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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q 
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ to ______________
 Commission File Number 000-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
 
 
 
 
 
Washington
91-1691604
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
10 South First Avenue, Walla Walla, Washington 99362
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code:  (509) 527-3636
 
 
 
 
 
Securities registered pursuant to Section 12(b) of the Act
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $.01 per share
BANR
The NASDAQ Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
 
 
 
 
 
 
 
Yes
[x]
 
No
[  ]
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Yes
[x]
 
No
[  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
 
 
 
Large accelerated filer
[x]
Accelerated filer    [ ]
Non-accelerated filer   [  ]
Smaller reporting company
Emerging growth company
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
 
No
[x]
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Title of class:
 
 
As of April 30, 2020
Common Stock, $.01 par value per share
 
 
 
 
 
35,155,551 shares
 
 
 
 
 
 
 
 
 
 

1


BANNER CORPORATION AND SUBSIDIARIES

Table of Contents
PART I – FINANCIAL INFORMATION
 
 
 
Item 1 – Financial Statements.  The Unaudited Condensed Consolidated Financial Statements of Banner Corporation and Subsidiaries filed as a part of the report are as follows:
 
 
 
Consolidated Statements of Financial Condition as of March 31, 2020 and December 31, 2019
4
 
 
Consolidated Statements of Operations for the Three Months Ended March 31, 2020 and 2019
5
 
 
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2020 and 2019
6
 
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2020 and the Year Ended December 31, 2019
7
 
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019
10
 
 
Selected Notes to the Consolidated Financial Statements
12
 
 
Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Executive Overview
56
 
 
Comparison of Financial Condition at March 31, 2020 and December 31, 2019
64
 
 
Comparison of Results of Operations for the Three Months Ended March 31, 2020 and 2019
67
 
 
Asset Quality
73
 
 
Liquidity and Capital Resources
75
 
 
Capital Requirements
76
 
 
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Market Risk and Asset/Liability Management
77
 
 
Sensitivity Analysis
77
 
 
Item 4 – Controls and Procedures
82
 
 
PART II – OTHER INFORMATION
 
 
 
Item 1 – Legal Proceedings
83
 
 
Item 1A – Risk Factors
83
 
 
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
84
 
 
Item 3 – Defaults upon Senior Securities
84
 
 
Item 4 – Mine Safety Disclosures
84
 
 
Item 5 – Other Information
84
 
 
Item 6 – Exhibits
85
 
 
SIGNATURES
87

2


Special Note Regarding Forward-Looking Statements

Certain matters in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements relate to our financial condition, liquidity, results of operations, plans, objectives, future performance or business.  Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.”  Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance and projections of financial items.  These forward looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited to: the effect of the novel coronavirus ("COVID-19") pandemic, including on Banner’s credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate customers, including economic activity, employment levels and market liquidity; the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses and provisions for credit losses that may be impacted by deterioration in the housing and commercial real estate markets and may lead to increased losses and non-performing assets, and may result in the allowance for credit losses not being adequate to cover actual losses and require a material increase in the allowance for credit losses; results of examinations by regulatory authorities, including the possibility that any such regulatory authority may, among other things, require the writing down of assets or increases in the allowance for credit losses; the ability to manage loan delinquency rates; competitive pressures among financial services companies; changes in consumer spending or borrowing and spending habits; interest rate movements generally and the relative differences between short and long-term interest rates, loan and deposit interest rates, net interest margin and funding sources; uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away from LIBOR toward new interest rate benchmarks; the impact of repricing and competitors’ pricing initiatives on loan and deposit products; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values; the ability to adapt successfully to technological changes to meet customers’ needs and developments in the marketplace; the ability to access cost-effective funding; increases in premiums for deposit insurance; the ability to control operating costs and expenses; the use of estimates in determining fair value of certain assets and liabilities, which estimates may prove to be incorrect and result in significant changes in valuation; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect employees, and potential associated charges; disruptions, security breaches or other adverse events, failures or interruptions in, or attacks on, information technology systems or on the third-party vendors who perform critical processing functions; changes in financial markets; changes in economic conditions in general and in Washington, Idaho, Oregon and California in particular; secondary market conditions for loans and the ability to sell loans in the secondary market; the costs, effects and outcomes of litigation; legislation or regulatory changes or reforms, including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including changes related to Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the implementing regulations; results of safety and soundness and compliance examinations by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (the FDIC), the Washington State Department of Financial Institutions, Division of Banks, (the Washington DFI) or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require restitution or institute an informal or formal enforcement action which could require an increase in reserves for loan losses, write-downs of assets or changes in regulatory capital position, or affect the ability to borrow funds, or maintain or increase deposits, or impose additional requirements and restrictions, any of which could adversely affect liquidity and earnings; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; the inability of key third-party providers to perform their obligations; changes in accounting principles, policies or guidelines, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory and technological factors affecting operations, pricing, products and services; including the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act"); future acquisitions by Banner of other depository institutions or lines of business; and future goodwill impairment due to changes in Banner’s business, changes in market conditions, including as a result of the COVID-19 pandemic or other factors; and other risks detailed from time to time in our filings with the U.S. Securities and Exchange Commission (SEC), including this report on Form 10-Q.  Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made.  We do not undertake and specifically disclaim any obligation to update any forward-looking statements included in this report or the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise.  These risks could cause our actual results to differ materially from those expressed in any forward-looking statements by, or on behalf of, us.  In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements.

As used throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to Banner Corporation and its consolidated subsidiaries, unless the context otherwise requires.  All references to “Banner” refer to Banner Corporation and those to “the Banks” refer to its wholly-owned subsidiaries, Banner Bank and Islanders Bank, collectively.



3


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited) (In thousands, except shares)
March 31, 2020 and December 31, 2019
ASSETS
March 31,
2020

 
December 31,
2019

Cash and due from banks
$
211,013

 
$
234,359

Interest bearing deposits
83,988

 
73,376

Total cash and cash equivalents
295,001

 
307,735

Securities—trading
21,040

 
25,636

Securities—available-for-sale, amortized cost $1,544,513 and $1,529,946, respectively
1,608,224

 
1,551,557

Securities—held-to-maturity, net of allowance for credit losses of $98 and none, respectively, fair value $449,237 and $237,805, respectively
437,846

 
236,094

     Total securities
2,067,110

 
1,813,287

Federal Home Loan Bank (FHLB) stock
20,247

 
28,342

Loans held for sale (includes $169.2 million and $199.4 million, at fair value, respectively)
182,428

 
210,447

Loans receivable
9,285,744

 
9,305,357

Allowance for credit losses - loans
(130,488
)
 
(100,559
)
Net loans receivable
9,155,256

 
9,204,798

Accrued interest receivable
40,732

 
37,962

Real estate owned (REO), held for sale, net
2,402

 
814

Property and equipment, net
175,235

 
178,008

Goodwill
373,121

 
373,121

Other intangibles, net
27,157

 
29,158

Bank-owned life insurance (BOLI)
193,140

 
192,088

Deferred tax assets, net
46,582

 
59,639

Other assets
202,539

 
168,632

Total assets
$
12,780,950

 
$
12,604,031

LIABILITIES
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
4,107,262

 
$
3,945,000

Interest-bearing transaction and savings accounts
5,175,969

 
4,983,238

Interest-bearing certificates
1,166,306

 
1,120,403

Total deposits
10,449,537

 
10,048,641

Advances from FHLB
247,000

 
450,000

Other borrowings
128,764

 
118,474

Junior subordinated debentures at fair value (issued in connection with Trust Preferred Securities)
99,795

 
119,304

Accrued expenses and other liabilities
208,753

 
227,889

Deferred compensation
45,401

 
45,689

Total liabilities
11,179,250

 
11,009,997

COMMITMENTS AND CONTINGENCIES (Note 13)

 

SHAREHOLDERS’ EQUITY
 
 
 
Preferred stock - $0.01 par value per share, 500,000 shares authorized; no shares outstanding at March 31, 2020 and December 31, 2019

 

Common stock and paid in capital - $0.01 par value per share, 50,000,000 shares authorized; 35,102,459 shares issued and outstanding at March 31, 2020; 35,712,384 shares issued and outstanding at December 31, 2019
1,343,699

 
1,373,198

Common stock (non-voting) and paid in capital - $0.01 par value per share, 5,000,000 shares authorized; no shares issued and outstanding at March 31, 2020; 39,192 shares issued and outstanding at December 31, 2019

 
742

Retained earnings
177,922

 
186,838

Carrying value of shares held in trust for stock-based compensation plans
(7,650
)
 
(7,507
)
Liability for common stock issued to stock related compensation plans
7,650

 
7,507

Accumulated other comprehensive income
80,079

 
33,256

Total shareholders' equity
1,601,700

 
1,594,034

Total liabilities and shareholders' equity
$
12,780,950

 
$
12,604,031

See Selected Notes to the Consolidated Financial Statements

4


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (In thousands, except shares and per share amounts)
For the Three Months Ended March 31, 2020 and 2019
 
Three Months Ended
March 31,
 
2020

 
2019

INTEREST INCOME:
 
 
 
Loans receivable
$
118,926

 
$
115,455

Mortgage-backed securities
9,137

 
10,507

Securities and cash equivalents
3,602

 
4,034

Total interest income
131,665

 
129,996

INTEREST EXPENSE:
 
 
 
Deposits
8,750

 
8,643

FHLB advances
2,064

 
3,476

Other borrowings
116

 
60

Junior subordinated debentures
1,477

 
1,713

Total interest expense
12,407

 
13,892

Net interest income
119,258

 
116,104

PROVISION FOR CREDIT LOSSES
21,748

 
2,000

Net interest income after provision for credit losses
97,510

 
114,104

NON-INTEREST INCOME:
 
 
 
Deposit fees and other service charges
9,803

 
12,618

Mortgage banking operations
10,191

 
3,415

Bank-owned life insurance (BOLI)
1,050

 
1,276

Miscellaneous
2,639

 
804

 
23,683

 
18,113

Net gain on sale of securities
78

 
1

Net change in valuation of financial instruments carried at fair value
(4,596
)
 
11

Total non-interest income
19,165

 
18,125

NON-INTEREST EXPENSE:
 
 
 
Salary and employee benefits
59,908

 
54,640

Less capitalized loan origination costs
(5,806
)
 
(4,849
)
Occupancy and equipment
13,107

 
13,766

Information/computer data services
5,810

 
5,326

Payment and card processing expenses
4,240

 
3,984

Professional and legal expenses
1,919

 
2,434

Advertising and marketing
1,827

 
1,529

Deposit insurance expense
1,635

 
1,418

State/municipal business and use taxes
984

 
945

REO operations, net
100

 
(123
)
Amortization of core deposit intangibles
2,001

 
2,052

Provision for credit losses - unfunded loan commitments
1,722

 

Miscellaneous
6,357

 
6,744

 
93,804

 
87,866

COVID-19 expenses
239

 

Acquisition-related expenses
1,142

 
2,148

Total non-interest expense
95,185

 
90,014

Income before provision for income taxes
21,490

 
42,215

PROVISION FOR INCOME TAXES
4,608

 
8,869

NET INCOME
$
16,882

 
$
33,346

Earnings per common share:
 
 
 
