Columbia Banking System, Inc.

This is the operator. Today's conference is scheduled to begin momentarily. Until that time, your lines will again be placed on music hold. Thank you for your patience. Thank you. Thank you. Ladies and gentlemen, thank you for standing by. Welcome to Columbia Banking System's second quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. If you are on the telephone and should require assistance during the conference, please press star zero. As a reminder, this conference is being recorded. I will now turn the call over to your host, Clint Stein, President and Chief Executive Officer of Columbia Banking System.

Thank you, Raquel. Welcome and 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. The earnings release and investor presentation are available at ColumbiaBank.com. Second quarter performance was outstanding as we continued to build upon the momentum generated by remaining open, and externally focused over the past 17 months. Excluding PPP, our teams generated record quarterly loan production exceeding $600 million for the first time in our history and shattering the previous record set in the fourth quarter of last year. Moreover, deposit inflows remained robust and well above our expectations. Our financial services group and trust company are having a breakout year and credit quality is exceptional. Making a great quarter even better, we announced our entrance into the Northern California market with the signing of a definitive merger agreement with Sacramento-based Bank of Commerce Holdings. Our success this quarter was due to the forward focus of all of our employees. Throughout the pandemic, we remained safely open and available to existing and prospective clients. Our bankers continue to cultivate relationships and win new business by deploying their solutions-based approach to meeting individual client needs, and the benefits of their efforts over the past year are evident in our year-to-date balance sheet growth and earnings performance. On the call with me today are Aaron Deer, our Chief Financial Officer, Chris Meriwell, our Chief Operating Officer, and Andy MacDonald, our Chief Credit Officer. Following our prepared remarks, we'll open the line and take your questions. As a reminder, we may make forward-looking statements during the call. For further information on forward-looking comments, please refer to either our earnings release, our website, or our SEC filings. At this time, I'll turn the call over to Aaron. Thank you, Clint, and good morning, everyone. During the quarter, Columbia generated net income of $55 million, or $0.77 per share. Adjusted for $510,000 of acquisition-related costs, pre-tax, pre-provision income of $66.3 million was one of our best quarters on record. The strong performance was driven by solid fundamentals. Earning assets increased, our cost of deposits remained among the best in the industry, and non-interest income was, again, a solid contributor. Total deposits increased by $578 million, or 16% annualized during the quarter, to $15.3 billion at June 30. Our cost of deposits held steady at just four basis points. Total loans increased modestly to $9.7 billion at June 30th. Net of PPP, our loan balance has increased by $219 million, or 10% annualized, and surpassed $9 billion for the first time in our history. The increase was driven by record production. During the quarter, we originated $657 million of new loans, which includes $52 million of PPP loans. New loan production, excluding PPP, was brought on at an average tax-adjusted coupon rate of 314, which compares to the overall portfolio rate, also excluding PPP, of 390. Our investment securities portfolio was $6.2 billion as of June 30th, which was a linked quarter increase of $718 million, driven by $942 million of purchases. During the quarter, we transferred securities with a fair value of $2 billion from the available for sale classification to the held to maturity classification. Because the intent is to hold these investments to maturity, the securities are no longer subject to valuation adjustments connected to interest rate changes, and that should reduce the related volatility in equity and book value. The net interest margin decreased 15 basis points linked quarter to 316, However, net interest income increased by $1.5 million linked quarter as we deployed more of our deposit growth into loans and investment securities. The deposit inflows and larger investment portfolio were key factors behind the margin pressure in the quarter, as higher securities balances and lower yields on those balances together contributed 10 basis points to the margin decline. The remaining decline was primarily due to a reduction in loan yields. mostly due to a drop in amortized fees from the PPP portfolio, but also from lower coupon rates on new loans. Noninterest income was down slightly on a linked quarter basis to $22.7 million. The drop was centered in loan revenue stemming from lower mortgage banking income, but most of that pressure was offset by strength in other business lines. Notably, card revenues, mostly driven by interchange fees, increased by $1 million, while financial services and trust revenue rose by $864,000 and deposit and treasury management fees increased by $343,000. Non-interest expense of $84.1 million included professional services costs of $510,000 related to the pending merchant's bank of commerce transaction. Excluding these acquisition costs, non-interest expense of $83.6 million was essentially flat when compared to the first quarter. Compensation and benefit costs increased in the first quarter mostly due to higher capitalized loan origination costs in the first quarter when compared to the second quarter. That said, even in the second quarter, we continued to benefit from a high level of capitalized loan origination expense. Meanwhile, the other expense line decreased in the first