Columbia Banking System, Inc. Q1 FY2024 Earnings Call

Welcome to the Columbia Banking Systems First Quarter 2024 Earnings Conference Call. Please be advised that today's conference is being recorded. At this time, I would like to introduce Clint Stein, President and CEO of Columbia to begin the conference call.

Thank you, Didi. Good afternoon, everyone. Thank you for joining us as we review our first quarter results. The earnings release and corresponding presentation are available on our website at columbiabankingsystem.com. 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 the disclosures contained within our SEC filings. We will also reference non-GAAP financial measures and encourage you to review the non-GAAP reconciliations provided in our earnings materials. With that, March 1 marked the 1-year anniversary of the closing of our merger. It was a notable milestone for our company for many reasons. Importantly, it provided us with a full year of data points for what was working well within the combined organization and allowed us to identify redundancies and inefficiencies that are a natural byproduct of large mergers. Our 1-year anniversary marked the conclusion of our merger integration phase and enabled us to start our operational effectiveness work. Armed with the observations and learnings over the first year, we made significant progress on identifying opportunities for improving our expense profile. During the first quarter, we reduced our head count by 91 FTE with additional reductions communicated internally of 142 for the month of April. The FTE reductions, combined with other expense savings enacted in the first quarter, represent annualized reductions of $18 million. These savings are reflected as of quarter end, not in the first quarter's normalized operating run rate of $286 million. The actions taken to date for the second quarter add an additional $25 million of annualized savings to the first quarter number. You've heard me say many times over the years that we target a top quartile level of performance across all financial metrics, and a lower cost structure moves us toward our goal and away from what has been, up to this point, average at best. The meaningful reductions to our associate base were done in a thoughtful manner, eliminating positions and retirement spanned all departments and levels of management, including the executive team, which is now 15% smaller. Over the past year, our leaders gained an in-depth knowledge of their teams, processes, and other factors, allowing them to identify areas for operational improvement. This full-scale review resulted in consolidated positions, simplified reporting and organizational structures, and an improved profitability outlook. We believe these changes will enable us to operate more efficiently while preserving the premier levels of service we provide to our customers. Associated cost savings will continue to be realized during the second and third quarters, with the full benefit of our actions reflected in the fourth quarter expense run rate we outlined in our March update. We expect to incur roughly $13 million in related restructuring expense in the second quarter, which will be fully mitigated by the associated expense reductions within the current year. Our organizational review resulted in a swift elimination of redundancies, but our work is not complete. Our process identified many longer-term initiatives to enhance operational efficiency and further drive franchise value. Columbia has always operated in a cost-conscious manner, and we will continue to seek out additional opportunities to optimize our performance from a revenue, expense, and profitability standpoint. I hope our actions year-to-date demonstrate that we are laser-focused on regaining our placement as a top quartile bank as we drive towards long-term consistent and repeatable performance. Upon completion of this initiative, our ability to reinvest in our people, our franchise, and our suite of products and services will remain intact. We believe these investments, along with a lower expense base, will continue to drive additional long-term shareholder value. And now I'll turn the call over to Ron.