Basic
$
0.48

 
$
0.95

Diluted
$
0.47

 
$
0.95

Cumulative dividends declared per common share
$
0.41

 
$
0.41

Weighted average number of common shares outstanding:
 
 
 
Basic
35,463,541

 
35,050,376

Diluted
35,640,463

 
35,172,056

See Selected Notes to the Consolidated Financial Statements

5


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (In thousands)
For the Three Months Ended March 31, 2020 and 2019

 
Three Months Ended
March 31,
 
2020

 
2019

NET INCOME
$
16,882

 
$
33,346

OTHER COMPREHENSIVE INCOME, NET OF INCOME TAXES:
 
 
 
Unrealized holding gain on available-for-sale securities arising during the period
42,178

 
16,656

Reclassification for net gain on available-for-sale securities realized in earnings
(78
)
 
(1
)
Changes in fair value of junior subordinated debentures related to instrument specific credit risk
19,509

 
174

Income tax expense related to other comprehensive income
(14,786
)
 
(4,039
)
Other comprehensive income
46,823

 
12,790

COMPREHENSIVE INCOME
$
63,705

 
$
46,136


See Selected Notes to the Consolidated Financial Statements

6


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited) (In thousands, except shares)
For the Three Months Ended March 31, 2020 and the Year Ended December 31, 2019


Continued on next page
 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other Comprehensive Income
 
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
Balance, January 1, 2019
35,182,772

 
$
1,337,436

 
$
134,055

 
$
7,104

 
$
1,478,595

 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
33,346

 
 
 
33,346

Other comprehensive income, net of income tax
 
 
 
 
 
 
12,790

 
12,790

Accrual of dividends on common stock ($0.41/share)
 
 
 
 
(14,490
)
 
 
 
(14,490
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(30,026
)
 
950

 
 
 
 
 
950

 
 
 
 
 
 
 
 
 
 
Balance, March 31, 2019
35,152,746

 
$
1,338,386

 
$
152,911

 
$
19,894

 
$
1,511,191


Balance, April 1, 2019
35,152,746

 
$
1,338,386

 
$
152,911

 
$
19,894

 
$
1,511,191

 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
39,700

 
 
 
39,700

Other comprehensive income, net of income tax
 
 
 
 
 
 
16,016

 
16,016

Accrual of dividends on common stock ($0.41/share)
 
 
 
 
(14,354
)
 
 
 
(14,354
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
20,897

 
575

 
 
 
 
 
575

Repurchase of common stock
(600,000
)
 
(32,073
)
 
 
 
 
 
(32,073
)
 
 
 
 
 
 
 
 
 
 
Balance, June 30, 2019
34,573,643

 
$
1,306,888

 
$
178,257

 
$
35,910

 
$
1,521,055


Continued on next page







7




 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other Comprehensive Income
 
Stockholders’
Equity
 
Shares
 
Amounts
 
 
 
Balance, July 1, 2019
34,573,643

 
$
1,306,888

 
$
178,257

 
$
35,910

 
$
1,521,055

 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
39,577

 
 
 
39,577

Other comprehensive income, net of income tax
 
 
 
 
 
 
4,610

 
4,610

Accrual of dividends on common stock ($0.41/share)
 
 
 
 
(14,130
)
 
 
 
(14,130
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(286
)
 
1,672

 
 
 
 
 
1,672

Repurchase of common stock
(400,000
)
 
(21,849
)
 
 
 
 
 
(21,849
)
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2019
34,173,357

 
$
1,286,711

 
$
203,704

 
$
40,520

 
$
1,530,935


 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other Comprehensive Income
 
Stockholders’
Equity
 
Shares
 
Amounts
 
 
 
Balance, October 1, 2019
34,173,357

 
$
1,286,711

 
$
203,704

 
$
40,520

 
$
1,530,935

 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
33,655

 
 
 
33,655

Other comprehensive loss, net of income tax
 
 
 
 
 
 
(7,264
)
 
(7,264
)
Accrual of dividends on common stock ($1.41/share)
 
 
 
 
(50,521
)
 
 
 
(50,521
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(132
)
 
2,029

 
 
 
 
 
2,029

Issuance of shares for acquisition
1,578,351

 
85,200

 
 
 
 
 
85,200

 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2019
35,751,576

 
$
1,373,940

 
$
186,838

 
$
33,256

 
$
1,594,034


Continued on next page


8


 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other Comprehensive Income
 
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
Balance, January 1, 2020
35,751,576

 
$
1,373,940

 
$
186,838

 
$
33,256

 
$
1,594,034

 
 
 
 
 
 
 
 
 
 
New credit standard (Topic 326) - impact in year of adoption
 
 
 
 
(11,215
)
 
 
 
(11,215
)
Net income
 
 
 
 
16,882

 
 
 
16,882

Other comprehensive income, net of income tax
 
 
 
 
 
 
46,823

 
46,823

Accrual of dividends on common stock ($0.41/share)
 
 
 
 
(14,583
)
 
 
 
(14,583
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(24,337
)
 
1,534

 
 
 
 
 
1,534

Repurchase of common stock
(624,780
)
 
(31,775
)
 
 
 
 
 
(31,775
)
 
 
 
 
 
 
 
 
 
 
Balance, March 31, 2020
35,102,459

 
$
1,343,699

 
$
177,922

 
$
80,079

 
$
1,601,700



See Selected Notes to the Consolidated Financial Statements


9


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In thousands)
For the Three Months Ended March 31, 2020 and 2019
 
Three Months Ended
March 31,
 
2020

 
2019

OPERATING ACTIVITIES:
 
 
 
Net income
$
16,882

 
$
33,346

Adjustments to reconcile net income to net cash provided from operating activities:
 
 
 
Depreciation
4,614

 
4,481

Deferred income and expense, net of amortization
(1,129
)
 
(895
)
Amortization of core deposit intangibles
2,001

 
2,052

Gain on sale of securities
(78
)
 
(1
)
Net change in valuation of financial instruments carried at fair value
4,596

 
(11
)
Decrease in deferred taxes, net
16,507

 
5,379

Increase in current taxes payable
2,067

 
7,243

Stock-based compensation
1,872

 
1,219

Increase in cash surrender value of BOLI
(1,041
)
 
(1,267
)
Gain on sale of loans, including capitalized servicing rights
(8,363
)
 
(2,063
)
Loss on disposal of real estate held for sale and property and equipment
444

 
371

Provision for credit losses
21,748

 
2,000

Provision for credit losses - unfunded loan commitments
1,722

 

Origination of loans held for sale
(296,712
)
 
(134,747
)
Proceeds from sales of loans held for sale
333,094

 
261,978

Net change in:
 
 
 
Other assets
(51,061
)
 
(1,472
)
Other liabilities
5,400

 
(12,847
)
Net cash provided from operating activities
52,563

 
164,766

INVESTING ACTIVITIES:
 
 
 
Purchases of securities—available-for-sale
(143,973
)
 
(5,140
)
Principal repayments and maturities of securities—available-for-sale
82,760

 
51,910

Proceeds from sales of securities—available-for-sale
44,509

 
516

Purchases of securitiesheld-to-maturity
(206,155
)
 

Principal repayments and maturities of securities—held-to-maturity
3,786

 
14,744

Loan originations, net of principal repayments
16,646

 
(8,988
)
Proceeds from sales of other loans
5,751

 
3,186

Purchases of property and equipment
(3,086
)
 
(3,947
)
Proceeds from sale of real estate held for sale and sale of other property, net
877

 
876

Proceeds from FHLB stock repurchase program
47,840

 
52,372

Purchase of FHLB stock
(39,745
)
 
(47,480
)
Other
(72
)
 
485

Net cash (used in) provided from investing activities
(190,862
)
 
58,534

FINANCING ACTIVITIES:
 
 
 
Increase (decrease) in deposits, net
400,895

 
(100,819
)
Proceeds from long term FHLB advances

 
300,000

Repayment of long term FHLB advances

 
(189
)
Repayment of overnight and short term FHLB advances, net
(203,000
)
 
(422,000
)
Increase in other borrowings, net
10,289

 
2,724

Cash dividends paid
(50,505
)
 
(13,405
)
Taxes paid related to net share settlement of equity awards
(339
)
 
(269
)
Cash paid for the repurchase of common stock
(31,775
)
 

Net cash provided from (used in) financing activities
125,565

 
(233,958
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
(12,734
)
 
(10,658
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
307,735

 
272,196

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
295,001

 
$
261,538


Continued on next page


10


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited) (In thousands)
For the Three Months Ended March 31, 2020 and 2019
 
Three Months Ended
March 31,
 
2020

 
2019

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Interest paid in cash
$
13,014

 
$
13,812

Tax refunds received
(29
)
 
(71
)
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
 
 
 
Loans, net of discounts, specific loss allowances and unearned income,
transferred to real estate owned and other repossessed assets
1,588

 

    Dividends accrued but not paid until after period end
15,277

 
14,863


See Selected Notes to the Consolidated Financial Statements

11


BANNER CORPORATION AND SUBSIDIARIES
SELECTED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 1:  BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements include the accounts of Banner Corporation (the Company or Banner), a bank holding company incorporated in the State of Washington and its wholly-owned subsidiaries, Banner Bank and Islanders Bank (the Banks).

These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (SEC). In preparing these financial statements, the Company has evaluated events and transactions subsequent to March 31, 2020 for potential recognition or disclosure. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC and the accounting standards for interim financial statements. Certain reclassifications have been made to the 2019 Consolidated Financial Statements and/or schedules to conform to the 2020 presentation. These reclassifications may have affected certain ratios for the prior periods. The effect of these reclassifications is considered immaterial. All significant intercompany transactions and balances have been eliminated.

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 the Company’s 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 significant to an understanding of Banner’s financial statements. These policies relate to (i) the methodology for the recognition of interest income, (ii) determination of the provision and allowance for credit losses, (iii) the valuation of financial assets and liabilities recorded at fair value (iv) the valuation of intangibles, such as goodwill, core deposit intangibles (CDI) and mortgage servicing rights, (v) the valuation of real estate held for sale, (vi) the valuation of assets acquired and liabilities assumed in business combinations and subsequent recognition of related income and expense, and (vii) the valuation or recognition of deferred tax assets and liabilities. These policies and judgments, estimates and assumptions are described in greater detail in subsequent notes to the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations (Critical Accounting Policies) in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC (2019 Form 10-K).  There have been no significant changes in our application of these accounting policies during the first three months of 2020, except for the change related to the adoption of Financial Instruments - Credit Losses (Topic 326) as described in below and Note 2.

The information included in this Form 10-Q should be read in conjunction with our 2019 Form 10-K.  Interim results are not necessarily indicative of results for a full year or any other interim period.

As a result of the adoption of Financial Instruments—Credit Losses (Topic 326) on January 1, 2020, the Company has updated the following significant accounting policies.

Securities: Debt securities are classified as held-to-maturity when the Company has the ability and positive intent to hold them to maturity.  Debt securities classified as available-for-sale are available for future liquidity requirements and may be sold prior to maturity.  Debt securities classified as trading are also available for future liquidity requirements and may be sold prior to maturity.  Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities, net of the allowance for credit losses- securities.  Debt securities classified as held-to-maturity are carried at cost, adjusted for amortization of premiums to the earliest callable date and accretion of discounts to maturity.  Debt securities classified as available-for-sale are measured at fair value.  Unrealized holding gains and losses on debt securities classified as available-for-sale are excluded from earnings and are reported net of tax as accumulated other comprehensive income (AOCI), a component of shareholders’ equity, until realized.  Debt securities classified as trading are also measured at fair value.  Unrealized holding gains and losses on securities classified as trading are included in earnings.  (See Note 9 for a more complete discussion of accounting for the fair value of financial instruments.)  Realized gains and losses on sale are computed on the specific identification method and are included in earnings on the trade date sold.

