter, so I’m a bit surprised by the increase in the reserve build compared to the macro trends. How should we view provisioning moving forward? Do you think this is somewhat excessive? We anticipate higher charge-offs with normalization, but I'm trying to understand the reserve coverage and whether this provision might be somewhat high.

Yes. I mean, good question. I guess in terms of the models and the slightly worsened economic forecast, I mean, there are dozens of variables that go into CECL models and not simply just GDP or CPI rates. You also have things along the lines of vacancy rates or rent changes within various markets that we operate in, which factor into those. I would characterize it as just in total, across, again, those dozens of variables. They were just a little bit worse. But that just means they were a little bit better a quarter ago, and they're all a guess, right? They're all projections, which we factor in the models from that standpoint. Underlying trends, though, I'd refer back to Frank's comments earlier, right? We do expect we'll see some abatement on the FinPac side, and then the rest is going to be what's going on with the overall economy two or three quarters from now. Then more interestingly have those forecasts looking ahead over the life of the portfolio at those points in time. So if I have more specifics for you in that but that's what we're dealing with.

Understood. Okay. And then sounds good. I'll leave it there. Thank you.

Yes, thank you.

Thank you. One moment, please. Our next question comes from the line of Jon Arfstrom of RBC Capital Markets. Your line is open.

Thanks. Good afternoon.

Good afternoon.

Hey, just most of my questions have been asked and answered. But on Slide 9, the red bar and deposit pricing, just kind of looking at that over the last couple of quarters. And Ron, what do you think that bar looks like in the first and second quarter? I know there's a lot that goes into it, but I guess it's this rate of change in deposit pricing. I'm just if you could take a stab at what you think that looks like over the next couple of quarters that might help.

Yes, that's a good question. I would point you back to the spot rates we disclosed at year-end. Use those as a starting point when considering Q1. However, I should mention that the 36 basis points change noted on page nine was largely due to our decision made late in Q3 to take on broker deposits, which helped reduce our Home Loan Bank advances classified under borrowings. I wouldn't anticipate such a significant change again, but that will depend on our management of those balances throughout the year. This was a key factor behind the 36 basis points in Q4, specifically concerning interest-bearing deposits. I noted that the change in interest-bearing liabilities wasn't as pronounced because we shifted from slightly higher borrowing costs to similar costs in broker deposits.

Yes. Okay. Okay. Yes, that was kind of my next question. I wanted to ask about funding cost peaking, and I think you may be saying you're reasonably close on that. Is that fair?

Yes. I mean we, again, models, right? But they also assume generally a 2-quarter lag on the back end of that.

Yes, Jon, this is Chris. As I mentioned earlier, we're starting to see the market pull back a little bit. I can't say for sure if we're at the peak, but it seems like we might be close. I expect things to start slowing down compared to what we experienced in previous quarters. On the CD side, there isn't as significant a difference between the current rates and where we might be in a month or two. Given all of this, I believe the pace will definitely slow down. We'll see how things go since it's a fluid market, but the pace should slow down.

Okay. Okay. Yes, that was kind of my next question. I wanted to ask about funding cost peaking, and I think you may be saying you're reasonably close on that. Is that fair?

Yes. I mean we, again, models, right? But they also assume generally a 2-quarter lag on the back end of that.

Yes, Jon, this is Chris. As I mentioned earlier in the call, we're starting to see the market pull back a little bit. I can't say for sure if we are at the peak, but it seems that we might be close. I expect things to begin slowing down compared to what we've seen in previous quarters. Regarding some items on the CD side, there isn't a significant difference between their current rate and what we project could happen in a month or two. Considering all of this, I believe the pace will definitely slow down. We'll have to see how everyone else responds in this fluid market. Therefore, the pace should slow down.

Okay. Okay. Yes, that was kind of my next question. I wanted to ask about funding cost peaking, and I think you may be saying you're reasonably close on that. Is that fair?

Thank you. I'm showing no further questions at this time. I'll turn the call back over to Jacque Bohlen for any closing remarks.

Thank you, Valerie. Thank you for joining this afternoon's call. Please contact me if you would like clarification on any of the items discussed today or provided in our earnings material. Thank you.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.