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BANR > SEC Filings for BANR > Form 10-K on 4-Mar-2014All Recent SEC Filings

Show all filings for BANNER CORP

Form 10-K for BANNER CORP


4-Mar-2014

Annual Report


Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's discussion and analysis of results of operations is intended to assist in understanding our financial condition and results of operations. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to the Consolidated Financial Statements of this Form 10-K.

Executive Overview

We are a bank holding company incorporated in the State of Washington and own two subsidiary banks, Banner Bank and Islanders Bank. Banner Bank is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and, as of December 31, 2013, its 85 branch offices and eight loan production offices located in Washington, Oregon and Idaho. Islanders Bank is also a Washington-chartered commercial bank and conducts its business from three locations in San Juan County, Washington. As of December 31, 2013, we had total consolidated assets of $4.4 billion, net loans of $3.3 billion, total deposits of $3.6 billion and total stockholders' equity of $539 million.

Banner Bank is a regional bank which offers a wide variety of commercial banking services and financial products to individuals, businesses and public sector entities in its primary market areas. Islanders Bank is a community bank which offers similar banking services to individuals, businesses and public entities located in the San Juan Islands. The Banks' primary business is that of traditional banking institutions, accepting deposits and originating loans in locations surrounding their offices in portions of Washington, Oregon and Idaho. Banner Bank is also an active participant in the secondary market, engaging in mortgage banking operations largely through the origination and sale of one- to four-family residential loans. Lending activities include commercial business and commercial real estate loans, agriculture business loans, construction and land development loans, one- to four-family residential loans and consumer loans.

Banner Corporation's successful execution of its strategic plan and operating initiatives continued in 2013, as evidenced by our solid operating results and profitability. Highlights for the year included further improvement in our asset quality, strong deposit growth, solid revenues from core operations and additional client acquisition. Additionally, the quarterly cash dividend was increased to $0.12 per share in the first two quarters of the year and to $0.15 per share in the last two quarters of the year, reflecting the strong performance and our expectation of continued success and sustained profitability.

Despite persistently weak economic conditions and exceptionally low interest rates which have created an unusually challenging banking environment for an extended period, the Company experienced marked improvement and consistent profitability in 2012 which continued in 2013. For the year ended December 31, 2013, our net income to common shareholders was $46.6 million or $2.40 per diluted share, compared to net income to common shareholders of $59.1 million, or $3.16 per diluted share for the year ended December 31, 2012. Although there continue to be indications that economic conditions are improving from the recessionary downturn, the pace of recovery has been modest and uneven and ongoing stress in the economy will likely continue to be challenging going forward. As a result, our future operating results and financial performance will be significantly affected by the course of the recovery. However, over the past three years we have significantly improved our risk profile by aggressively managing and reducing our problem assets, which has resulted in lower credit costs and stronger revenues, and which we believe has positioned the Company well to meet this challenging environment.

Our return to consistent profitability was punctuated in the second quarter of 2012 by management's decision to reverse the valuation allowance against our deferred tax assets. This decision resulted in a substantial tax benefit for the full year 2012, and resulted in a significant reduction in our tax expense for the year ended December 31, 2012. The decision to reverse the valuation allowance reflected our confidence in the sustainability of our future profitability. Further, as a result of our return to profitability, including the reversal of our deferred tax asset, our improved asset quality and operating trends, strong capital position and our expectation for sustainable profitability for the foreseeable future, we also significantly reduced the credit risk component associated with the estimated fair value of the junior subordinated debentures issued by the Company. Changes in these two significant accounting estimates, while substantial, represent non-cash valuation adjustments that had no effect on our liquidity or our ability to fund our operations.

As a result of substantial reserves already in place representing 2.19% of total loans outstanding at December 31, 2013, as well as declining net charge-offs, Banner did not record a provision for loan losses in year ended December 31, 2013. By contrast, we recorded a $13.0 million provision for the year ended December 31, 2012 and $35 million for the year ended December 31, 2011. The decrease in loan loss provisioning from a year earlier reflects significant progress in reducing the levels of delinquencies, non-performing loans and net charge-offs, particularly for loans for the construction of one- to four-family homes and for acquisition and development of land for residential properties. The allowance for loan losses at December 31, 2013 was $75.0 million, representing 303% of non-performing loans. Non-performing loans decreased by 28% to $24.8 million at December 31, 2013, compared to $34.4 million a year earlier. (See Note 7 of the Notes to the Consolidated Financial Statements, Loans Receivable and the Allowance for Loan Losses, as well as "Asset Quality" below in this Form 10-K.)