Okay. Thank you, Clint. We reported first quarter EPS of $0.59 and operating EPS of $0.65 per share, and our operating return on average tangible equity was 16%, while the operating PPNR was $201 million. Please refer to non-GAAP reconciliations provided at the end of our earnings release and presentation for details related to our calculation of operating metrics. On the balance sheet, we had $200 million of loan growth and $100 million of deposit growth. For deposits, we had a decline in unsparing demand that occurred in January, but we're encouraged to see those balances flat for both February and March. Our net interest margin of 3.52% was within our estimated range of 3.45% to 3.60%, and the expected reduction from the prior quarter was driven primarily by the deposit shifts that occurred in Q4 and January. Our NIM increased to 3.55% in the month of March due to pricing reductions on wholesale and promotional fund. Our cost of inspiring deposits was 2.88% for the quarter. Within the quarter, this cost was 2.90% for both February and March but ticked down to 2.89% at the very end of March. Our projected interest rate sensitivity under both ramp and shock scenarios remains in a liability-sensitive position, and we expect our rates down deposit betas to approximate those experienced on the way out. Our provision for credit loss was $17 million for the quarter. We updated our commercial CECL models this quarter to better reflect historical and expected future losses. In 2023, the methodology for our combined company was structured to the historical Umpqua portfolio composition. The outcome was an increased volatility in our provision expense that wasn't characteristic of the granularity and quality of our combined commercial portfolio. Our recalibrated commercial models, which now integrate additional data and operating knowledge, have effectively reduced our commercial allowance for credit losses. It's important to note that the increase in our CRE and multifamily ACL is a response to the transient market conditions in Western downtown cores, where we maintain a minimal presence in our portfolio. Despite these adjustments, our overall allowance for credit loss remains robust, closing the quarter at 1.16% of total loans or 1.36% when including the remaining credit discount. Total GAAP expenses for the quarter were $288 million, while operating expenses were $277 million. We've reflected the FDIC special assessment as a nonoperating item in the press release. Of note, we had a number of one-off items in the quarter that benefited our expense level. Absent these, our normalized level of operating expense was $286 million. As a reminder, on the expense front, we expect to record a restructuring charge of approximately $13 million related to the efficiency initiatives that Clint discussed as nonoperating expense in Q2. And with respect to our regulatory capital position, our risk-based capital ratio has increased as expected in Q1. We expect to build capital above all long-term targets, which will provide for enhanced future flexibility. I'll close with our outlook for 2024 on several key financial statement items. These are consistent with those included in our early March investor presentation. Average earning assets are expected to remain in the $48 billion to $49 billion range. Our NIM is expected to remain in the 3.45% to 3.60% range, which includes stability in deposit balances. For discount accretion, we continue to expect $130 million to $140 million of securities rate-related accretion, $90 million to $100 million of loan rate-related accretion and $15 million to $20 million of loan credit-related accretion. We expect full year operating expense, including CDI amortization, to be in the $975 million to $1.025 billion range. With the cost savings that Clint discussed earlier, we expect our Q4 operating expense, excluding CDI amortization, to be in the $965 million to $985 million range on an annualized basis. We expect CDI amortization of $120 million for the year, with about $29 million in each of the remaining quarters of 2024. Merger-related expense of $10 million to $15 million and our effective income tax rate at 26.5%. With that, I will now turn the call over to Frank.

Thank you, Ron. The loan portfolio's credit performance continues to demonstrate the strength of our through-the-cycle underwriting process and discipline, together with the quality of our borrowers and sponsors. The trends we are observing in delinquency and nonperforming loans are consistent with the shift towards a more standard credit environment, which follows an extended period of outstanding credit quality. The $30 million increase in nonperforming assets this quarter, primarily attributed to our SBA portfolio and a single C&I-related property, is within expected parameters and reflects the dynamic nature of the credit landscape. After accounting for the government-guaranteed portion, the rise in nonperforming loans remains modest. Our vigilant and ongoing monitoring of the portfolio is augmented by focused reviews of specific asset classes, such as our multifamily and office portfolios. These detailed analyses have consistently shown no systemic issues across different industries, sectors, or regions. We have no delinquent loans in our multifamily portfolio and our office portfolio delinquencies remain extremely low at less than 50 basis points of the total office portfolio. Neither portfolio has had any charge-off activity. Net charge-offs for the consolidated company were 47 basis points annualized for the quarter, with 22 basis points attributable to the bank and 25 basis points to FinPac. We remain very satisfied with the quality of our granular and diversified loan portfolio, which is highlighted in greater detail in our investor presentation. I'll now turn the call over to Chris.