If debt securities were transferred from held-to-maturity to available-for-sale, unrealized gains or losses from the time of transfer would be accreted or amortized over the remaining life of the debt security based on the amount and timing of future estimated cash flows.  The accretion or amortization of the amount recorded in AOCI increases the carrying value of the investment and does not affect earnings.

Equity securities are measured at fair value with changes in the fair value recognized through net income and are reported in other assets.


12


Allowance for Credit Losses - Securities: Management measures expected credit losses on held-to-maturity debt securities on a collective basis by major security type. The Company’s held-to maturity portfolio contains mortgage-backed securities issued by U.S. government entities and agencies. These securities are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major rating agencies and have a long history of no credit losses. The Company’s held-to-maturity portfolio also contains municipal bonds that are typically rated by major rating agencies as Aa or better. The Company has never incurred a loss on a municipal bond, therefore the expectation of credit losses on these securities is small. The Company uses industry historical credit loss information adjusted for current conditions to establish the allowance for credit losses on the municipal bond portfolio. Less than 2% of the Company’s held-to-maturity portfolio are community development bonds representing pools of one- to four-family loans. The expected credit losses on these bonds is similar to Banner’s one- to four-family residential loan portfolio.

For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings.  If the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized costs, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security.  Projected cash flows are discounted by the current effective interest rate.  If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to AOCI.  

Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when management believes the non-collectability of an available-for-sale security is confirmed or when either of the criteria regarding intent of requirement to sell is met.

Loans Receivable:  The Banks originate residential one- to four-family and multifamily mortgage loans for both portfolio investment and sale in the secondary market.  The Banks also originate construction and land development, commercial real estate, commercial business, agricultural and consumer loans for portfolio investment.  Loans receivable not designated as held for sale are recorded at amortized cost, net of the allowance for credit losses. Amortized cost is the principal amount outstanding, net of deferred fees, discounts and premiums.  Accrued interest on loans is reported in accrued interest receivable on the consolidated statements of financial condition. Premiums, discounts and deferred loan fees are amortized to maturity using the level-yield methodology.

Loans Held for Sale. Residential one- to four-family and multifamily mortgage loans originated with the intent to be sold in the secondary market are considered held for sale. Residential one- to four-family loans under best effort delivery commitments are carried at the lower of aggregate cost or estimated market value. Residential one- to four-family loans under mandatory delivery commitments are carried at fair value in order to match changes in the value of the loans with the value of the related economic hedges on the loans. Fair values for residential mortgage loans held for sale are determined by comparing actual loan rates to current secondary market prices for similar loans. The multifamily held-for-sale loans are carried at fair value in order to match changes in the value of the loans with the value of the related economic hedges on the loans. Fair values for multifamily loans held for sale are calculated based on discounted cash flows using a discount rate that is a combination of market spreads for similar loan types added to selected index rates. Net unrealized losses on loans held for sale that are carried at lower of cost or market are recognized through the valuation allowance by charges to income.  Non-refundable fees and direct loan origination costs related to loans held for sale are recognized as part of the cost basis of the loan. Gains and losses on sales of loans held for sale are determined using the specific identification method and are recorded in the mortgage banking operations component of non-interest income.

Loans Acquired in Business Combinations: Loans acquired in business combinations, are recorded at their fair value at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased credit deteriorated or purchased non-credit-deteriorated. Purchased credit deteriorated (PCD) loans have experienced more than insignificant credit deterioration since origination. For PCD loans, an allowance for credit losses is determined at the acquisition date using the same measurement methodology as other loans held for investment. The initial allowance for credit losses determined on a collective basis is allocated to individual loans. The loan’s fair value grossed up for the allowance for credit losses becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through a provision for credit losses.

For purchased non-credit deteriorated loans, the difference between the fair value and unpaid principal balance of the loan at the acquisition date is amortized or accreted to interest income over the life of the loans. While credit discounts are included in the determination of the fair value for non-credit deteriorated loans, since these discounts are expected to be accreted over the life of the loans, they cannot be used to offset the allowance for credit losses that must be recorded at the acquisition date. As a result, an allowance for credit losses is determined at the acquisition date using the same methodology as other loans held for investment and is recognized as a provision for credit losses in the statement of operations. Any subsequent deterioration (improvement) in credit quality is recognized by recording (recapturing) a provision for credit losses.

Income Recognition on Nonaccrual Loans and Securities:  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 or principal and the loans are then placed on nonaccrual status.  Loans are reported as past due when installment payments,

13


interest payments, or maturity payments are past due based on contractual terms. All previously accrued but uncollected interest is written off by reversing 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 interest may be uncollectable.  While less common, similar interest reversal and nonaccrual treatment is applied to investment securities if their ultimate collectability becomes questionable. Loans modified due to the COVID-19 pandemic are considered current if they are less than 30 days past due on the contractual payments at the time the loan modification program was put in place and therefore continue to accrue interest unless the interest is being waived.

Provision and Allowance for Credit Losses - Loans:  The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. The Banks have elected to exclude accrued interest receivable from the amortized cost basis in their estimate of the allowance for credit losses. The provision for credit losses reflects the amount required to maintain the allowance for credit losses at an appropriate level based upon management’s evaluation of the adequacy of collective and individual loss reserves.  The Company has established systematic methodologies for the determination of the adequacy of the Company’s allowance for credit losses.  The methodologies are set forth in a formal policy and take into consideration the need for a valuation allowance for loans evaluated on a collective (pool) basis which have similar risk characteristics as well as allowances that are tied to individual loans that do not share risk characteristics.  The Company increases its allowance for credit losses by charging provisions for credit losses on its consolidated statement of operations. Losses related to specific assets are applied as a reduction of the carrying value of the assets and charged against the allowance for credit loss reserve when management believes the non-collectability of a loan balance is confirmed.  Recoveries on previously charged off loans are credited to the allowance for credit losses.  

Management estimates the allowance for credit losses using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The allowance for credit losses is maintained at a level sufficient to provide for expected credit losses over the life of the loan based on evaluating historical credit loss experience and making adjustments to historical loss information for differences in the specific risk characteristics in the current loan portfolio.  These factors include, among others, changes in the size and composition of the loan portfolio, differences in underwriting standards, delinquency rates, actual loss experience and current economic conditions.

The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. In estimating the component of the allowance for credit losses for loans that share common risk characteristics, loans are pooled based on loan type and areas of risk concentration. For loans evaluated collectively, the allowance for credit losses is calculated using life of loan historical losses adjusted for economic forecasts and current conditions.

For commercial real estate, multifamily real estate, construction and land, commercial business and agricultural loans with risk rating segmentation, historical credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and risk rating. For one- to four- family residential loans, historical credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and delinquency status. These models calculate an expected life-of-loan loss percentage for each loan category by calculating the probability of default, based on the migration of loans from performing to loss by risk rating or delinquency categories using historical life-of-loan analysis and the severity of loss, based on the aggregate net lifetime losses incurred for each loan pool. For commercial real estate, commercial business, and consumer loans without risk rating segmentation, historical credit loss assumptions are estimated using a model that calculates an expected life-of-loan loss percentage for each loan category by considering the historical cumulative losses based on the aggregate net lifetime losses incurred for each loan pool. The model captures historical loss data back to the first quarter of 2008. For loans evaluated collectively, management uses economic indicators to adjust the historical loss rates so that they better reflect management’s expectations of future conditions over the remaining lives of the loans in the portfolio based on reasonable and supportable forecasts. These economic indicators are selected based on correlation to the Company’s historical credit loss experience and are evaluated for each loan category. The economic indicators evaluated include unemployment, gross domestic product, real estate price indices and growth, yield curve spreads, treasury yields, the corporate yield, the market volatility index, the Dow Jones index, the consumer confidence index, and the prime rate. Management considers various economic scenarios and forecasts when evaluating the economic indicators and probability weights the various scenarios to arrive at the forecast that most reflects management’s expectations of future conditions. The allowance for credit losses is then adjusted for the period in which those forecasts are considered to be reasonable and supportable. To the extent the lives of the loans in the portfolio extend beyond the period for which a reasonable and supportable forecast can be made, the adjustments discontinue to be applied so that the model reverts back to the historical loss rates using a straight line reversion method. Management selected an initial reasonable and supportable forecast period of 12 months with a reversion period of 12 months. Both the reasonable and supportable forecast period and the reversion period are periodically reviewed by management.

Further, for loans evaluated collectively, management also considers qualitative and environmental factors for each loan category to adjust for differences between the historical periods used to calculate historical loss rates and expected conditions over the remaining lives of the loans in the portfolio. In determining the aggregate adjustment needed management considers the financial condition of the borrowers, the nature and volume of the loans, the remaining terms and the extent of prepayments on the loans, the volume and severity of past due and classified loans as well as the value of the underlying collateral on loans in which the collateral dependent practical expedient has not been used. Management also considers the Company’s lending policies, the quality of the Company’s credit review system, the quality of the Company’s management and lending staff, and the regulatory and economic environments in the areas in which the Company’s lending activities are concentrated.

Loans that do not share risk characteristics with other loans in the portfolio are individually evaluated for impairment are not included in the collective evaluation.  Factors involved in determining whether a loan should be individually evaluated include, but are not limited to, the financial condition of the borrower and the value of the underlying collateral.  Expected credit losses for loans evaluated individually are measured

14


based on the present value of expected future cash flows discounted at the loan’s original effective interest rate or when the Banks determine that foreclosure is probable, the expected credit loss is measured based on the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. As a practical expedient, the Banks measure the expected credit loss for a loan using the fair value of the collateral, if repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty based on the Banks' assessment as of the reporting date.

In both cases, if the fair value of the collateral is less than the amortized cost basis of the loan, the Banks will recognize an allowance as the difference between the fair value of the collateral, less costs to sell (if applicable), at the reporting date and the amortized cost basis of the loan. If the fair value of the collateral exceeds the amortized cost basis of the loan, any expected recovery added to the amortized cost basis will be limited to the amount previously charged-off . Subsequent changes in the expected credit losses for loans evaluated individually are included within the provision for credit losses in the same manner in which the expected credit loss initially was recognized or as a reduction in the provision that would otherwise be reported.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Banks.

Some of the Banks’ loans are reported as troubled debt restructures (TDRs).  Loans are reported as TDRs when the Banks grant a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider.  Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk.  The allowance for credit losses on a TDR is determined using the same method as all other loans held for investment, except when the value of the concession cannot be measured using a method other than the discounted cash flow method. When the value of a concession is measured using the discounted cash flow method the allowance for credit losses is determined by discounting the expected future cash flows at the original interest rate of the loan.

The CARES Act provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act if they are less than 30 days past due on their contractual payments at the time a modification program is implemented.

