Columbia Banking System, Inc. Q3 FY2024 Earnings Call

Welcome to the Columbia Banking System Third Quarter 2024 Earnings Conference Call. Please be advised that today's conference is being recorded. At this time, I would like to introduce Jacque Bohlen, Investor Relations Director to begin the conference call.

Thank you, Gigi. Good morning, everyone. Thank you for joining us as we review our third 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 I encourage you to review the non-GAAP reconciliations provided in our earnings material. We'll now hand the call over to Columbia's President and CEO, Clint Stein.

Thank you, Jacque, and good morning, everyone. Our third quarter activities and results demonstrate our commitment and continued progress toward regaining long-term top quartile performance. We grew core deposits even as we reduced their costs. We also completed the near-term initiatives we detailed in April, and we continue to reinvest in our people, systems and processes to drive our franchise profitably forward. When we spoke last quarter, I outlined the drivers of $270 million in merger to date gross expense reductions, and we fully achieved our target during the third quarter. Our operational effectiveness work eliminated redundancies and streamlined operations, making our organization more efficient. This work is enabling us to better serve our customers and our communities while enhancing long-term shareholder value. Our gross expense savings represent double the $135 million we outlined at the announcement of the merger. The merger to date net savings of roughly $213 million accounts for $45 million of franchise expansion and reinvestments made leading up to and shortly after the merger close as well as the additional $12 million of investments planned in the coming months and quarters. Our expense run rate in the third quarter was just below the expected fourth quarter annualized run rate we have consistently discussed since March. Planned reinvestments will continue into 2025. Our cost-conscious culture will support a reasonable amount of inflationary lift from this level. However, we will continue to remain diligent with resource allocation and work to find expense offsets for franchise reinvestment beyond the $12 million already earmarked. We believe our reinvestment dollars will support the continued growth and competitiveness of our company. We continue to remain an employer of choice for experienced bankers throughout our footprint. Our ability to attract top talent enabled us to enter and grow our newer markets like Arizona, Colorado, and Utah, while continuing to invest in long-established regions. Recent examples include establishing a team of seasoned private bankers in Colorado, commercial banking teams in Southern Idaho and Northern California, and a new market leader for Southern Nevada. In all cases, these new team members have spent their careers serving a broad range of customers ranging from families and entrepreneurs up through larger commercial clients within these markets. We opened our second retail branch in Arizona and announced a planned third location in Mesa to supplement the commercial teams that established our presence in the state three years ago. Subsequent to quarter-end, we have identified the site for our fourth Arizona office, and we'll provide more specific details on next quarter's call. We also continue to enhance our internal technology in support of our associates. We are piloting applications to improve efficiency, and we are onboarding 1,000 associates to an upgraded CRM tool. The third quarter also included a reduction in transactional loans and funding sources. Solid seasonal customer deposit growth and an intentional reduction in transactional real estate loans enabled us to reduce brokered deposits by 20% during the quarter. Although commercial loan growth was below our expectations, portfolio activity reflected healthy customer behavior, which Chris will cover in more detail. We are very optimistic for the future of our company. With the merger and integration behind us, activity throughout our organization is fully focused on driving balanced growth with new and existing customers, and we continue to win business every day. We're driving franchise value through relationship banking, and we will continue to opportunistically reduce our exposure to transactional loans and funding sources. We continue to remain laser-focused on regaining Columbia's placement as a top-performing bank that produces long-term, consistent, and repeatable results. I'll now turn the call over to Ron.