Thank you, Frank. For obvious reasons, deposits remain a key focal area for our teams this quarter. We adjusted how we evaluate and improved deposit pricing during the first quarter. A comprehensive review of exception and other pricing authorities resulted in tighter controls and a renewed discipline around deposit pricing. These changes directly contributed to the stability of our interest-bearing core deposit rates late into the quarter. We also reduced our promotional rates on money market and CD accounts, and the CD repricing impact in the first quarter was significantly lower than it was in the fourth quarter. Beyond our actions related to deposit pricing, the teams are also focused on bringing new relationships to the bank. Our branches are wrapping up a three-month small business campaign launched in early February, which contributed $225 million in deposit generation to our first quarter results and an additional $75 million to date in the second quarter. The campaign includes bundled solutions for customers without promotional pricing for special products. Additionally, 25% of the balances are noninterest-bearing. Total cost of funds for these deposits was 1.95%. In addition, we have seen an increase in our commercial card and merchant card activity from the increased referrals. These actions all contributed to a significantly slower pace of increase in our cost of interest-bearing deposits, which was 2.89% as of March 31, compared to 2.75% as of December 31 and 2.27% as of September 30. So the first quarter's increase was a less impactful 14 basis points compared to the 48 basis point increase during the fourth quarter. While these recent pricing and balance trends are encouraging, we expect continued declines in noninterest-bearing deposit balances during the second quarter due to seasonal pressures that include customer tax payments. Noninterest-bearing balances were down 3% on an end-of-period basis in the first quarter, but they were down 7% on an average basis due to seasonal declines late in the fourth quarter. The higher rate environment and inflationary pressures have contributed to noninterest-bearing balance migration over the past two years. With the Fed funds rate seemingly stabilized and given our proactive pricing discussions, we expect deposit pricing pressures to remain moderated when compared to 2023. However, persistent inflation continues to draw down customers' account balances, which may exacerbate the tough seasonal deposit flows we typically experience in the second quarter. That said, our teams are focused on generating new business to offset these headwinds, and their success will be key to continuing our deposit costs regardless of where we see any rate cuts from the Fed this year. Turning to the loan portfolio, relationship-driven growth remains our primary focus. Loan balances increased 2% on an annualized basis during the quarter. Commercial lines of credit and owner-occupied commercial real estate drove half of the quarter's expansion and were the primary drivers of the new originations. Lastly, on the loan book, I'll note that our customers had a number of projects in process, which resulted in construction drawdowns and the transition from construction financing to permanent financing during the quarter. This activity accounted for the remaining portfolio growth. Our bankers remain focused on the activities that drive balanced growth in customer deposits, core fee income, and relationship-based loans. And with that, I'll now turn the call back over to Clint.

Thanks, Chris. We're committed to optimizing our financial performance to drive long-term shareholder value. In line with our expectations, our total capital ratio has increased more than 100 basis points over the past year since we closed our merger with Umpqua. At 12% for the parent company, we are now at our long-term target. The bank remains modestly below at 11.7%, so we are on the cusp of all regulatory ratios exceeding our long-term targets. However, our TCE ratio was 6.6% at quarter end, and we would like to see that ratio grow closer to 8% before considering meaningful options for deploying excess capital. We still expect to organically generate capital well above what is required to support prudent growth and our regular dividend, providing us longer-term flexibility for additional returns to shareholders. This concludes our prepared comments. Tory, Chris, Ron, Frank, and I are happy to take your questions now. Didi, please open the call for Q&A.

And our first question comes from David Feaster of Raymond James.

You guys have been extremely busy since announcing the cost-saving initiatives. The cost savings have come through a lot earlier than I think we had expected. I was hoping maybe you could help us think through some of the initiatives that are in place and where you're reinvesting some of those savings? You talked about opening a few de novo branches. I know you're always looking for new talent and have had several announcements. And then just kind of how you think about that expense line trending over the course of the year? Would you expect to be fairly steady improvement or more heavily weighted towards the fourth quarter to get to kind of those targets? I mean you're already in the top end of the range right now.

Well, David, you ask a complex question, and there are several of us here who can provide insights. I'll start, and then Tory, Chris, and Ron will likely chime in. To begin, in my prepared comments, we had a year of running the company. We established the original organizational design in January of '22, nearly 14 months before we could operate the company together. At that time, we aimed to avoid making deep cuts that would directly impact our customer-facing areas. We also maintained some redundancy because, as you know, during any merger, especially one of this size where teams are integrated, some individuals will opt out. Thus, we thought it was wise to assess what was functioning well, what could be improved, and which leaders would help us progress. If we encountered processes that were ineffective, there would be opportunities to reengineer them and enhance our automation. This will be a gradual improvement, focusing on becoming better every day, which is what has been expected from Columbia over the years. The main effort to adjust our expense base began in the first quarter before we spoke about it publicly. We undertook branch consolidations and renegotiated various contracts at their renewal. Additionally, we initiated the FTE initiative towards the end of the quarter, along with announcing $25 million in annualized savings starting from the first of the month. Most of this effort will unfold and finish in the second quarter, but you will see a complete run rate from this initiative in the fourth quarter. That’s why we provided that number.