Loan Origination and Commitment Fees:  Loan origination fees, net of certain specifically defined direct loan origination costs, are deferred and recognized as an adjustment of the loans’ interest yield using the level-yield method over the contractual term of each loan adjusted for actual loan prepayment experience.  Net deferred fees or costs related to loans held for sale are recognized as part of the cost basis of the loan.  Loan commitment fees are deferred until the expiration of the commitment period unless management believes there is a remote likelihood that the underlying commitment will be exercised, in which case the fees are amortized to fee income using the straight-line method over the commitment period.  If a loan commitment is exercised, the deferred commitment fee is accounted for in the same manner as a loan origination fee.  Deferred commitment fees associated with expired commitments are recognized as fee income.

Allowance for Credit Losses - unfunded loan commitments: An allowance for credit losses - unfunded loan commitments is maintained at a level that, in the opinion of management, is adequate to absorb expected credit losses associated with the contractual life of the Banks' commitments to lend funds under existing agreements such as letters or lines of credit. The Banks use a methodology for determining the allowance for credit losses - unfunded loan commitments that applies the same segmentation and loss rate to each pool as the funded exposure adjusted for probability of funding. Draws on unfunded loan commitments that are considered uncollectible at the time funds are advanced are charged to the allowance for credit losses on off-balance sheet exposures. Provisions for credit losses - unfunded loan commitments are recognized in non-interest expense and added to the allowance for credit losses - unfunded loan commitments, which is included in other liabilities in the consolidated statements of financial condition.


15


Note 2:  ACCOUNTING STANDARDS RECENTLY ISSUED OR ADOPTED

Financial Instruments—Credit Losses (Topic 326)

On January 1, 2020, the Company adopted the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred loss methodology that delays recognition until it is probable a loss has been incurred with an expected loss methodology that is referred to as CECL. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The ASU affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial asset not excluded from the scope that have the contractual right to receive cash. The ASU replaces the incurred loss impairment methodology in previous GAAP with CECL, a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU requires a financial asset (or group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This ASU broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss, which will be more decision useful to users of the financial statements. The following table illustrates the pre-tax impact of the adoption of this ASU (in thousands):

 
January 1, 2020 As Reported Under Topic 326
 
January 1, 2020 Pre-Topic 326 Adoption
 
Impact of Topic 326 Adoption
Assets
 
 
 
 
 
Held-to-maturity debt securities
 
 
 
 
 
U.S. Government and agency obligations
$

 
$

 
$

Municipal bonds
28

 

 
28

Corporate bonds
35

 

 
35

Mortgage-backed or related securities

 

 

Allowance for credit losses on held-to-maturity debt securities
$
63

 
$

 
$
63

 
 
 
 
 
 
Loans
 
 
 
 
 
Commercial real estate
$
27,727

 
$
30,591

 
$
(2,864
)
Multifamily real estate
2,550

 
4,754

 
(2,204
)
Construction and land
25,509

 
22,994

 
2,515

Commercial business
26,380

 
23,370

 
3,010

Agricultural business
3,769

 
4,120

 
(351
)
One-to four-family residential
11,261

 
4,136

 
7,125

Consumer
11,175

 
8,202

 
2,973

Unallocated

 
2,392

 
(2,392
)
Allowance for credit losses on loans
$
108,371

 
$
100,559

 
$
7,812

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Allowance for credit losses on unfunded loan commitments
$
9,738

 
$
2,716

 
$
7,022

 
 
 
 
 
 
Total
 
 
 
 
$
14,897

 
 
 
 
 
 

The $14.9 million total increase was recorded net of tax as an $11.2 million reduction to shareholders' equity as of the adoption date. In addition to the increase in the allowance for credit losses upon adoption, the Company expects more variability in its quarterly provision for credit losses going forward due to the CECL model’s sensitivity to changes in the economic forecast and other factors. The Company has updated its accounting policies based on the adoption of this ASU. See Note 1 of the Notes to the Consolidated Financial Statements for additional information.

Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40)

16



In August 2018, FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The amendments in this ASU broaden the scope of ASC Subtopic 350-40 to include costs incurred to implement a hosting arrangement that is a service contract. The amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The costs are capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred, consistent with the accounting for costs for internal-use software. The amendments in this ASU result in consistent capitalization of implementation costs of a hosting arrangement that is a service contract and implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this ASU. The Company adopted this ASU effective January 1, 2020. The adoption of this ASU did not have a material impact on the Company’s Consolidated Financial Statements.

Fair Value Measurement (Topic 820)

In August 2018, FASB issued ASU 2018-13, Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The ASU removes, modifies and adds disclosure requirements in Topic 820. The following disclosure requirements were removed: 1) the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, 2) the policy for timing of transfers between levels, and 3) the valuation processes for Level 3 fair value measurements. This ASU modified disclosure requirements by requiring: that the measurement uncertainty disclosure communicates information about the uncertainty in measurement as of the reporting date. The following disclosure requirements were added: 1) changes in unrealized gains and losses for the period included in other comprehensive income for the recurring Level 3 fair value measurements held at the end of the reporting period, and 2) the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The Company adopted this ASU effective January 1, 2020. The adoption of this ASU did not have a material impact on the Company’s Consolidated Financial Statements.

NOTE 3: BUSINESS COMBINATION
Acquisition of AltaPacific Bancorp
On November 1, 2019, the Company completed the acquisition of 100% of the outstanding common shares of AltaPacific Bancorp (AltaPacific), the holding company for AltaPacific Bank, a California state-chartered commercial bank. AltaPacific was merged into Banner and AltaPacific Bank was merged into Banner Bank. Pursuant to the previously announced terms of the acquisition, AltaPacific shareholders received 0.2712 shares of Banner common stock in exchange for each share of AltaPacific common stock, plus cash in lieu of any fractional shares and to cancel in-the-money AltaPacific stock options. The merged banks operate as Banner Bank. The primary reason for the acquisition was to expand the Company's presence in California by adding density within our existing geographic footprint. The acquisition provided $425.7 million in assets, $313.4 million in deposits and $332.4 million in loans to Banner.

The application of the acquisition method of accounting resulted in recognition of a CDI asset of $4.6 million and goodwill of $34.0 million. The acquired CDI has been determined to have a useful life of approximately ten years and will be amortized on an accelerated basis. Goodwill is not amortized but will be evaluated for impairment on an annual basis or more often if circumstances dictate to determine if the carrying value remains appropriate. Goodwill will not be deductible for income tax purposes as the acquisition is accounted for as a tax-free exchange for tax purposes.


17


The following table presents a summary of the consideration paid and the estimated fair values as of the acquisition date for each major class of assets acquired and liabilities assumed (in thousands):
 
AltaPacific
 
November 1, 2019
Consideration to AltaPacific equity holders:
 
 
Cash paid
 
$
2,360

Fair value of common shares issued
 
85,200

Total consideration
 
87,560

 
 
 
Fair value of assets acquired:
 
 
Cash and cash equivalents
39,686

 
Securities
20,348

 
Federal Home Loan Bank stock
2,005

 
Loans receivable (contractual amount of $338.2 million)
332,355

 
Real estate owned held for sale
650

 
Property and equipment
3,809

 
Core deposit intangible
4,610

 
Bank-owned life insurance
11,890

 
Deferred tax asset
166

 
Other assets
10,150

 
Total assets acquired
425,669

 
 
 
 
Fair value of liabilities assumed:
 
 
Deposits
313,374

 
Advances from FHLB
40,226

 
Junior subordinated debentures
5,814

 
Deferred compensation
4,508

 
Other liabilities
8,154

 
Total liabilities assumed
372,076

 
 
 
 
Net assets acquired
 
53,593

Goodwill
 
$
33,967


Acquired goodwill represents the premium the Company paid over the fair value of the net tangible and intangible assets acquired. The Company paid this premium for a number of reasons, including growing the Company's customer base, acquiring assembled workforces, and expanding its presence in existing markets. See Note 7, Goodwill, Other Intangible Assets and Mortgage Servicing Rights for the accounting for goodwill and other intangible assets.
Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available. Additional adjustments to the acquisition accounting that may be required would most likely involve loans, property and equipment, or the deferred tax asset. As of November 1, 2019, the unpaid principal balance on purchased non-credit-impaired loans was $333.5 million. The fair value of the purchased non-credit-impaired loans was $328.2 million, resulting in a discount of $5.3 million recorded on these loans, which includes $5.8 million of a credit related discount. This discount is being accreted into income over the life of the loans on an effective yield basis.

18


The following table presents the acquired AltaPacific purchased credit-impaired (PCI) loans as of the acquisition date (in thousands):
 
AltaPacific
 
November 1, 2019
Acquired PCI loans:
 
Contractually required principal and interest payments
$
5,881

Nonaccretable difference
(1,046
)
Cash flows expected to be collected
4,835

Accretable yield
(683
)
Fair value of PCI loans
$
4,152


The financial results of the Company include the revenues and expenses produced by the acquired assets and assumed liabilities of AltaPacific since November 1, 2019. Disclosure of the amount of AltaPacific's revenue and net income (excluding integration costs) included in the Company’s consolidated statements of operations is impracticable due to the integration of the operations and accounting for this acquisition. The pro forma impact of the AltaPacific acquisition to the historical financial results was determined to not be significant.





19


Note 4:  SECURITIES

The amortized cost, gross unrealized gains and losses and estimated fair value of securities at March 31, 2020 and December 31, 2019 are summarized as follows (in thousands):
 
March 31, 2020
 
Amortized Cost
 
Fair
Value
Trading:
 
 
 
Corporate bonds
$
27,203

 
$
21,040

 
$
27,203

 
$
21,040

 
March 31, 2020
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Allowance for Credit Losses
 
Fair
Value
Available-for-Sale:
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
82,197

 
$
520

 
$
(954
)
 
$

 
$
81,763

Municipal bonds
171,486

 
9,726

 
(173
)
 

 
181,039

Corporate bonds
30,094

 
1,101

 
(209
)
 

 
30,986

Mortgage-backed or related securities
1,252,606

 
54,711

 
(518
)
 

 
1,306,799

Asset-backed securities
8,130

 

 
(493
)
 

 
7,637

 
$
1,544,513

 
$
66,058

 
$
(2,347
)
 
$

 
$
1,608,224

 
March 31, 2020
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair
Value
 
Allowance for Credit Losses
Held-to-Maturity:
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
373

 
$
8

 
$

 
$
381

 
$

Municipal bonds
380,483

 
10,830

 
(2,292
)
 
389,021

 
61

Corporate bonds
3,325

 

 
(10
)
 
3,315

 
37

Mortgage-backed or related securities
53,763

 
2,769

 
(12
)
 
56,520

 

 
$
437,944

 
$
13,607

 
$
(2,314
)
 
$
449,237

 
$
98


20




 
December 31, 2019
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair
Value
Trading:
 
 
 
 
 
 
 
Corporate bonds
$
27,203

 
 
 
 
 
$
25,636

 
$
27,203

 
 
 
 
 
$
25,636

Available-for-Sale:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
90,468

 
$
286

 
$
(1,156
)
 
$
89,598

Municipal bonds
101,927

 
5,233

 
(3
)
 
107,157

Corporate bonds
4,357

 
14

 
(6
)
 
4,365

Mortgage-backed or related securities
1,324,999

 
20,325

 
(3,013
)
 
1,342,311

Asset-backed securities
8,195

 

 
(69
)
 
8,126

 
$
1,529,946

 
$
25,858

 
$
(4,247
)
 
$
1,551,557

Held-to-Maturity:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
385

 
$
4

 
$

 
$
389

Municipal bonds
177,208

 
3,733

 
(2,213
)
 
178,728

Corporate bonds
3,353

 

 
(11
)
 
3,342

Mortgage-backed or related securities
55,148

 
921

 
(723
)
 
55,346

 
$
236,094

 
$
4,658

 
$
(2,947
)
 
$
237,805



Accrued interest receivable on held-to-maturity debt securities was $2.8 million and $1.1 million as of March 31, 2020 and December 31, 2019, respectively, and was $5.8 million and $4.8 million on available-for-sale debt securities as of March 31, 2020 and December 31, 2019, respectively. Accrued interest receivable on securities is reported in accrued interest receivable on the consolidated statements of financial condition and is excluded from the calculation of the allowance for credit losses.