Okay. Thank you, Clint. We reported second quarter EPS of $0.70 and operating EPS of $0.69 per share, and our operating return on tangible equity was 16%, while the operating PPNR was $221 million. Please refer to the 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 maintained our target interest-bearing cash levels of approximately $1.5 billion. As Clint mentioned, loans declined $200 million in the quarter, driven mostly by reduced transactional loans and deposits in total were flat. Within deposits, we saw the seasonal increase in noninterest-bearing DDA, along with strong customer interest-bearing deposit growth and utilized the excess to reduce brokered deposits by $635 million or 20%, along with reducing term borrowings by $0.25 billion. Within investments, the increase in available-for-sale investments was market value driven as the bond market rallied during the quarter. The locked-out structure of the portfolio, combined with this rally led to the 50% reduction in our accumulated other comprehensive loss, adding $1.06 or 6% to our tangible book value per share. Overall, tangible book value per share increased 10% to $17.81. Our net interest margin was stable at 3.56% in Q3 and on the upper end of our estimated range of 3.45% to 3.60%. Our interest-bearing deposit costs declined to 2.95% for Q3. Given the Fed's 50-basis-point cut late in the quarter, it may help to compare the month of September to the month of June. Our month of September interest-bearing deposit costs was 2.90%, down 10 basis points from 3% in June. More importantly, the spot cost as of September 30 was 2.74%, down 26 basis points from the month of June. This represents a beta of 52% in a very short period of time. Now I want to thank all of our bankers and support professionals for their timely work with customers on reducing deposit rates. It was great to see the speed with which they worked, and it is reflective of a relationship banking strategy, where our customers bank with us for the value our bankers provide, not just rate. Absent any further Fed moves down, we expect continued reductions in our interest-bearing deposit costs in Q4, given the term structure on time deposit repricing and wholesale funding, along with continued expected reductions in wholesale funding balances. 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 up. Our slide deck includes enhanced repricing and maturity disclosure, including details on over $8 billion in customer CDs and wholesale funding that matures over the next six months. Our provision for credit loss was $29 million for the quarter. The portion related to our leasing portfolio declined again as expected this quarter to $16 million. Our overall allowance for credit loss remains robust, increasing to 1.17% of total loans or 1.34% when including the remaining credit discount. Total GAAP expense for the quarter was $271 million, while operating expense was $268 million. In Q2, we had the restructuring charge, along with the nonrecurring credit. So our operating expense of $268 million for Q3 was lower than the $270 million normalized level in Q2 and $287 million in Q1, reflecting continued achievement of our efficiency initiatives. The Q3 level, excluding CD amortization, annualizes at $957 million. Clint mentioned our reinvestment plans earlier, which will increase our quarterly operating expense, including excluding CD amortization into the annualized range of $965 million to $985 million. We expect continued annual inflation of approximately 3% on top of our expected Q4 exit range, inclusive of items such as the typical Q1 payroll tax increase, a 7% increase in health insurance costs, and the annual merit cycle for the end of Q1. We'll always work to find additional efficiencies to help offset these pressures and enable continued franchise reinvestment. Now I'll close with commentary about our regulatory capital position. Our risk-based capital ratios increased as expected in Q3 and are now all above our long-term target levels. We expect capital ratios to continue to build, which will provide enhanced future allocation flexibility. With that, I will now turn the call over to Frank.

Thank you, Ron. The stable performance of our loan portfolio highlights the strength of our through-the-cycle underwriting process, portfolio management, and the quality of our borrowers and sponsors. As we transition to a more typical credit environment after a period of exceptional quality, we observed a 22% improvement in 31 to 89-day delinquencies, reducing them to $67 million, following similar improvements in the previous quarter. The slight increase in nonaccrual loans and 90-plus delinquencies reflects normal business fluctuations and the migration of smaller credits affected by higher interest rates. Classified loans declined due to risk rating upgrades and a payoff during the quarter. Our proactive and detailed monitoring of the portfolio continues to reveal no systemic issues across various industries, sectors, or geographic regions. At the end of the quarter, there were effectively no delinquencies in our entire non-owner-occupied and multifamily portfolios with no charge-offs in either category. Overall, net charge-offs for the company stood at an annualized rate of 31 basis points for the quarter with the bank contributing 10 basis points and FinPac 21. As mentioned in previous quarters, loss activity within FinPac was anticipated to improve and did by approximately 20% this quarter, reflective of an annualized rate of 4.7%. We are pleased with this progress, but we are not finished. We remain very satisfied with the quality and directionality of our granular and diversified loan portfolio, which is detailed further in our investor presentation. It remains relatively predictable and boring, similar to waiting in line for a haircut. I'll now turn the call over to Chris.