Aside from the level of loan loss provision, our operating results depend primarily on our net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of customer deposits and borrowings. Net interest income is primarily a function of our interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balances of interest-earning assets and interest-bearing liabilities. Our net interest income before provision for loan losses decreased modestly to $166.7 million for the year ended December 31, 2013, compared to $167.6 million for the year earlier. During the same period, our net interest spread decreased to 4.08% from 4.13%. These decreases in net interest income and net interest spread reflect declining yields on performing loans and securities, partially offset by continuing reductions in deposit and other funding costs.


Our net income also is affected by the level of our other operating income, including deposit fees and service charges, loan origination and servicing fees, and gains and losses on the sale of loans and securities, as well as our non-interest operating expenses and income tax provisions. In addition, our net income is affected by the net change in the value of certain financial instruments carried at fair value, in certain periods by other-than-temporary impairment (OTTI) charges or recoveries and in the current period by a $3.0 million termination fee related to the termination of the proposed acquisition of Home Federal Bancorp, Inc. (See Note 22 of the Notes to the Consolidated Financial Statements.) For the year ended December 31, 2013, we recorded a net charge of $2.3 million for fair value adjustments, which was offset by $1.0 million in gains on the sale of securities, $409,000 in OTTI recoveries and the $3.0 million acquisition termination fee. In comparison, we recorded a net fair value loss of $16.5 million (primarily related to the estimated fair value of our junior subordinated debentures) and an OTTI loss of $409,000 for the year ended December 31, 2012, which were partially offset by $51,000 in gains on the sale of securities.

Our total other operating income, which includes the gain on sale of securities, OTTI recovery, changes in the value of financial instruments carried at fair value and, for 2013, including the acquisition termination fee was $43.3 million for the year ended December 31, 2013, compared to $26.9 million for the year ended December 31, 2012. However, other operating income excluding the gain on sale of securities, OTTI adjustments, changes in the value of financial instruments and the acquisition termination fee, which we believe is more indicative of our core operations, decreased 5.8% to $41.2 million for the year ended December 31, 2013 compared to $43.8 million for the same period a year earlier, as decreased mortgage banking revenues were only partially offset by increased deposit fees and service charges.

Our total revenues (net interest income before the provision for loan losses plus total other operating income) for the year ended December 31, 2013 increased $15.5 million, or 8%, to $210.1 million, compared to $194.6 million for the same period a year earlier, largely as a result of the much smaller net fair value loss in 2013 as well as the acquisition termination fee and gains on the sale of securities. Our total revenues from core operations, which excludes gains on sale of securities, OTTI and fair value adjustments and the termination fee, decreased by $3.5 million, or 2%, to $208.0 million for the year ended December 31, 2013, compared to $211.4 million for the same period a year earlier, as increased deposit fees and service charges were not sufficient to fully offset decreases in net interest income and mortgage banking revenues.

For the year ended December 31, 2013, other operating expenses decreased minimally to $141.0 million, compared to $141.5 million for the year ended December 31, 2012, largely as a result of decreased costs related to REO operations and FDIC deposit insurance, which were generally offset by increased compensation and payment and card processing expenses, as well as approximately $550,000 of expenses related to the proposed acquisition of Home Federal Bancorp, Inc.

Other operating income, revenues and other earnings information excluding fair value adjustments, OTTI losses or recoveries, gains or losses on sale of securities and other one-time transactions, and common stockholders' tangible equity per share and the ratio of tangible common stockholders' equity to tangible assets referred to in footnote (9) to Item 6 - Selected Financial Data above, are non-GAAP financial measures. Management has presented these non-GAAP financial measures in this report because it believes that they provide useful and comparative information to assess trends in our core operations and in understanding our capital position. However, these non-GAAP financial measures are supplemental and are not a substitute for any analysis based on GAAP. Where applicable, we have also presented comparable earnings information using GAAP financial measures. For a reconciliation of these non-GAAP financial measures, see the tables below. Because not all companies use the same calculations, our presentation may not be comparable to other similarly titled measures as calculated by other companies. See "Comparison of Results of Operations for the Years Ended December 31, 2013 and 2012" for more detailed information about our financial performance.