At March 31, 2020, the gross unrealized losses and the fair value for securities available-for-sale aggregated by the length of time that individual securities have been in a continuous unrealized loss position were as follows (in thousands):
 
March 31, 2020
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
2,575

 
$
(18
)
 
$
56,531

 
$
(936
)
 
$
59,106

 
$
(954
)
Municipal bonds
11,767

 
(173
)
 

 

 
11,767

 
(173
)
Corporate bonds
4,148

 
(209
)
 

 

 
4,148

 
(209
)
Mortgage-backed or related securities
42,545

 
(487
)
 
7,218

 
(31
)
 
49,763

 
(518
)
Asset-backed securities
1,371

 
(53
)
 
5,871

 
(440
)
 
7,242

 
(493
)
 
$
62,406

 
$
(940
)
 
$
69,620

 
$
(1,407
)
 
$
132,026

 
$
(2,347
)



21


At December 31, 2019, the gross unrealized losses and the fair value for securities available-for-sale and held-to-maturity aggregated by the length of time that individual securities have been in a continuous unrealized loss position were as follows (in thousands):
 
December 31, 2019
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
2,747

 
$
(20
)
 
$
60,979

 
$
(1,136
)
 
$
63,726

 
$
(1,156
)
Municipal bonds
1,902

 

 
494

 
(3
)
 
2,396

 
(3
)
Corporate bonds
594

 
(6
)
 

 

 
594

 
(6
)
Mortgage-backed or related securities
300,852

 
(2,829
)
 
33,360

 
(184
)
 
334,212

 
(3,013
)
Asset-backed securities
1,204

 
(17
)
 
5,989

 
(52
)
 
7,193

 
(69
)
 
$
307,299

 
$
(2,872
)
 
$
100,822

 
$
(1,375
)
 
$
408,121

 
$
(4,247
)
Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$

 
$

 
$

 
$

 
$

 
$

Municipal bonds
44,605

 
(1,889
)
 
19,017

 
(324
)
 
63,622

 
(2,213
)
Corporate bonds

 

 
489

 
(11
)
 
489

 
(11
)
Mortgage-backed or related securities
11,117

 
(723
)
 

 

 
11,117

 
(723
)
 
$
55,722

 
$
(2,612
)
 
$
19,506

 
$
(335
)
 
$
75,228

 
$
(2,947
)

At March 31, 2020, there were 59 securities—available-for-sale with unrealized losses, compared to 90 at December 31, 2019.  At December 31, 2019, there were 17 securities—held-to-maturity with unrealized losses.  Management does not believe that any individual unrealized loss as of March 31, 2020 resulted from credit loss or that any individual unrealized loss represented other-than-temporary impairment (OTTI) as of December 31, 2019.  The decline in fair market value of these securities was generally due to changes in interest rates and changes in market-desired spreads subsequent to their purchase.

There were no sales of securities—trading during the three months ended March 31, 2020 or 2019. There were no securities—trading in a nonaccrual status at March 31, 2020 or December 31, 2019.  Net unrealized holding losses of $4.6 million were recognized during the three months ended March 31, 2020 compared to $58,000 of net unrealized holding losses recognized during the three months ended March 31, 2019.

There were 10 sales of securities—available-for-sale during the three months ended March 31, 2020, with a net gain of $78,000.  There was one sale of securities—available-for-sale during the three months ended March 31, 2019, which resulted in a net gain of $1,000. There were no securities—available-for-sale in a nonaccrual status at March 31, 2020 or December 31, 2019.

There were no sales of securities—held-to-maturity during the three months ended March 31, 2020 or 2019. There were no securities—held-to-maturity in a nonaccrual status or 30 days or more past due at March 31, 2020 or December 31, 2019.

The amortized cost and estimated fair value of securities at March 31, 2020, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or without call or prepayment penalties.
 
March 31, 2020
 
Trading
 
Available-for-Sale
 
Held-to-Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Maturing in one year or less
$

 
$

 
$
2,500

 
$
2,496

 
$
807

 
$
808

Maturing after one year through five years

 

 
66,644

 
68,453

 
59,949

 
61,827

Maturing after five years through ten years

 

 
352,386

 
370,139

 
44,006

 
46,085

Maturing after ten years through twenty years
27,203

 
21,040

 
265,561

 
277,549

 
124,627

 
126,785

Maturing after twenty years

 

 
857,422

 
889,587

 
208,555

 
213,732

 
$
27,203

 
$
21,040

 
$
1,544,513

 
$
1,608,224

 
$
437,944

 
$
449,237




22


The following table presents, as of March 31, 2020, investment securities which were pledged to secure borrowings, public deposits or other obligations as permitted or required by law (in thousands):
 
March 31, 2020
 
Carrying Value
 
Amortized Cost
 
Fair
Value
Purpose or beneficiary:
 
 
 
 
 
State and local governments public deposits
$
155,588

 
$
154,453

 
$
160,654

Interest rate swap counterparties
28,049

 
26,923

 
28,432

Repurchase agreements
153,285

 
147,608

 
153,286

Other
2,665

 
2,665

 
2,733

Total pledged securities
$
339,587

 
$
331,649

 
$
345,105



The Company monitors the credit quality of held-to-maturity debt securities through the use of credit rating. Credit ratings are reviewed and updated quarterly. The following table summarizes the amortized cost of held-to-maturity debt securities by credit rating at March 31, 2020 (in thousands):

 
March 31, 2020
 
U.S. Government and agency obligations
 
Municipal bonds
 
Corporate bonds
 
Mortgage-backed or related securities
 
Total
AAA/AA/A
$

 
$
348,662

 
$
500

 
$

 
$
349,162

BBB/BB/B

 

 

 

 

Not Rated
373

 
31,821

 
2,825

 
53,763

 
88,782

 
$
373

 
$
380,483

 
$
3,325

 
$
53,763

 
$
437,944



The following table presents the activity in the allowance for credit losses for held-to-maturity debt securities by major type for the three months ended March 31, 2020 (in thousands):

 
Three Months Ended
March 31, 2020
 
U.S. Government and agency obligations
 
Municipal bonds
 
Corporate bonds
 
Mortgage-backed or related securities
 
Total
Allowance for credit losses - securities
 
 
 
 
 
 
 
 
 
Beginning Balance
$

 
$

 
$

 
$

 
$

Impact of adopting ASC 326

 
28

 
35

 

 
63

Provision for credit losses

 
33

 
2

 

 
35

Securities charged-off

 

 

 

 

Recoveries

 

 

 

 

Ending Balance
$

 
$
61

 
$
37

 
$

 
$
98




23


Note 5: LOANS RECEIVABLE AND THE ALLOWANCE FOR CREDIT LOSSES - LOANS

As a result of the adoption of Financial Instruments - Credit Losses (Topic 326), effective January 1, 2020, the Company changed the segmentation of its loan portfolio based on the common risk characteristics used to measure the allowance for credit losses.  The following table presents the loans receivable at March 31, 2020 and December 31, 2019 by class (dollars in thousands). The presentation of loans receivable at December 31, 2019 has been updated to conform to the loan portfolio segmentation that became effective on January 1, 2020.
 
March 31, 2020
 
December 31, 2019
 
Amount
 
Percent of Total
 
Amount
 
Percent of Total
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
1,024,089

 
11.0
%
 
$
980,021

 
10.5
%
Investment properties
2,007,537

 
21.6

 
2,024,988

 
21.8

Small balance CRE
591,783

 
6.4

 
613,484

 
6.6

Multifamily real estate
400,206

 
4.3

 
388,388

 
4.2

Construction, land and land development:
 
 
 
 
 
 
 
Commercial construction
205,476

 
2.2

 
210,668

 
2.3

Multifamily construction
250,410

 
2.7

 
233,610

 
2.5

One- to four-family construction
534,956

 
5.8

 
544,308

 
5.8

Land and land development
232,506

 
2.5

 
245,530

 
2.6

Commercial business:
 
 
 
 
 
 
 
Commercial business
1,357,817

 
14.6

 
1,364,650

 
14.7

Small business scored
807,539

 
8.7

 
772,657

 
8.3

Agricultural business, including secured by farmland
330,257

 
3.6

 
337,271

 
3.6

One- to four-family residential
881,387

 
9.5

 
925,531

 
9.9

Consumer:
 
 
 
 
 
 
 
Consumer—home equity revolving lines of credit
521,618

 
5.6

 
519,336

 
5.6

Consumer—other
140,163

 
1.5

 
144,915

 
1.6

Total loans
9,285,744

 
100.0
%
 
9,305,357

 
100.0
%
Less allowance for credit losses - loans
(130,488
)
 
 

 
(100,559
)
 
 

Net loans
$
9,155,256

 
 

 
$
9,204,798

 
 




24


The presentation of loans receivable at December 31, 2019 in the table below is based on loan segmentation as presented in the 2019 Form 10-K.
 
December 31, 2019
 
Amount
 
Percent of Total
Commercial real estate:
 
 
 
Owner-occupied
$
1,580,650

 
17.0
%
Investment properties
2,309,221

 
24.8

Multifamily real estate
473,152

 
5.1

Commercial construction
210,668

 
2.3

Multifamily construction
233,610

 
2.5

One- to four-family construction
544,308

 
5.8

Land and land development:
 
 
 
Residential
154,688

 
1.7

Commercial
26,290

 
0.3

Commercial business
1,693,824

 
18.2

Agricultural business, including secured by farmland
370,549

 
4.0

One- to four-family residential
945,622

 
10.2

Consumer:
 
 
 
Consumer secured by one- to four-family
550,960

 
5.8

Consumer—other
211,815

 
2.3

Total loans
9,305,357

 
100.0
%
Less allowance for loan losses
(100,559
)
 
 
Net loans
$
9,204,798

 
 

Loan amounts are net of unearned loan fees in excess of unamortized costs of $451,000 as of March 31, 2020 and $438,000 as of December 31, 2019. Net loans include net discounts on acquired loans of $22.2 million and $25.0 million as of March 31, 2020 and December 31, 2019, respectively. Net loans does not include accrued interest receivable. Accrued interest receivable on loans was $32.0 million as of March 31, 2020 and $31.8 million as of December 31, 2019 and was reported in accrued interest receivable on the consolidated statements of financial condition.