Thank you, Frank. Customer deposit growth during the third quarter reflects continued success through targeted small business campaigns, expanding balances with existing commercial and new relationship customers. Customer deposit balances increased $602 million, enabling a 20% reduction in brokered deposits. Notably, core deposit growth occurred even as we reduced the rate on both deposits, both ahead of and following the Fed funds rate reduction in September. Our teams continue to lead with service, not price in their customer interactions. Our branches wrapped up their summer small business campaign in July, and we launched a new campaign in September that will run through the next several weeks. Through mid-October, our three highly successful campaigns have generated $600 million in new deposits, and account retention from the first two campaigns exceeds 99%. We are also seeing a related increase in cross-department referrals as we work towards additional needs-based solutions for our customers. As a reminder, there are no special products or pricing associated with these campaigns, and we would like to thank our bankers for their focus and attention in driving new relationships to the bank. Loan balances declined by $207 million during the quarter as we intentionally allowed transactional real estate balances to trend lower. Healthy customer activity, which includes business and property sales as well as project completions, also contributed to net portfolio contraction during the quarter. We continue to target a low single-digit level of loan growth in the current operating environment as our activities focus on relationship-driven commercial loans and the balanced deposit and core fee income growth that activity supports. Our core fee income pipelines continue to expand across all categories. Treasury management and commercial card income increased by 12% and 19%, respectively, for the year-to-date period. Income from Wealth Management is also up notably for the period as our teams continue to find opportunities following our transition to a new broker-dealer platform at the end of last year. Additionally, our trust team is benefiting from our new larger organization, handling more referrals and onboarding new relationships. While overall noninterest income remains a relatively smaller percentage of our total revenue, the favorable trends in our collective product and service income will drive incremental bottom line growth over time, helping to diversify our revenue stream while strengthening and deepening our customer relationships. I'll now turn the call back over to Clint.

Thanks, Chris. We remain committed to optimizing our financial performance to drive long-term shareholder value. Our bankers' activities and the organic runoff of transactional loans and funding sources drive us closer to optimal capital efficiency. As Ron mentioned, our capital position continues to build, and our ratios are expanding in line with our expectations. With a total risk-based capital ratio of 12.5% at the holding company and 12.2% at the bank, we are above our long-term targets of 12%. Our TCE ratio was 7.4% at quarter-end, up from 6.8% at June 30 as capital generation received an added lift from favorable AOCI changes. Our performance continues to demonstrate our ability to organically generate capital well above what is required to support prudent growth and our regular dividend, providing us flexibility for considering additional returns to shareholders. This concludes our prepared comments. Tory, Chris, Ron, Frank, and I are happy to take your questions now. Gigi, please open the call for Q&A.

Please enter your question in the Q&A box.

Just on the core margin, we had a Fed cut, obviously, late in the quarter. We gave us the spot rates on deposits, which is really helpful. But any color on kind of where your core NIM looks like at the end of September, maybe on a spot basis? Or just your kind of near-term thoughts on the core NIM given not only the rate changes but also your expectation for deposit flows?

Matt, this is Ron. Yes. On the NIM, I mean, we're not clear on the inflection point with the core up, but the bigger driver is going to be, again, deposit flows. I do feel good about the tailwinds we have with the $8 billion of CDs and wholesale funding that we laid out on that new table on Slide 20. But again, I think normalized deposit flows would be the key. Generally, in the fourth quarter, we see it flat to up slightly early in the quarter and then tailing off later in the quarter. This is, of course, long-term seasonal averages around property tax payments, year-end distributions, things of that nature. So we'll see how it plays out. But I feel good about the tailwinds, at least at this point.

Okay. And then just on the adjusted expense kind of annualized run rate guide, how do you feel about that range? Do you feel like you can hit the low end of that range here in Q4?