And David, this is Ron. Just one thing because you mentioned we've already achieved savings today. I would just reiterate, as we look back at Q1, we did have some one-off credits in the operating expense number that ended at $277 million. We paid the normalized number at $286 million. When you think about go-forward quarters, part of the savings will come in and that will end in the expected range of $965 million to $985 million of Q4 2024 operating expense, excluding CDI amortization.

Yes. So sitting here today with the numbers I threw out, it's $43 million annualized that's done. So if that helps you as you think about how to tune your model going forward.

Terrific. That's helpful. And then maybe just as we think about the margin, I think Chris alluded to it. One of the primary keys to the margin is going to be core deposit trends. So I guess I'm curious maybe your thoughts on core deposits and some of the initiatives you've got in place. It sounds like there were some really encouraging trends from that targeted deposit campaign, with $300 million of core deposit growth. I'm curious what else you are working on and maybe some other campaigns or initiatives that you're considering to help support core deposit growth, especially on the NIB front?

Yes, David, this is Chris. I won't provide all the details, but I can share some insights. The retail campaign demonstrates what can be achieved with just over 300 branches targeting the small business market. We'll take a short pause and look into the second quarter, where we'll likely announce another initiative similar to this. I'm also excited about the noninterest-bearing balances that we've seen coming in from this customer segment so far. As of last night, we have worked with around 5,300 accounts totaling $314 million in deposits. These accounts are either maintaining their balances or exceeding our average balance, and they continue to be added at a steady pace. We still have about five days to go. Regarding other aspects, we discussed in the fourth and first quarters the results related to CDs and similar products. We're observing a decrease in those maturing in the second quarter, as we previously mentioned. The rates as we enter the second quarter are lower, which is good news, as it opens up the possibility for us to reduce those rates throughout the year. While I don’t have specific details to share at this moment, we are planning to lower rates as we continue.

David, this is Tory. I want to just add a couple of things regarding the commercial side. We've identified several key areas where we have a lot of opportunity for deposit growth, notably our FinPac portfolio and our multifamily portfolio, which traditionally have been more transactional. We are putting plans in place to convert them into full-fledged banking relationships, so we feel very good about kicking that off and seeing strong results as the year progresses.

Okay, great. And then maybe just touching on credit more broadly. You talked about recalibrating the CECL model. Could you touch a little about what went into that and the methodology there? It looks like there is an increase of reserves on CRE and maybe a reduction a bit on commercial. But more broadly, it seems like FinPac has stabilized a bit. Curious what happened to the commercial credit which was a larger driver of losses? Also, broader commentary on what you're seeing on the credit front?

Yes, David, this is Ron. I'll start off on that front just in terms of the CECL models themselves. I would characterize it as a better reflection of the combined company's historical loss experience within the commercial. We have recalibrated those models to drive towards a reduction. You're right, it was a shift, lower in commercial given lower historical loss rates, and a bit higher in the commercial real estate categories. Again, those are based on economic forecasts for rents and vacancies in Western downtown cores, slightly deteriorating quarter-over-quarter. So not something we're seeing on the ground with our customers as given the portfolio composition. But it is one of the drivers of the CECL models. Frank, I'll turn over to you for the second half of that about credit loss in FinPac.

Yes, FinPac continues to perform as we expected. The losses have peaked. They are leveling out, and we expect that drop to occur sometime around the third quarter continuing through the year-end as we migrate back down to that 3.5%-ish run rate in charge-offs. We constantly do deep dives within that portfolio looking for patterns of any other systemic type activity developing within the portfolio, and we see that it's really not. What we are seeing is in particular, in the 61- to 90-day delinquency bucket—a key delinquency range—that feeds into nonperforming and eventually loss, we are seeing that decrease. So those levels are at the lowest we've seen in several quarters. This is encouraging that a lot of the work we did many quarters ago to tighten up underwriting standards and the model is working. I continue to be extremely impressed with the resiliency of our portfolio, especially in the multifamily and office verticals that many are focused on right now.

And our next question comes from Jared Shaw of Barclays.