Purchased credit deteriorated and purchased non-credit-deteriorated loans. Loans acquired in business combinations are recorded at their fair value at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased credit-deteriorated (PCD) or purchased non-credit-deteriorated. There were no PCD loans acquired for the three months ended March 31, 2020.
Purchased credit-impaired loans and purchased non-credit-impaired loans. Prior to the implementation of Financial Instruments—Credit Losses (Topic 326) on January 1, 2020, acquired loans were evaluated upon acquisition and classified as either purchased credit-impaired (PCI) or purchased non-credit-impaired. PCI loans reflected credit deterioration since origination such that it was probable at acquisition that the Company would be unable to collect all contractually required payments. The outstanding contractual unpaid principal balance of PCI loans, excluding acquisition accounting adjustments, was $23.5 million at December 31, 2019. The carrying balance of PCI loans was $15.9 million at December 31, 2019. These loans were converted to PCD loans on January 1, 2020.
The following table presents the changes in the accretable yield for PCI loans for the three months ended March 31, 2019 (in thousands):
 
Three Months Ended
March 31,
 
2019
Balance, beginning of period
$
5,216

Accretion to interest income
(493
)
Disposals

Reclassifications from non-accretable difference
55

Balance, end of period
$
4,778



As of December 31, 2019, the non-accretable difference between the contractually required payments and cash flows expected to be collected was $7.4 million.


25


Impaired Loans and the Allowance for Loan Losses.  Prior to the implementation of Financial Instruments—Credit Losses (Topic 326) on January 1, 2020, a loan was considered impaired when, based on current information and circumstances, the Company determines it was probable that it would be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments.  Factors involved in determining impairment included, but were not limited to, the financial condition of the borrower, the value of the underlying collateral and the status of the economy. Impaired loans were comprised of loans on nonaccrual, TDRs that were performing under their restructured terms, and loans that were 90 days or more past due, but were still on accrual. PCI loans were considered performing within the scope of the purchased credit-impaired accounting guidance and were not included in the impaired loan tables.

The following table provides information on impaired loans, excluding PCI loans, with and without allowance reserves at December 31, 2019. Recorded investment includes the unpaid principal balance or the carrying amount of loans less charge-offs and net deferred loan fees (in thousands):
 
December 31, 2019
 
Unpaid Principal Balance
 
Recorded Investment
 
Related Allowance
 
 
Without Allowance (1)
 
With Allowance (2)
 
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
4,185

 
$
3,816

 
$
194

 
$
18

Investment properties
3,536

 
1,883

 
690

 
40

Multifamily real estate
82

 
85

 

 

Multifamily construction
573

 
98

 

 

One- to four-family construction
1,799

 
1,799

 

 

Land and land development:
 
 
 
 
 
 
 
Residential
676

 
340

 

 

Commercial business
25,117

 
4,614

 
19,330

 
4,128

Agricultural business/farmland
3,044

 
661

 
2,243

 
141

One- to four-family residential
7,290

 
5,613

 
1,648

 
41

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
3,081

 
2,712

 
127

 
5

Consumer—other
222

 
159

 
52

 
1

 
$
49,605

 
$
21,780

 
$
24,284

 
$
4,374


(1) 
Includes loans without an allowance reserve that had been individually evaluated for impairment and that evaluation concluded that no reserve was needed, and $13.5 million of homogeneous and small balance loans, as of December 31, 2019, that were collectively evaluated for impairment for which a general reserve was established.
(2) 
Loans with a specific allowance reserve were individually evaluated for impairment using either a discounted cash flow analysis or, for collateral dependent loans, current appraisals less costs to sell to establish realizable value.

26



The following table summarizes our average recorded investment and interest income recognized on impaired loans by loan class for the three months ended March 31, 2019 (in thousands):
 
 
Three Months Ended
March 31, 2019
 
 
Average Recorded Investment
 
Interest Income Recognized
Commercial real estate:
 
 
 
 
Owner-occupied
 
$
3,451

 
$
2

Investment properties
 
7,227

 
76

Commercial construction
 
1,427

 

One- to four-family construction
 
919

 

Land and land development:
 
 
 
 
Residential
 
726

 

Commercial business
 
3,803

 
5

Agricultural business/farmland
 
5,117

 
27

One- to four-family residential
 
6,446

 
65

Consumer:
 
 
 
 
Consumer secured by one- to four-family
 
2,063

 
5

Consumer—other
 
319

 
1

 
 
$
31,498

 
$
181



Troubled Debt Restructurings. Loans are reported as TDRs when the bank grants one or more concessions to a borrower experiencing financial difficulties that it would not otherwise consider.  Our TDRs have generally not involved forgiveness of amounts due, but almost always include a modification of multiple factors; the most common combination includes interest rate, payment amount and maturity date.

As of March 31, 2020 and December 31, 2019, the Company had TDRs of $13.1 million and $8.0 million, respectively, and commitments to advance additional funds related to TDRs up to $1.2 million and none, respectively.

The following table presents new TDRs that occurred during the three months ended March 31, 2020 and March 31, 2019 (dollars in thousands):
 
Three months ended March 31, 2020
 
Number of
Contracts
 
Pre-
modification Outstanding
Recorded
 Investment
 
Post-
modification Outstanding
Recorded
Investment
Recorded Investment
 
 
 
 
 
Commercial business:
 
 
 
 
 
Commercial business
2

 
4,796

 
4,796

Total
2

 
$
4,796

 
$
4,796

 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2019
 
Number of
Contracts
 
Pre-
modification Outstanding
Recorded
Investment
 
Post-
modification Outstanding
Recorded
Investment
Recorded Investment
 

 
 

 
 

Commercial real estate
 

 
 

 
 

Investment properties
1

 
1,090

 
1,090

 
1

 
$
1,090

 
$
1,090



There were no TDRs which incurred a payment default within twelve months of the restructure date during the three-month periods ended March 31, 2020 and 2019. A default on a TDR results in either a transfer to nonaccrual status or a partial charge-off, or both.


27


Credit Quality Indicators:  To appropriately and effectively manage the ongoing credit quality of the Company’s loan portfolio, management has implemented a risk-rating or loan grading system for its loans.  The system is a tool to evaluate portfolio asset quality throughout each applicable loan’s life as an asset of the Company.  Generally, loans are risk rated on an aggregate borrower/relationship basis with individual loans sharing similar ratings.  There are some instances when specific situations relating to individual loans will provide the basis for different risk ratings within the aggregate relationship.  Loans are graded on a scale of 1 to 9.  A description of the general characteristics of these categories is shown below:

Overall Risk Rating Definitions:  Risk-ratings contain both qualitative and quantitative measurements and take into account the financial strength of a borrower and the structure of the loan or lease.  Consequently, the definitions are to be applied in the context of each lending transaction and judgment must also be used to determine the appropriate risk rating, as it is not unusual for a loan or lease to exhibit characteristics of more than one risk-rating category.  Consideration for the final rating is centered in the borrower’s ability to repay, in a timely fashion, both principal and interest.  The Company's risk-rating and loan grading policies are reviewed and approved annually. There were no material changes in the risk-rating or loan grading system for the periods presented.

Risk Ratings 1-5: Pass
Credits with risk ratings of 1 to 5 meet the definition of a pass risk rating. The strength of credits vary within the pass risk ratings, ranging from a risk rated 1 being an exceptional credit to a risk rated 5 being an acceptable credit that requires a more than normal level of supervision.

Risk Rating 6: Special Mention
A credit with potential weaknesses that deserves management’s close attention is risk rated a 6.  If left uncorrected, these potential weaknesses will result in deterioration in the capacity to repay debt.  A key distinction between Special Mention and Substandard is that in a Special Mention credit, there are identified weaknesses that pose potential risk(s) to the repayment sources, versus well defined weaknesses that pose risk(s) to the repayment sources.  Assets in this category are expected to be in this category no more than 9-12 months as the potential weaknesses in the credit are resolved.

Risk Rating 7: Substandard
A credit with well defined weaknesses that jeopardize the ability to repay in full is risk rated a 7.  These credits are inadequately protected by either the sound net worth and payment capacity of the borrower or the value of pledged collateral.  These are credits with a distinct possibility of loss.  Loans headed for foreclosure and/or legal action due to deterioration are rated 7 or worse.

Risk Rating 8: Doubtful
A credit with an extremely high probability of loss is risk rated 8.  These credits have all the same critical weaknesses that are found in a substandard loan; however, the weaknesses are elevated to the point that based upon current information, collection or liquidation in full is improbable.  While some loss on doubtful credits is expected, pending events may make the amount and timing of any loss indeterminable.  In these situations taking the loss is inappropriate until the outcome of the pending event is clear.

Risk Rating 9: Loss
A credit that is considered to be currently uncollectible or of such little value that it is no longer a viable bank asset is risk rated 9.  Losses should be taken in the accounting period in which the credit is determined to be uncollectible.  Taking a loss does not mean that a credit has absolutely no recovery or salvage value but, rather, it is not practical or desirable to defer writing off the credit, even though partial recovery may occur in the future.


28


The following tables present the Company’s portfolio of risk-rated loans by grade as of March 31, 2020 (in thousands). Revolving loans that are converted to term loans are treated as new originations in the table below and are presented by year of origination.
 
March 31, 2020
 
Term Loans by Year of Origination
 
Revolving Loans
 
Total Loans
By class:
2020
 
2019
 
2018
 
2017
 
2016
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate - owner occupied
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
86,515

 
$
209,528

 
$
171,907

 
$
133,579

 
$
109,177

 
$
280,979

 
$
7,927

 
$
999,612

Special Mention

 
2,438

 
1,369

 
2,353

 

 
103

 

 
6,263

Substandard

 
500

 

 
5,805

 
1,295

 
10,614

 

 
18,214

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Commercial real estate - owner occupied
$
86,515

 
$
212,466

 
$
173,276

 
$
141,737

 
$
110,472

 
$
291,696

 
$
7,927

 
$
1,024,089

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate - investment properties
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
42,548

 
$
296,128

 
$
347,941

 
$
309,865

 
$
328,239

 
$
631,602

 
$
30,284

 
$
1,986,607

Special Mention

 
3,360

 

 

 

 
976

 

 
4,336

Substandard

 
3,934

 
2,405

 

 
442

 
9,813

 

 
16,594

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Commercial real estate - investment properties
$
42,548

 
$
303,422

 
$
350,346

 
$
309,865

 
$
328,681

 
$
642,391

 
$
30,284

 
$
2,007,537

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
21,907

 
$
72,099

 
$
45,457

 
$
102,668

 
$
47,554

 
$
108,743

 
$
1,778

 
$
400,206

Special Mention

 

 

 

 

 

 

 

Substandard

 

 

 

 

 

 

 

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Multifamily real estate
$
21,907

 
$
72,099

 
$
45,457

 
$
102,668

 
$
47,554

 
$
108,743

 
$
1,778

 
$
400,206

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


29


 
March 31, 2020
 
Term Loans by Year of Origination
 
Revolving Loans
 
Total Loans
By class:
2020
 
2019
 
2018
 
2017
 
2016
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial construction
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
17,290

 
$
101,679

 
$
55,535

 
$
9,326

 
$
2,231

 
$
1,599

 
$

 
$
187,660

Special Mention

 

 
6,197

 

 

 

 

 
6,197

Substandard

 
11,521

 

 

 
98

 

 

 
11,619

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Commercial construction
$
17,290