Yes, I do. And more importantly, as we look at that range going into 2025, we talked about the expectation for approximately 3% inflation on that. Generally, seasonally over the course of the year, your payroll taxes pop in Q1 and Q2 and come down a bit Q3 and Q4. Merit cycle is usually into Q1 looking forward. And the health insurance costs, of course, are throughout the year. But feel good about that. We know we've got quite a few reinvestments that are in flight. We'll continue to make additional reinvestments. But you're talking only a couple of million dollars a quarter annualized to get into the basically the midpoint of that range from what we're at now. So we're pretty close.

Okay, Clint. I know interest rates have recently increased, but we're approaching that 8% mark and you're above your desired level for regulatory capital. What are your expectations regarding the potential for stock buybacks? Should we anticipate this mid next year, or could it happen sooner?

We are in ongoing discussions with our Board about this matter. As you mentioned, we are above the regulatory requirements. The 8% on TCE serves as more of a guideline rather than a strict minimum, unlike the 12% we consider for total risk-based capital. As we indicated when announcing the merger, our focus has been on capital generation and its utilization, aiming for a capital return story for shareholders. I believe that by 2025, we'll be in a position to move forward with that. However, it's still too early to determine the exact timing. Rest assured, we are actively assessing the situation internally.

I wanted to start on these small business campaigns. You have experienced significant success with this. Retention has been very high. I'm curious whether these campaigns have been targeted at specific markets or geographies, or if they have been more broad-based. Do you see more opportunities here for additional campaigns? Also, how can you deepen the relationship with your existing customers and continue to drive growth in both loans and deposits?

Yes, David, this is Chris. Thank you for the question. As we have discussed before, the success has been broad-based, spanning all markets with widespread participation. Every segment in our campaigns has seen positive results. This success is tied to our relationship strategy, as we focus on building new connections by engaging with people, communicating what we do, and showcasing the value our bankers provide daily to these relationships in a community banking manner. What's particularly notable is the strengthening of our relationships with merchants, corporate card clients, and wealth management referrals, alongside treasury management referrals. These targeted businesses present significant growth potential for us. We are also discovering larger opportunities that are being referred to our commercial bank, and we have some excellent partnership examples. Our team is effectively collaborating to secure more substantial relationships. Overall, our approach remains consistent and straightforward, utilizing all available products and services to meet customer needs. This strategy has proven to be highly effective, and we couldn't be more satisfied with the results. Looking ahead, we plan to take a brief pause around mid-November to allow everyone to recharge, and I anticipate we will launch something in the first quarter of next year. This effort is more about establishing a way of doing business than running a campaign.

That's great. You've also been active with your expansion plans, particularly in hiring and growing your branch network. You mentioned this in the prepared remarks. How do you see opportunities moving forward? Arizona seems to be a focus given the branches you're opening there. However, looking at the branch maps, Colorado, Utah, and Nevada also appear to be attractive opportunities, especially with the new hires. What are your thoughts on de novo expansion opportunities, the areas you're focusing on, and whether organic growth is the best approach? Or could mergers and acquisitions serve as a means to support the organic expansion you're pursuing?

David, it's Tory. I'll take the first part of that and then let Chris and Clint kind of weigh in at the end of it. We have basically, for I would say, de novo markets over the last 1.5 years or so. You've got Utah, Colorado, Arizona, and then a little bit in Northern California and just kind of a specialty team that we've hired into the bank and then kind of put the branch system around it, some private banking folks around it to kind of fill in this full relationship banking. One of the great things about the company is really our ability to attract talent into the organization, as Clint mentioned earlier. Folks want to be here and want to work here and find this place to be a great place to be successful. In all of those markets, the de novo markets, we've been profitable within a year, and they're starting to drive some really nice balances and some growth in relationships. A prime example is our wine team in Northern California; they've got about $17 million in outstanding loan balances and about $95 million in deposits. So just a really nice mix for the company and some really nice strong relationships. And we see that in all of our de novo markets. So we'll continue to kind of infill on that and to grow as we are presented with the opportunity to get the right talent into the company continuously. Another real important market for us on the expansion plan is going to be Southern California. It's just tremendous density in Southern California. We've got some really good strong teams there today, and we've been very successful, but we will continue to invest in the market and grow in Southern California as well. So I think there is a really good opportunity just organically for us to continue to invest in those markets and to grow quite nicely.