The following tables set forth reconciliations of non-GAAP financial measures discussed in this report (dollars in thousands):

                                                       For the Years Ended December 31
                                                        2013           2012           2011
Total other operating income                     $    43,342     $   26,902     $   33,990
Exclude gain on sale of securities                    (1,022 )          (51 )            5
Exclude other-than-temporary impairment losses
(recoveries)                                            (409 )          409         (3,000 )
Exclude change in valuation of financial
instruments carried at fair value                      2,278         16,515            624
Exclude one-time termination fee                      (2,954 )            -              -
Total other operating income, excluding fair
value adjustments, OTTI, gain on sale of
securities and one-time fees                     $    41,235     $   43,775     $   31,619

Net interest income before provision for loan
losses                                           $   166,716     $  167,648     $  164,571
Total other operating income                          43,342         26,902         33,990
Total revenue                                        210,058        194,550        198,561
Exclude gain on sale of securities                    (1,022 )          (51 )            5
Exclude other-than-temporary impairment losses
(recoveries)                                            (409 )          409         (3,000 )
Exclude change in valuation of financial
instruments carried at fair value                      2,278         16,515            624
Exclude one-time termination fee                      (2,954 )            -              -
Total revenue, excluding fair value adjustments,
OTTI, gain on sale of securities and one-time
fees                                             $   207,951     $  211,423     $  196,190

Income before provision for taxes                $    69,083     $   40,097     $    5,457
Exclude gain on sale of securities                    (1,022 )          (51 )            5
Exclude other-than-temporary impairment losses
(recoveries)                                            (409 )          409         (3,000 )
Exclude change in valuation of financial
instruments carried at fair value                      2,278         16,515            624
Exclude one-time termination fee                      (2,954 )            -              -
Income before provision for taxes, excluding
fair value adjustments, OTTI, gain on sale of
securities and one-time fees                     $    66,976     $   56,970     $    3,086

Net income                                       $    46,555     $   64,882     $    5,457
Exclude gain on sale of securities                    (1,022 )          (51 )            5
Exclude other-than-temporary impairment losses
(recoveries)                                            (409 )          409         (3,000 )
Exclude change in valuation of financial
instruments carried at fair value                      2,278         16,515            624
Exclude one-time termination fee                      (2,954 )            -              -
Exclude related tax expense (benefit)                    759         (6,074 )          854
Total earnings, excluding fair value
adjustments, OTTI, gain on sale of securities
and one-time fees, net of related tax effects    $    45,207     $   75,681     $    3,940


                                                                  December 31
                                                        2013            2012            2011
Stockholders' equity                             $   538,972     $   506,919     $   532,450
Other intangible assets, net                           2,449           4,230           6,331
Tangible equity                                      536,523         502,689         526,119
Preferred equity                                           -               -         120,702
Tangible common stockholders' equity             $   536,523     $   502,689     $   405,417
Total assets                                     $ 4,388,166     $ 4,265,564     $ 4,257,312
Other intangible assets, net                           2,449           4,230           6,331
Tangible assets                                  $ 4,385,717     $ 4,261,334     $ 4,250,981
Tangible common stockholders' equity to tangible
assets                                                 12.23 %         11.80 %          9.54 %

Common stockholders' tangible equity per share   $     27.50     $     25.88     $     23.14

We offer a wide range of loan products to meet the demands of our customers. Our lending activities are primarily directed toward the origination of real estate and commercial loans. Prior to 2008, real estate lending activities were significantly focused on residential construction and first mortgages on owner-occupied, one- to four-family residential properties; however, over the subsequent three years our origination of construction and land development loans declined materially and the proportion of the portfolio invested in these types of loans declined substantially. Beginning in 2011 and continuing since then, we have experienced increased demand for one- to four-family construction loans and, while outstanding balances have increased only modestly, originations have increased significantly in 2012 and 2013. One- to four-family construction loans increased $57 million to $201 million at December 31, 2013, compared to $144 million at December 31, 2011. Our residential mortgage loan originations also decreased during the earlier years of this cycle, although less significantly than the decline in construction and land development lending as exceptionally low interest rates supported demand for loans to refinance existing debt as well as loans to finance home purchases. Refinancing activity was particularly significant in 2012 and in the in the first six months of 2013, leading to meaningful increases in residential mortgage originations during these periods; however, the rise in mortgage interest rates that began in the second quarter slowed origination activity in the last two quarters of 2013 and may result in lower refinancing activity in the future. Despite significant loan originations, in 2012 and 2013 our outstanding balances for residential mortgages have continued to decline, as most of the new originations have been sold in the secondary market while existing residential loans have been repaying at an accelerated pace. However, as a result of these originations and loan sales, our portfolio of loans serviced for others has increased to $1.216 billion at December 31, 2013. Our real estate lending activities also include the origination of multifamily and commercial real estate loans including construction and development loans for these types of properties. While our level of activity and investment in these types of loans has been relatively stable for many years, we have experienced an increase in new originations in recent periods. Our commercial business lending is directed toward meeting the credit and related deposit needs of various small- to medium-sized business and agribusiness borrowers operating in our primary market areas. Reflecting the slowly recovering economy, demand for these types of commercial business loans has been modest although our production levels have increased in recent periods. Commercial and agricultural business loans increased $62 million to $910 million at December 31, 2013, compared to $848 million at December 31, 2012. Our consumer loan activity is primarily directed at meeting demand from our existing deposit customers and, while we have increased our emphasis on consumer lending in recent years, demand for consumer loans also has been modest during this period of economic weakness as we believe many consumers have been focused on reducing their personal debt. At December 31, 2013, our net loan portfolio totaled $3.343 billion compared to $3.158 billion at December 31, 2012.