 
$
113,200

 
$
61,732

 
$
9,326

 
$
2,329

 
$
1,599

 
$

 
$
205,476

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily construction
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
39,395

 
$
115,501

 
$
76,925

 
$
12,945

 
$

 
$

 
$
5,644

 
$
250,410

Special Mention

 

 

 

 

 

 

 

Substandard

 

 

 

 

 

 

 

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Multifamily construction
$
39,395

 
$
115,501

 
$
76,925

 
$
12,945

 
$

 
$

 
$
5,644

 
$
250,410

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four- family construction
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
143,457

 
$
357,179

 
$
11,536

 
$

 
$
7

 
$

 
$
5,058

 
$
517,237

Special Mention
2,254

 
13,540

 

 

 

 

 
630

 
16,424

Substandard

 
1,295

 

 

 

 

 

 
1,295

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total One- to four- family construction
$
145,711

 
$
372,014

 
$
11,536

 
$

 
$
7

 
$

 
$
5,688

 
$
534,956

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

30


 
March 31, 2020
 
Term Loans by Year of Origination
 
Revolving Loans
 
Total Loans
By class:
2020
 
2019
 
2018
 
2017
 
2016
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land and land development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
36,452

 
$
126,901

 
$
44,296

 
$
10,708

 
$
7,275

 
$
6,580

 
$
260

 
$
232,472

Special Mention

 

 

 

 

 

 

 

Substandard

 
34

 

 

 

 

 

 
34

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Land and land development
$
36,452

 
$
126,935

 
$
44,296

 
$
10,708

 
$
7,275

 
$
6,580

 
$
260

 
$
232,506

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
74,684

 
$
284,798

 
$
228,436

 
$
98,502

 
$
52,755

 
$
89,037

 
$
466,294

 
$
1,294,506

Special Mention
65

 
1,314

 
5,021

 
1,472

 
4,846

 
5,091

 
8,635

 
26,444

Substandard
2,904

 
2,199

 
7,548

 
3,934

 
293

 
949

 
19,040

 
36,867

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Commercial business
$
77,653

 
$
288,311

 
$
241,005

 
$
103,908

 
$
57,894

 
$
95,077

 
$
493,969

 
$
1,357,817

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural business including secured by farmland
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pass
$
17,928

 
$
64,309

 
$
35,934

 
$
26,835

 
$
27,403

 
$
35,133

 
$
102,965

 
$
310,507

Special Mention

 
1,328

 

 
919

 
676

 
1,418

 

 
4,341

Substandard
625

 
5,523

 
5,974

 
191

 
62

 
707

 
2,327

 
15,409

Doubtful

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

Total Agricultural business including secured by farmland
$
18,553

 
$
71,160

 
$
41,908

 
$
27,945

 
$
28,141

 
$
37,258

 
$
105,292

 
$
330,257

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



31


The following table presents the Company’s portfolio of non-risk-rated loans by delinquency status as of March 31, 2020 (in thousands). Revolving loans that are converted to term loans are treated as new originations in the table below and are presented by year of origination.

 
March 31, 2020
 
Term Loans by Year of Origination
 
Revolving Loans
 
Total Loans
By class:
2020
 
2019
 
2018
 
2017
 
2016
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Small balance CRE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Past Due Category
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current
$
3,076

 
$
72,221

 
$
91,455

 
$
75,742

 
$
80,463

 
$
265,178

 
$
1,189

 
$
589,324

30-59 Days Past Due

 
380

 
382

 

 

 
738

 

 
1,500

60-89 Days Past Due

 

 

 

 

 
396

 

 
396

90 Days + Past Due

 

 

 
340

 

 
223

 

 
563

Total Small balance CRE
$
3,076

 
$
72,601

 
$
91,837

 
$
76,082

 
$
80,463

 
$
266,535

 
$
1,189

 
$
591,783

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Small business scored
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Past Due Category
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current
$
49,408

 
$
176,863

 
$
161,438

 
$
115,884

 
$
60,448

 
$
85,896

 
$
151,905

 
$
801,842

30-59 Days Past Due
31

 
459

 
215

 
977

 
68

 
325

 
466

 
2,541

60-89 Days Past Due

 
184

 
150

 
197

 
55

 

 
5

 
591

90 Days + Past Due

 
243

 
568

 
715

 
610

 
152

 
277

 
2,565

Total Small business scored
$
49,439

 
$
177,749

 
$
162,371

 
$
117,773

 
$
61,181

 
$
86,373

 
$
152,653

 
$
807,539

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
One- to four- family residential
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Past Due Category
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current
$
10,298

 
$
119,074

 
$
141,540

 
$
156,046

 
$
77,252

 
$
357,521

 
$
4,801

 
$
866,532

30-59 Days Past Due
559

 
4,107

 
639

 
1,615

 
264

 
5,215

 

 
12,399

60-89 Days Past Due
21

 

 

 

 

 
82

 

 
103

90 Days + Past Due
358

 

 
607

 
45

 

 
1,343

 

 
2,353

Total One- to four- family residential
$
11,236

 
$
123,181

 
$
142,786

 
$
157,706

 
$
77,516

 
$
364,161

 
$
4,801

 
$
881,387

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



32


 
March 31, 2020
 
Term Loans by Year of Origination
 
Revolving Loans
 
Total Loans
By class:
2020
 
2019
 
2018
 
2017
 
2016
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer—home equity revolving lines of credit
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Past Due Category
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current
$
14,227

 
$
2,053

 
$
1,774

 
$
2,137

 
$
1,223

 
$
3,840

 
$
493,903

 
$
519,157

30-59 Days Past Due

 

 

 

 

 
14

 
664

 
678

60-89 Days Past Due

 

 

 

 

 
267

 

 
267

90 Days + Past Due

 

 

 
520

 
297

 
158

 
541

 
1,516

Total Consumer—home equity revolving lines of credit
$
14,227

 
$
2,053

 
$
1,774

 
$
2,657

 
$
1,520

 
$
4,279

 
$
495,108

 
$
521,618

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer-other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Past Due Category
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current
$
7,199

 
$
22,156

 
$
21,985

 
$
18,571

 
$
12,885

 
$
26,316

 
$
30,214

 
$
139,326

30-59 Days Past Due
102

 
21

 
174

 
78

 
100

 
95

 
78

 
648

60-89 Days Past Due

 
30

 
29

 
17

 

 
10

 
54

 
140

90 Days + Past Due

 

 

 

 
49

 

 

 
49

Total Consumer-other
$
7,301

 
$
22,207

 
$
22,188

 
$
18,666

 
$
13,034

 
$
26,421

 
$
30,346

 
$
140,163

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 






33


The following tables present the Company’s portfolio of risk-rated loans and non-risk-rated loans by grade or other characteristics as of December 31, 2019 (in thousands):
 
December 31, 2019
By class:
Pass (Risk Ratings 1-5)(1)
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total Loans
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
1,546,649

 
$
4,198

 
$
29,803

 
$

 
$

 
$
1,580,650

Investment properties
2,288,785

 
2,193

 
18,243

 

 

 
2,309,221

Multifamily real estate
472,856

 

 
296

 

 

 
473,152

Commercial construction
198,986

 

 
11,682

 

 

 
210,668

Multifamily construction
233,610

 

 

 

 

 
233,610

One- to four-family construction
530,307

 
12,534

 
1,467

 

 

 
544,308

Land and land development:
 
 
 
 
 
 
 
 
 
 
 
Residential
154,348

 

 
340

 

 

 
154,688

Commercial
26,256

 

 
34

 

 

 
26,290

Commercial business
1,627,170

 
31,012

 
35,584

 
58

 

 
1,693,824

Agricultural business, including secured by farmland
352,408

 
10,840

 
7,301

 

 

 
370,549

One- to four-family residential
940,424

 
409

 
4,789

 

 

 
945,622

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Consumer secured by one- to four-family
547,388

 

 
3,572

 

 

 
550,960

Consumer—other
211,475

 
3

 
337

 

 

 
211,815

Total
$
9,130,662

 
$
61,189

 
$
113,448

 
$
58

 
$

 
$
9,305,357


(1)  
The Pass category includes some performing loans that are part of homogenous pools which are not individually risk-rated.  This includes all consumer loans, all one- to four-family residential loans and, as of December 31, 2019, in the commercial business category, $764.6 million of credit-scored small business loans.  As loans in these pools become non-performing, they are individually risk-rated.

34


The following table provides the amortized cost basis of collateral-dependent loans as of March 31, 2020 (in thousands). Our collateral dependent loans presented in the table below have no significant concentrations by property type or location. The table below includes one commercial banking relationship with a balance of $14.7 million.

 
March 31, 2020
 
Real Estate
 
Accounts Receivable
 
Equipment
 
Inventory
 
Total
Commercial real estate:
 
 
 
 
 
 
 
 
 
Owner-occupied
$
1,838

 
$

 
$

 
$

 
$
1,838

Investment properties
3,421

 

 

 

 
3,421

Small Balance CRE
1,367

 

 

 

 
1,367

Multifamily real estate

 

 

 

 

Construction, land and land development:
 
 
 
 
 
 
 
 
 
Commercial construction

 

 

 

 

Multifamily construction

 

 

 

 

One- to four-family construction
964

 

 

 

 
964

Land and land development

 

 

 

 

Commercial business
 
 
 
 
 
 
 
 
 
Commercial business
2,851

 
11,344

 
4,597

 
1,215

 
20,007

Small business Scored
48

 

 
49

 

 
97

Agricultural business, including secured by farmland

 

 

 

 

One- to four-family residential
868

 

 

 

 
868

Consumer:
 
 
 
 
 
 
 
 
 
Consumer—home equity revolving lines of credit


 

 

 

 

Consumer—other

 

 

 

 

Total
$
11,357

 
$
11,344

 
$
4,646

 
$
1,215

 
$
28,562






35



The following tables provide additional detail on the age analysis of the Company’s past due loans as of March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90 Days or More
Past Due
 
Total
Past Due
 
Current
 
Total Loans
 
Non-accrual with no Allowance
 
Total Non-accrual (1)
 
Loans 90 Days or More Past Due and Accruing
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
1,209

 
$

 
$
1,837

 
$
3,046

 
$
1,021,043

 
$
1,024,089

 
$
1,837

 
$
2,243

 
$

Investment properties
607

 

 
3,888

 
4,495

 
2,003,042

 
2,007,537

 
3,420

 
3,863

 
24

Small Balance CRE
1,500

 
396

 
563

 
2,459

 
589,324

 
591,783

 
1,222

 
2,406

 

Multifamily real estate

 

 

 

 
400,206

 
400,206

 

 

 

Construction, land and land development:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial construction
11,521

 

 
1,505

 
13,026

 
192,450

 
205,476

 

 
98

 
1,407

Multifamily construction

 

 

 

 
250,410

 
250,410

 

 

 

One- to four-family construction
1,027

 

 
964

 
1,991

 
532,965

 
534,956

 
964

 
1,295

 

Land and land development
1,783

 

 

 
1,783

 
230,723

 
232,506

 

 

 

Commercial business
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business
4,849

 
537

 
1,508

 
6,894

 
1,350,923

 
1,357,817

 
198

 
21,737

 