Yes. And I'll jump in on the back half of that question. As usual, David, you pack a lot into your questions. But from an M&A perspective, our focus is really getting the most performance we can out of the company that we're running today. And we're very excited about the opportunities that we have. And as Tory mentioned, those de novo markets, but even our long, well-established markets, I mean, we continue to win new business every day and take market share from the larger banks. And so there's a lot of enthusiasm around what we can just do on an organic basis. The M&A front itself, we should talk next quarter. There's quite a bit of election activity going on, and whatever the outcome is, it will have an impact on a bank of our size. And so as we get greater clarity on that, as we get greater clarity on where the Fed takes interest rates and how that looks, our thoughts might change. But right now, that focus is truly on getting the most that we can out of the company that we're running.

Okay. That makes sense. And then maybe just staying on the organic growth side. I mean, look, we've talked in the past about the pipeline that your bankers have and the momentum that it seems to be picking up. It hasn't necessarily materialized yet as payoffs and pay downs have been a headwind and some of the strategic runoff in the CRE book. But I'm curious how the pipeline is shaping up? Where you're seeing the most opportunity as you think about that low single-digit pace that you talked about and just the competitive landscape on the growth front from your seat?

Dave, it's Tory again. The pipeline has been pretty stable and steady over the last several quarters. We talked previously about the total pipeline staying about the same, but the mix changing from the real estate pipeline being down a little bit in the C&I pipeline up a little bit. That continued even into this quarter. And the overall number is about the same. And it's a nice, healthy loan pipeline spread throughout the company. So I feel really good about continuing a low to mid-single-digit loan growth number and kind of core relationship banking, excluding some of the transactional rundown in real estate that we'll see a little bit of as we continue to go forward. There's a very nice pivot in the company of moving away from transactional into full relationship banking. So the lending piece is just one part of it and going back to even Chris's comment on small business campaigns of bringing small business relationships into the bank, deposit, loan, and fee income relationships into the bank. So when we look at the pipeline, the fee income pipeline is very strong and healthy. Chris mentioned a couple of statistics on just some growth we've had in treasury and other parts of the company, and we'll continue to see that because the bankers are doing an exceptional job focusing on all different parts of a relationship to bring into the company as we look at value to our customers.

Just a follow-up on loans. Chris, can you talk about how large that pool of transactional loans is that you're looking to reduce?

Well, I think we've previously talked about between multifamily and single-family, it was approximately $6 billion on the balance sheet that didn't have relationships attached to them. And bankers are working to try and generate relationships. That's not always the easiest thing to do, but that gives you kind of a marker that's out there. They come due over time. So it's not anything that happens tomorrow by any means, but it's always under evaluation.

It seems like it was a significant prepayment quarter for you. Is that solely due to that, or is there something else happening?

Yes, this is Tory. I want to add a bit regarding that matter. We had a significant commercial and industrial loan that was paid off. The customer, who we had a long-standing banking relationship with, sold their business and received a substantial payment, which allowed them to pay us back. This was an unusual occurrence compared to our usual experience, but it was a considerable amount. This also contributed to the overall situation.

Yes. Okay. That's helpful. Good. Ron, on Slide 21, it's a good slide of balance sheet optimization slide. What do you want us to take away from the slide, and what could make this more likely to happen?

My takeaway from this is to recognize that these two items together are challenges in the current lower rate environment, but they will be relatively neutral. We see this as non-relationship focused. Consistent with our strategy moving forward, we expect to have significant options in the future as rates decline, allowing us to reposition parts of the balance sheet and reallocate capital towards ongoing organic growth and reinvestment opportunities. I'm highlighting this as the challenge it presents today. Ideally, in the future, we will be able to address it as rates decrease. Over time, these will naturally decline based on scheduled amortization, and at some point in the future, we will have the opportunity to reduce this portion of our debt.