Maybe looking first at capital, you've been able to grow capital really nicely and as you said, get your long-term targets. Does this provide an opportunity to maybe look at accelerating or seeing better growth on the loan side earlier than expected? Or is the outlook for earning asset growth really more market-driven than capital driven at this point?

Yes. From my perspective, it's more market-driven. We continue to see it's a psychological phenomenon with our customers, where some are using their own cash rather than borrowing at higher rates. So there's a little bit of cautiousness, keeping some dry powder using their own cash, waiting for opportunities. So it's more about demand at this time. We could see an influx of deposits might prompt us to look at ways of growing earning assets. But right now, we're focused on the loan-to-deposit ratios at a level that we’re comfortable with. We could see that go a little higher. We'd be comfortable with that. But we're not actively looking to grow the balance sheet. It's really about driving improved profitability.

No, same thing, obviously. This is Tory. I just think the pipeline has been steady over the last two or three quarters, but the mix has changed. We're seeing growth in C&I in the pipeline and a reduction in real estate, which aligns with our strategic direction. We feel positive about opportunities throughout the franchise to grow the C&I book.

Okay. And actually, as a corollary to that, your CRE capital concentration is now below that 300% threshold. Would you like to see that continue to trend lower? Or do you feel comfortable with where the mix of the loan portfolio is here and future growth will just be more dependent on the market?

I think, over the long term, you will see that drift down. Our C&I customers own real estate. We have relationships; some of our wealth management customers are in the real estate business. We're always going to be active in the CRE space. But I think the focus now is on relationship banking. The concentration will stay under that 300%, but there may be variability from quarter to quarter due to commitments that we have out there.

And our next question comes from Jeff Rulis of D.A. Davidson.

I wanted to chase down the loan and deposit growth expectations for this year. I think you've talked about relationship-driven loans and the moves you've made on the deposit side. But I'm trying to get a good direction of—is that kind of low single-digit growth for both?

Jeff, this is Tory. I'll start, and then Chris can chime in. I think that's well said, low single digits for both, with the focus on C&I. There are some quarter-round growth happening through construction project draws, but we're focused on the C&I side and its full banking relationships. We're aiming for operating accounts and noninterest-bearing balances, with strong core fee income pipelines.

Not on the loan side for my part, but on the deposit side, that's a good target. There are a lot of variables that could come into play. How long does inflation remain high will affect it. Our focus is on driving new relationships across the bank and keeping the costs as low as possible. Running promotions could drive deposits, but those wouldn't be right for our long-term strategic plan.

And one quick one on the margin. You kind of cautioned in the deck that maybe we haven't seen the cycle floor yet. It seems your guidance range, right in the middle of the 3.45% and 3.60%. I want to know if, if you were to pick that apart, you'd be on the lower side initially due to seasonality, but potentially trending towards the higher end as we go?

Yes, that's close. The bigger driver of where we end up in that range is based on core deposit flows. Seasonally, we usually see DDA outflows during tax time and then rebuild into Q3, so fluctuations within the range are expected.

And our next question comes from Ben Gerlinger of Citi.

I know that you gave quite a bit of color on the margin already, but the repricing of deposits clearly had a major impact this quarter. I know you gave guidance that repiping is much less than it was. Can you quantify what the yield might be over the next six months in terms of any specials or general pricing?

So Ben, this is Chris. As for the pricing aspect of it, yes, there are no plans for promotional types of pricing. It's about where we want to be in the market. Money markets reached around 5%, now down to about 4.15% to 4.3%. CDs peaked at about 5.25% and are down to 3.9% to 4.55%. We've talked about second quarters having a lower repricing of CDs, building back into the third and fourth quarters at rates higher than today, which could create a positive outcome.

We're in all those cities. All the dots you see on the map were there. We've been there. We put our first retail location in the Utah market last fall. We put our first retail in Colorado. Actually, we are opening two retail locations in the Phoenix metro market this quarter. The focus is on commercial banking, where it's branch-light model. It's different from what we have in the Northwest.

Ben, this is Tory. I think it's great that we've been in these markets for about 18 months or less, or maybe up to 2 years at most. And all three are operating profitably and very successfully. So we are excited about this strategy.

And our next question comes from Timur Braziler of Wells Fargo.

