Columbia Banking System, Inc.

Ladies and gentlemen, thank you for standing by and welcome to Columbia Banking System's second quarter 2020 earnings update. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session through both the telephone and web. Instructions will be given at that time. If you are on the telephone and should require assistance during conference, please press star zero as a reminder. This conference is being recorded. I would now like to turn the call over to your host, Clint Stein, President and Chief Executive Officer of Columbia Banking System. Please go ahead.

Thank you, Myra. Good morning, everyone, and thank you for joining us on today's call as we review our second quarter results, which we released before the market opened this morning. Our earnings release and investor presentation are available at ColumbiaBank.com. I'm extremely proud of our talented bankers who have demonstrated their unwavering commitment to each other, our clients, and communities through one of the toughest quarters in the history of banking. Because Columbia Bank had a well-developed and tested pandemic plan at the ready, we've been able to focus on growing our business, stand up new lending programs as part of the CARES Act, and pledge $1 million to support communities through our Pass It On and COVID-19 Community Relief campaigns. COVID-driven changes to our operating model have resulted in minimal disruption, and I'd like to recognize that this is in large part due to the expertise and tenacity of our business continuity and crisis management teams. The individual that leads this team is military trained and has over 15 years of corporate business continuity experience. Her guidance and leadership in executing on our pandemic plan has allowed the entire executive team to remain outwardly focused on managing and growing the bank. The pandemic and resulting economic turmoil has magnified the focus on credit within our industry. At Columbia, we have always taken an active approach in assisting clients through full economic cycles. While the pandemic is beyond typical, we have experienced bankers with thorough knowledge of our clients' businesses. We believe this gives us a competitive advantage over most community banks. The strength of our capital position provides us the flexibility to help our clients and communities recover from the economic effects of the pandemic. Like most banks, we are managing a surplus of liquidity, and while this has negatively affected our net interest margin, net interest income is relatively stable even in light of the Fed's March rate cuts. On the call with me today are Aaron Deer, our Chief Financial Officer, Chris Merrywell, our Chief Operating Officer, and Andrew McDonnell, our Chief Credit Officer. Following our prepared remarks, we will be happy to answer your questions. Let me remind you that we may make forward-looking statements during the call. For further information on forward-looking comments, please refer to our earnings release, our website, or our SEC filings. At this point, I'll turn the call over to Aaron.

Thank you, Clint. Second quarter earnings of $36.6 million and EPS of $0.52 were an increase of $22 million and $0.32 respectively on a linked quarter basis. After factoring out the significant provision expense of $33.5 million, quarterly pre-tax, pre-provision earnings of $78.3 million were our best quarter on record, which was $14.2 million higher than the prior record set in the second quarter of 2019 and up $18.9 million on a linked quarter basis. The increase was primarily due to the gain on the sale portion of our Visa Class B Restricted Stock and subsequent write-up of the remaining shares, which together contributed $16.4 million to pre-tax income. We also recognized an $875,000 gain on the sale of the loan that had been previously charged off. Net interest income for the second quarter was $121.9 million, A decrease of $571,000 on a linked quarter basis. The drop was due to the early path of three investment securities in the first quarter, which added $1.9 million of non-recurring income to that earlier period. Meanwhile, second quarter interest income was negatively affected by the full quarter impact of the March Federal Reserve rate cuts, which were largely offset by interest earned on PPP loans. Interest expense declined significantly during the period as short-term borrowings were replaced with lower cost deposit funded. The net interest margin of 364 represented a drop of 38 basis points on a linked quarter basis. Excess liquidity from record deposit inflows as well as lower yields on loans and investment securities caused by the rate environment contributed 13 basis points and 11 basis points of the decrease respectively. The addition of lower yielding PPP loans proctored by four basis points and the margin dropped by eight basis points due to a one-time prepayment fees in the first quarter combined with increased premium amortization in the second quarter on investment securities. The remaining two basis point decline was due to balance sheet mix. Our cost of deposits continued to be industry leading at seven basis points, which was down seven basis points on a linked quarter basis and 13 basis points compared to the second quarter of 2019. Total deposits ended the quarter at 13.1 billion up $2.3 billion during the quarter. Approximately 60% of this increase was concentrated in non-interest-bearing demand deposits, which rose by $1.4 billion, or 26%. At June 30, our loans totaled $9.8 billion, with PPP loans accounting for about 10% of that. Our loan-to-deposit ratio was 74% at quarter end. Chris will give more color on the drivers behind those balance sheet trends in a moment. Given the very strong deposit inflows and excess liquidity, we are starting to deploy more of the funds that we expect much of the PPP money to be depleted over the coming months and could see other outflows as well. So we're taking a very cautious and incremental approach for our new investments. Non-interest income of $37.3 million was an increase of $16.1 million from the prior quarter. due to the aforementioned $16.4 million gain on Visa stock and $875,000 gain on the loan sale. This was offset by a reduction in overdraft fees of $1.1 million. The decrease in overdraft fees is attributed to higher deposit balances as well as lower transaction volumes due to the shelter-in-place orders. Non-interest expense was $80.8 million in the second quarter, which was a decrease of $3.4 million on a linked quarter basis. The change was principally due to an $8.8 million reduction in compensation and employee benefit costs stemming mostly from the capitalization of loan origination costs from the PPP loan program. This was partly offset by $3.6 million of systems, legal and professional, and various other costs, much of which were incurred to respond to the pandemic and set up the PPP program. In addition, the provision for unfunded loan commitments included in other non-interest expense increased by $1.8 million. Our non-interest expense ratio fell to 2.13% for the quarter, while our operating efficiency ratio dropped to 54.9%. We expect our quarterly non-interest expense run rates to return to the mid-80s for the balance of the year. Our effective tax rate for the quarter was 18.3%, which compares to 18.1% on a linked quarter basis and 19% for the second quarter of 2019.