quarter due to $1.3 million of less provision for unfunded commitments. Lastly, the provision for income taxes increased $2 million on a linked quarter basis to $14.5 million, representing a 20.9% effective rate. We continue to expect our 2021 tax rates to remain in the range of 19% to 21%. With that, I'll turn the call over to Chris. Thank you, Aaron, and good morning, everyone. Throughout the economic turbulence of the past 17 months, we have focused on what we can control in order to take care of our employees, clients, and communities. We continue to invest in our people, relationship training, and banking systems. Our bankers have responded by keeping the pipeline full and providing custom solutions to meet the needs of existing and new clients. Following this business-as-usual mindset positioned us to capitalize on high-quality credits and win new business during the quarter. While still in the background during the second quarter, the pandemic is no longer the lead story. The bank continued to originate PPP loans through the program's end on May 4th, and in the final tally for both rounds of PPP, approximately 9,300 loans were originated, which infused over $1.5 billion into the Pacific Northwest economy. Forgiveness for both rounds is now underway as the Round 2 platform opened for our clients on July 7th. Net of unearned income PPP loans were $692 million at the end of the second quarter. We have received over $820 million of payoffs and paydowns related to round one of the program, and we have received over 2,000 applications for forgiveness of round two loans since the portal opened. As Clint noted, excluding round two PPP loans, we achieved a new loan production record of $605 million. which was notably higher than the prior quarter record of $468 million set during the fourth quarter of 2020. Production was especially strong in CRE, and CNI was diversified with good growth in real estate lending and leasing, healthcare, construction, and the agriculture sectors. Line utilization was flat at 44.6%. but we saw absolute dollar increases in CNI and construction lines. Excluding PPP, the quarterly production mix was 58% fixed, 34% floating, and 8% variable. The composition of the loan portfolio remained relatively unchanged, and the overall portfolio mix is now 7% PPP loans, 49% non-PPP fixed, 33% floating and 11% variable. As was mentioned, deposits grew by $578 million during the quarter and by over $2 billion over the past 12 months. The quarterly inflows were split between non-interest and interest-bearing with the majority from business customers. Over half of the increases from new accounts, with the remainder attributed to delayed spending and investment by existing business clients and consumers. Approximately 60% of the quarterly increase came from our Puget Sound region, with approximately 35% from Oregon and the Columbia Gorge clients. The deposit mix increased slightly to 61% business and 39% consumer. We continue to drive exception rates down, maintaining our industry leading costs of deposits. Although residential mortgage activity slowed on a linked quarter basis, other fee income categories were up during the quarter as we benefit from our relationship focus and higher quality referrals. CB Financial Services and Columbia Trust Company have both had a tremendous year, achieving record revenues and assets under management. Card revenue was up $1 million on a linked quarter basis and deposit service fees increased by $343,000. As part of our ongoing branch rationalization process, we recently announced the consolidation of three branches scheduled to occur during September and October of this year. We are continually optimizing our delivery strategy and have been proactive in consolidating branches over the past decade. expanding each branch of service coverage area given local market conditions and projected growth. Continuing to expand our delivery strategy, on July 12th, we relocated our Tigard, Oregon branch and opened a new financial hub. It joins our Ballard and Boise neighbor hubs, which are specifically designed to support a relationship-based approach to helping our clients achieve their financial goals. Now I will turn the call over to Andy to review our credit performance. Thank you, Chris. This quarter's allowance for credit losses totaled $143 million, a reduction of $5.3 million from last quarter. Net recoveries of about $200,000 led to a provision release of $5.5 million for the quarter. It should also be noted that the release from the provision was muted by over $215 million in loan growth net of PPP during the quarter. Our IHS market economic forecast assumes full year GDP growth at 6.7% for 2021 and 4.7% for 2022, with the unemployment rate predicted to end 2021 at 4.2% and end 2022 close to pre-pandemic levels. This forecast is an improvement over last quarter when GDP was forecasted at 5.7% for 2021. The improved forecast is counterbalanced by the continued stress in our loan portfolio as borrowers continue to be impacted by the lingering effects of the pandemic and related lockdowns. As such, we continue to apply an overlay for what we consider high-risk commercial real estate and downstream potential impacts of permanent job losses at a significant Northwest employer. These amounted to a combined 10 million in Q2 reserves, a decrease from 11.7 million in Q1. Our adjustment is driven by the continuing impacts of the pandemic affecting hospitality shifting dynamics in office and retail, and business closures and labor challenges in the restaurant industry. We ended the quarter with an allowance relative to period-end loans of 1.48%. Adjusting for PPP loans, the allowance to period-end loans increases to 1.59%. MPAs for the quarter improved to 14 basis points. The decline in NPAs was principally due to paydowns and payoffs, with a modest amount returning to accrual status. Most of our remaining