Deposits, customer retail repurchase agreements and loan repayments are the major sources of our funds for lending and other investment purposes. We compete with other financial institutions and financial intermediaries in attracting deposits and we generally attract deposits within our primary market areas. Much of the focus of our earlier branch expansion and current marketing efforts has been directed toward attracting additional deposit customer relationships and balances. This effort has been particularly focused on increasing transaction and savings accounts and for the past three years we have been very successful in increasing these core deposit balances. The long-term success of our deposit gathering activities is reflected not only in the growth of deposit balances, but also in increases in the level of deposit fees, service charges and other payment processing revenues compared to periods prior to that expansion.

Total deposits were $3.618 billion at December 31, 2013 compared to $3.558 billion a year earlier. Non-interest-bearing account balances increased 14% to $1.115 billion at December 31, 2013, compared to $981 million a year ago. Interest-bearing transaction and savings accounts totaled $1.630 billion at December 31, 2013, compared to $1.547 billion a year ago, while certificates of deposit further decreased to $873 million compared to $1.029 billion a year earlier. Non-certificate core deposits represented 76% of total deposits at December 31, 2013, compared to 71% of total deposits a year ago and 64% two years earlier.


Critical Accounting Policies

In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of Operations, Comprehensive Income, Changes in Stockholders' Equity and Cash Flows reflect all adjustments (which include reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with U.S. Generally Accepted Accounting Principles (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements.

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to (i) the methodology for the recognition of interest income,
(ii) determination of the provision and allowance for loan and lease losses,
(iii) the valuation of financial assets and liabilities recorded at fair value, including OTTI losses, (iv) the valuation of intangibles, such as core deposit intangibles and mortgage servicing rights, (v) the valuation of real estate held for sale and (vi) the valuation of or recognition of deferred tax assets and liabilities. These policies and judgments, estimates and assumptions are described in greater detail below. Management believes the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Further, subsequent changes in economic or market conditions could have a material impact on these estimates and our financial condition and operating results in future periods. There have been no significant changes in our application of accounting policies since December 31, 2012. For additional information concerning critical accounting policies, see Notes 1, 6, 13, 21 and 22 of the Notes to the Consolidated Financial Statements and the following:

Interest Income: (Notes 1 and 6) Interest on loans and securities is accrued as earned unless management doubts the collectability of the asset or the unpaid interest. Interest accruals on loans are generally discontinued when loans become 90 days past due for payment of interest and the loans are then placed on nonaccrual status. All previously accrued but uncollected interest is deducted from interest income upon transfer to nonaccrual status. For any future payments collected, interest income is recognized only upon management's assessment that there is a strong likelihood that the full amount of a loan will be repaid or recovered. A loan may be put on nonaccrual status sooner than this policy would dictate if, in management's judgment, the amounts owed, principal or interest, may be uncollectable. While less common, similar interest reversal and nonaccrual treatment is applied to investment securities if their ultimate collectability becomes questionable.

Provision and Allowance for Loan Losses: (Notes 1 and 6) The provision for loan losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management's evaluation of the adequacy of general and specific loss reserves. We maintain an allowance for loan losses consistent in all material respects with the GAAP guidelines outlined in ASC 450, Contingencies. We have established systematic methodologies for the determination of the adequacy of our allowance for loan losses. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual problem loans. We increase our allowance for loan losses by charging provisions for probable loan losses against our income and value impaired loans consistent with the accounting guidelines outlined in ASC 310, Receivables.

The allowance for losses on loans is maintained at a level sufficient to provide for probable losses based on evaluating known and inherent risks in the loan portfolio and upon our continuing analysis of the factors underlying the quality of the loan portfolio. These factors include, among others, changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectability may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. Realized losses related to specific assets are applied as a reduction of the carrying value of the assets and charged immediately against the allowance for loan loss reserve. Recoveries on previously charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by us at the time financial statements are prepared. Although we use the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond our control. The adequacy of general and specific reserves is based on our continuing evaluation of the pertinent factors underlying the quality of the loan portfolio as well as individual review of certain large balance loans. Loans are considered impaired when, based on current information and events, we determine that it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, the value of the underlying collateral and the current status of the economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated . . .

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