Okay. So nothing imminent, but just flag unit. Okay. And then just a follow-up on the small business deposit campaign. You said that's really not rate driven. But what kind of pricing on those new deposits are you offering?

It's simply our regular posted rates. There's a range from the mid-3s to upper-3s, and some CDs may still be around 4, but overall, it's just our posted rates with nothing special attached.

I was hoping to dig into maybe just some of the loan yield repricing dynamics. The core loan yield up kind of 6 basis points this quarter was maybe a little better than I expected, especially given the move or the leg down we saw kind of mid-quarter in SOFR. So I guess it kind of implies that some of the repricing dynamics of the fixed rate or adjustable rate is a bit better than I was thinking. Can you maybe just talk through some of those dynamics over the next few quarters, how much you have kind of coming up its fixed rate, adjustable and the incremental spread do you think you can get on those loans?

Yes. Those were excellent questions. I want to emphasize Slide 20 of our investor presentation, where Jacque assembled all the relevant information regarding our loan portfolio, including fixed maturities, floating repricing, and adjustable repricing over different periods. This will give you a clear view of our performance over time. Additionally, I want to reiterate the significance of the $8 billion in wholesale funding from brokered CDs and term advances at the bottom of that table, which indicates lower repricing opportunities in the upcoming quarter, excluding any influences from the Fed.

Yes. If I'm interpreting this correctly, in the 4- to 6-month timeframe, there’s about $50 million of fixed and adjustable repricing. Does that seem like a reasonable estimate on a quarterly basis? And what kind of spread increase can we expect from that?

Spread pickup just in terms of as those reprice?

Well, this is Tory. I'll address the new loan side. The new commercial production varies depending on asset type, loan type, geography, and other factors. It is generally between the mid-7s to mid-8s for new loan activity. This figure has been gradually increasing over the past few quarters but remains relatively stable.

Yes. And just from a repricing standpoint, they'll continue to move higher. Just even as rates come down, the spread, of course, depends on the loan type, which are mixed throughout those categories. But we'll see continued repricing higher from that adjustable bucket.

Got it. Okay. And if I could just shift gears a little bit. I appreciate all the commentary around capital as well as the discussion around the buyback. I'm just curious, as you kind of have conversations with the Board and you contemplate incremental capital deployment from here, you obviously also earmarked a couple of portfolios of loans that are discontinued or kind of running down over time. I guess as you think about the buyback, is the other contemplation potentially early exit of any of those kind of loan pools? And how do you compare and contrast the attractiveness of the two?

In my prepared remarks, I was general regarding capital alternatives and didn't specifically mention buybacks. However, that's certainly one option we can consider in terms of exiting those transactional portfolios. As Frank mentioned, the credit situation is very stable, and we have no concerns regarding the credit quality of these portfolios. When we first identified these in March, they created an earnings headwind due to the differences between the rates on our wholesale funding and the yields on these loans. Although rates have come down and the earnings headwind is easing, it still exists. If we were to assess the market price, we would likely find it priced below par, with a payback period longer than what would be reasonable given the expectation of further rate decreases. If our deposit growth continues and we can replace our wholesale funding with strong core customer deposits, there may not be a need to take drastic actions. This would improve our operating ratios and free up some capital. We're comfortably above all our regulatory ratio targets and heading in the right direction on a tangible common equity basis. Thus, there is no urgent need to make changes, and with no credit concerns in these portfolios, the best approach for long-term shareholder value is to wait it out and either let the loans amortize or decide on selective exits when rates reach a favorable level.

Thank you. At this time, I would now like to turn the conference back over to Jacque Bohlen for closing remarks.

Thank you, Gigi. Thank you for joining us on this morning's call. Please contact us if you have any questions, and have a good rest of the day. Bye.

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