Looking again at the margin, I just want to see the 3.55% margin for the month of March. Is that fully accounting for the price reductions on wholesale and promotional fundings? Or does that trend higher as the effect fully kicks in and you get some moderate pricing pressures off that base?

That makes sense. The majority of those adjustments were in February. Looking at March itself, there were still reductions throughout the month, but the major impact occurred earlier.

Got it. And on core expenses, could you clarify what the tieback is from the $276 million core expenses versus the $286 million normalized that's been mentioned?

$286 million is definitely the number to use. It's just a handful of one-off items that happen to be credit-related.

Okay. Got it. And on the migration of credit on the SBA specifically, could you remind us the size of that portfolio and maybe some nuances about it?

It's about $600 million. They've historically been involved in large business acquisition financing, which is where losses have been centered. In a higher rate environment, that has an adverse impact. The guarantees on those credit obligations can run anywhere from 50% to 90%. The rise in nonperforming loans related to SBAs, if they go to loss, will generally be guaranteed, averaging about 75%. The remaining increase is due to a single credit in the C&I space that we are well-collateralized on. I expect this will likely be resolved within the next quarter or two.

Timur, this is Tory. I want to highlight a strategic shift in our SBA business. We have historically been a nationwide lender focusing on gain on sale. We've adjusted the focus of the SBA group to deal exclusively with referrals from retail and commercial banking customers of the bank. This change in business model will align with our full relationship banking strategy.

And our next question comes from Brandon King of Truist.

Could you please characterize the deposit outlooks you're still seeing? I believe some of the commentary is around inflationary pressures, but I wonder if some is also attributed to mix shift?

I think here early in the second quarter will be mostly tax-related seasonal declines, but the trends from Q4 carried into January, and we have seen stability in February and March.

Right, the shifts continue as customers look at how to manage their balances. We've seen money migrate into higher-earning accounts, or it's being spent for other uses.

Closer to three-quarters of what exits the noninterest-bearing accounts is reallocated into interest-bearing accounts. The rest has been largely spent on distributions, taxes, dividends, etc.

Yes, we track the renewal rates closely on our CDs. Renewals average about 87% to 88%, with somewhat of a variable tied to our rates at the time.

And our next question comes from Andrew Terrell of Stephens.

Clint, just quickly—the TCE ratio is targeted at 8% versus the current 6.6%. I'm curious about the change in approach and more focus on the TCE ratio now compared to the total risk-based capital we've discussed for a while.

It's a good clarifying question. It has been about 15 years since Columbia set its long-term target ratios. Early on, we had 12% total risk-based or 8% TCE. The focus has shifted slightly; our regulatory ratios aren't misaligned. The bank's capital is expected to move to the 12% level and TCE ratios should rise as well. We continue to monitor that and see it remain stable looking at AOCI. Enhanced capital is something we would pursue strategically when appropriate.

Understood. Appreciate the clarification. On the $14 million commercial loan charge-off this quarter, was that previously in nonaccrual?

No, during the quarter we witnessed a significant internal fraud discovered by a C&I relationship, leading quickly to bankruptcy. Given the nature, we decided to charge off the balance now and recover proceeds as we move through the process. For now, that's all I can discuss on the topic.

And our next question comes from Chris McGratty of KBW.

Clint, regarding the loans you don't view as long-term strategic, what is it about these loans? What would lead you to dispose of them?

That plays into the earlier question about CRE levels and where we see those over the long run. A checking account, a wealth management relationship, or anything of that nature would change how I view those segments. Those predominantly involve our multifamily division portfolio and the single-family residential loans. Our SBA focus is shifting to target existing relationships, converting them into banking opportunities. As market conditions improve, we will take a hard look at exiting non-performing assets from the portfolio. I think that's one of the things we talk about even internally. The normalized level for FinPac is about 3.5%. It's running, what? 5.5% or so. We expect that to come back but then it skews the overall bank number. Moving forward, we’ll do a better job to bifurcate where FinPac is at on a normalized level so you can see where the bank stands.

I'd now like to turn it back to Clint Stein for closing remarks.

Thank you, Didi, and thanks for joining us on this afternoon's call. We hope you have a good rest of your afternoon or evening, depending on where you're at. Goodbye.

This concludes today's conference call. Thank you for participating, and you may now disconnect.