NPAs are assets that gained this classification due to reasons not related to the pandemic. However, with that said, the pandemic has, in some cases, impacted the business's ability to rebound. Nevertheless, at 14 basis points, NPAs are very manageable at this point. Fast new loans for the quarter were 17 basis points compared to 11 basis points last quarter. Net charge-offs, as noted earlier, posted a small recovery of about $200,000. Problem loans, which we define as loans rated watch or worse, declined from $920 million last quarter to $804 million as of June 30, 2021. When compared to a year ago, when problem loans were about $1.1 billion, you can see there has been a meaningful amount of healing within the portfolio. This is principally within the hospitality, transportation, food and beverage, and retail portfolios. Okay, deferrals. At the close of the quarter, we had $40 million in active deferrals, or less than 1% of our portfolio, excluding PPP loans. This is, of course, very different from this time last year when we had $1.6 billion. The majority of these deferrals are roughly 75% are on their first referral. It can be found in our hospitality and restaurant portfolios along with some urban parking lots. Deferrals for the most part continue to run off as expected. We continue to classify our retail, hospitality, restaurant, and aviation portfolios as portfolios subject to an elevated level of risk due to the pandemic. In aggregate, these portfolios account for about $1.2 billion in loans, or 13% of our loan portfolio. Retail is the largest segment at $572 million in loans outstanding at the end of the quarter. While we remain concerned over the pandemic's impact on this portfolio, problem loans are actually down year over year, as well as from last quarter. In fact, this portfolio has now exhibited improving credit trends for four consecutive quarters, and problem loans are half of what they were a year ago. We had no past dues in this segment, non-accruals were only four basis points, and no retail loans were on deferral as of June 30th. As mentioned before, PPP loans have certainly made a difference for our borrowers in this portfolio. While these statistics are all positive, we continue to be cautious here given the colloquial evidence we see in our footprint along with conditions seen in the labor market. Hospitality at 331 million has shown a mixed bag of results. In total, problem loans in this segment declined during the quarter and now represent about 53% of the portfolio down from 70% a year ago. As discussed last quarter, there is clearly a bifurcation in the portfolio between leisure oriented and business oriented properties. Leisure accounts for about 69% of our portfolio, while business accounts for 31%. Leisure properties have weathered the pandemic much better than our original expectations, while business oriented properties, which make up most of the substandard assets in this portfolio, are taking longer to recover. About half of the hospitality portfolio's $169 million of problem loans are substandard, or roughly $89 million. It does appear that this level of classification in substandard hospitality loans has leveled off. For most of these hotel properties rated substandard, we have put into place long-term action plans Restaurants, which account for about $217 million, remained consistent this past quarter. Problem loans were stable at roughly 22% of the portfolio. We had about $2.6 million in deferrals in this portfolio at quarter end. Similar to the bank in general, deferrals this time last year amounted to $66 million, so a dramatic reduction year over year. Again, PPP loans have had a meaningful impact for restaurant operators. As of June 30th, 100% of our restaurant operators were clear to open at 100% occupancy, which of course is great news. However, the new issue affecting these operators is finding enough employees to support 100% occupancy. So it's a good news, bad news scenario for restaurant operators. Finally, the aviation portfolio at roughly $117 million, down by about $32 million from a year ago, was stable during the quarter. As in past quarters, no loans were past due, all customers continued to pay as agreed, and no loans were on deferral. This industry will take time to recover, mostly due to business travel, which, as of yet, has not rebounded as dramatically as leisure travel. There is a lot of pent-up demand on the leisure side, as seen by the TSA traffic, with July traffic averaging 80% of 2019 levels. Grandparents are excited to go visit their grandchildren, and many families are finally taking that long-awaited trip to Hawaii. However, headwinds continue with low demand for business travel, as noted before, and an unequal global recovery. Despite the slow recovery due to these continued headwinds, many U.S. airlines are projecting a return to positive cash flow within the next few quarters and have begun using their liquidity to retire debt and deleverage their balance sheet. I will now hand the call back over to Clint. Thanks, Andy. We're excited to have Bank of Commerce Holdings join the Columbia family and are still on target for a fourth quarter close. Randy Eslick and his team have been working closely with their Columbia counterparts to ensure a seamless closing and integration of the merger. The partnership will bring together two community-focused banks with complementary business models and cultures. This morning, we announced our regular quarterly dividend of $0.28. This quarter's dividend will be paid on August 25th to shareholders of record as of the close of business on August 11th. This concludes our prepared comments. As a reminder, Andy, Chris, and Aaron are with me to answer your questions. And now, Raquel, we will open the line for questions.

At this time, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from the line of Matthew Clark with Piper Sandler.