Small business scored
2,541

 
591

 
2,565

 
5,697

 
801,842

 
807,539

 
98

 
3,290

 
77

Agricultural business, including secured by farmland
580

 
2,083

 
894

 
3,557

 
326,700

 
330,257

 

 
495

 
461

One- to four-family residential
12,399

 
103

 
2,353

 
14,855

 
866,532

 
881,387

 
865

 
3,045

 
1,089

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer—home equity revolving lines of credit

678

 
267

 
1,516

 
2,461

 
519,157

 
521,618

 

 
1,713

 
320

Consumer—other
648

 
140

 
49

 
837

 
139,326

 
140,163

 

 
99

 

Total
$
39,342

 
$
4,117

 
$
17,642

 
$
61,101

 
$
9,224,643

 
$
9,285,744

 
$
8,604

 
$
40,284

 
$
3,378





36



 
December 31, 2019
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90 Days or More
Past Due
 
Total
Past Due
 
Purchased Credit-Impaired
 
Current
 
Total Loans
 
Loans 90 Days or More Past Due and Accruing
 
Total Non-accrual (1)
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
486

 
$
1,246

 
$
2,889

 
$
4,621

 
$
8,578

 
$
1,567,451

 
$
1,580,650

 
$
89

 
$
4,069

Investment properties

 
260

 
1,883

 
2,143

 
6,345

 
2,300,733

 
2,309,221

 

 
1,883

Multifamily real estate
239

 
91

 

 
330

 
7

 
472,815

 
473,152

 

 
85

Commercial construction
1,397

 

 
98

 
1,495

 

 
209,173

 
210,668

 

 
98

Multifamily construction

 

 

 

 

 
233,610

 
233,610

 

 

One-to-four-family construction
3,212

 

 
1,799

 
5,011

 

 
539,297

 
544,308

 
332

 
1,467

Land and land development:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential

 

 
340

 
340

 

 
154,348

 
154,688

 

 
340

Commercial

 

 

 

 

 
26,290

 
26,290

 

 

Commercial business
2,343

 
1,583

 
3,412

 
7,338

 
368

 
1,686,118

 
1,693,824

 
401

 
23,015

Agricultural business, including secured by farmland
1,972

 
129

 
584

 
2,685

 
393

 
367,471

 
370,549

 

 
661

One-to four-family residential
3,777

 
1,088

 
2,876

 
7,741

 
74

 
937,807

 
945,622

 
877

 
3,410

Consumer:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consumer secured by one- to four-family
1,174

 
327

 
1,846

 
3,347

 
110

 
547,503

 
550,960

 
398

 
2,314

Consumer—other
350

 
161

 

 
511

 
63

 
211,241

 
211,815

 

 
159

Total
$
14,950

 
$
4,885

 
$
15,727

 
$
35,562

 
$
15,938

 
$
9,253,857

 
$
9,305,357

 
$
2,097

 
$
37,501



(1)  
The Company did not recognize any interest income on non-accrual loans during both the three months ended March 31, 2020 and the year ended December 31, 2019.

37



The following table provides the activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2020 (in thousands):
 
For the Three Months Ended March 31, 2020
 
Commercial
Real Estate
 
Multifamily
Real Estate
 
Construction and Land
 
Commercial Business
 
Agricultural Business
 
One- to Four-Family Residential
 
Consumer
 
Unallocated
 
Total
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
30,591

 
$
4,754

 
$
22,994

 
$
23,370

 
$
4,120

 
$
4,136

 
$
8,202

 
$
2,392

 
$
100,559

Impact of Adopting Topic 326
(2,864
)
 
(2,204
)
 
2,515

 
3,010

 
(351
)
 
7,125

 
2,973

 
 
 
7,812

Provision/(recapture) for credit losses
1,545

 
321

 
8,708

 
6,447

 
(1,006
)
 
539

 
5,159

 

 
21,713

Recoveries
167

 

 

 
205

 
1,750

 
148

 
96

 

 
2,366

Charge-offs
(100
)
 
(66
)
 

 
(1,384
)
 

 
(64
)
 
(348
)
 

 
(1,962
)
Ending balance
$
29,339

 
$
2,805

 
$
34,217

 
$
31,648

 
$
4,513

 
$
11,884

 
$
16,082

 
$

 
$
130,488

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

The changes in the allowance for credit losses during the three months ended March 31, 2020 were primarily the result of the $21.7 million provision for credit losses recorded during the current quarter, mostly due to the deterioration in the economy during the current quarter as a result of the COVID-19 pandemic, as well as forecasted additional future economic deterioration based on the reasonable and supportable economic forecast as of March 31, 2020. In addition, the change for the current quarter included a $7.8 million increase related to the adoption of Financial Instruments - Credit Losses (Topic 326).

38


The following tables provide additional information on the allowance for loan losses and loan balances individually and collectively evaluated for impairment at or for the three months ended March 31, 2019 (in thousands):

 
For the Three Months Ended March 31, 2019
 
Commercial
 Real Estate
 
Multifamily
Real Estate
 
Construction and Land
 
Commercial Business
 
Agricultural Business
 
One- to Four-Family Residential
 
Consumer
 
Unallocated
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
27,132

 
$
3,818

 
$
24,442

 
$
19,438

 
$
3,778

 
$
4,714

 
$
7,972

 
$
5,191

 
$
96,485

Provision/(recapture) for loan losses
369

 
202

 
(751
)
 
(209
)
 
(178
)
 
(46
)
 
269

 
2,344

 
2,000

Recoveries
21

 

 
22

 
23

 

 
43

 
110

 

 
219

Charge-offs
(431
)
 

 

 
(590
)
 
(4
)
 

 
(371
)
 

 
(1,396
)
Ending balance
$
27,091

 
$
4,020

 
$
23,713

 
$
18,662

 
$
3,596

 
$
4,711

 
$
7,980

 
$
7,535

 
$
97,308

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
March 31, 2019
 
Commercial
Real Estate
 
Multifamily
Real Estate
 
Construction and Land
 
Commercial Business
 
Agricultural Business
 
One- to Four-Family Residential
 
Consumer
 
Unallocated
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
240

 
$

 
$

 
$
12

 
$
66

 
$
59

 
$
8

 
$

 
$
385

Collectively evaluated for impairment
26,851

 
4,020

 
23,713

 
18,627

 
3,472

 
4,652

 
7,972

 
7,535

 
96,842

Purchased credit-impaired loans

 

 

 
23

 
58

 

 

 

 
81

Total allowance for loan losses
$
27,091

 
$
4,020

 
$
23,713

 
$
18,662

 
$
3,596

 
$
4,711

 
$
7,980

 
$
7,535

 
$
97,308

Loan balances:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
9,806

 
$

 
$
2,988

 
$
514

 
$
4,110

 
$
4,116

 
$
193

 
$

 
$
21,727

Collectively evaluated for impairment
3,545,162

 
387,014

 
1,093,159

 
1,523,166

 
368,781

 
963,370

 
776,948

 

 
8,657,600

Purchased credit impaired loans
11,805

 
128

 

 
618

 
431

 
95

 
253

 

 
13,330

Total loans
$
3,566,773

 
$
387,142

 
$
1,096,147

 
$
1,524,298

 
$
373,322

 
$
967,581

 
$
777,394

 
$

 
$
8,692,657



39


Note 6:  REAL ESTATE OWNED, NET

The following table presents the changes in REO for the three months ended March 31, 2020 and 2019 (in thousands):
 
Three Months Ended
March 31,
 
2020
 
2019
Balance, beginning of the period
$
814

 
$
2,611

Additions from loan foreclosures
1,588

 

Balance, end of the period
$
2,402

 
$
2,611



REO properties are recorded at the estimated fair value of the property, less expected selling costs, establishing a new cost basis.  Subsequently, REO properties are carried at the lower of the new cost basis or updated fair market values, based on updated appraisals of the underlying properties, as received.  Valuation allowances on the carrying value of REO may be recognized based on updated appraisals or on management’s authorization to reduce the selling price of a property. The Company had $727,000 of foreclosed one- to four-family residential real estate properties held as REO at March 31, 2020 and $48,000 at December 31, 2019. The recorded investment in one- to four-family residential loans in the process of foreclosure was $313,000 at March 31, 2020 compared with $1.5 million at December 31, 2019.

Note 7:  GOODWILL, OTHER INTANGIBLE ASSETS AND MORTGAGE SERVICING RIGHTS

Goodwill and Other Intangible Assets:  At March 31, 2020, intangible assets are comprised of goodwill and CDI acquired in business combinations. Goodwill represents the excess of the purchase consideration paid over the fair value of the assets acquired, net of the fair values of liabilities assumed in a business combination, and is not amortized but is reviewed at least annually for impairment. Banner has identified one reporting unit for purposes of evaluating goodwill for impairment. At March 31, 2020, the Company completed its qualitative assessment of goodwill and concluded that it is more likely than not that the fair value of Banner, the reporting unit, exceeds the carrying value. If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the COVID-19 pandemic were to be deemed sustained in the future rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges.

CDI represents the value of transaction-related deposits and the value of the customer relationships associated with the deposits. At December 31, 2018 intangible assets also included favorable leasehold intangibles (LHI). LHI represented the value ascribed to leases assumed in an acquisition in which the lease terms are favorable compared to a market lease at the date of acquisition. LHI was reclassified to the right of use lease asset in connection with the adoption of Lease Topic 842 on January 1, 2019. The Company amortizes CDI assets over their estimated useful lives and reviews them at least annually for events or circumstances that could impair their value. 

The following table summarizes the changes in the Company’s goodwill and other intangibles for the three months ended March 31, 2020 and the year ended December 31, 2019 (in thousands):
 
Goodwill
 
CDI
 
LHI
 
Total
Balance, December 31, 2018
$
339,154

 
$
32,699

 
$
225

 
$
372,078

Additions through acquisitions(1)
33,967

 
4,610

 

 
38,577

Amortization

 
(8,151
)
 

 
(8,151
)
Adjustments(2)

 

 
(225
)
 
(225
)
Balance, December 31, 2019
373,121

 
29,158

 

 
402,279

Amortization

 
(2,001
)
 

 
(2,001
)
Balance, March 31, 2020
$
373,121

 
$
27,157

 
$

 
$
400,278


(1) The additions to Goodwill and CDI in 2019 relate to the acquisition of AltaPacific.
(2) The adjustment to LHI represents a reclassification to the right-of-use lease asset in connection with the implementation of Lease Topic 842.


40



The following table presents the estimated amortization expense with respect to CDI as of March 31, 2020 for the periods indicated (in thousands):
 
 
Estimated Amortization
Remainder of 2020
 
$
5,730

2021
 
6,571

2022
 
5,317

2023
 
3,814

2024
 
2,659

Thereafter
 
3,066

 
 
$
27,157



Mortgage Servicing Rights:  Mortgage servicing rights are reported in other assets. Mortgage servicing rights are initially recorded at fair value and are amortized in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.  Mortgage servicing rights are subsequently evaluated for impairment based upon the fair value of the rights compared to the amortized cost (remaining unamortized initial fair value).  If the fair value is less than the amortized cost, a valuation allowance is created through an impairment charge, which is recognized in servicing fee income within mortgage banking operations on the consolidated statement of operations.   However, if the fair value is greater than the amortized cost, the amount above the amortized cost is not recognized in the carrying value.  During the three months ended March 31, 2020 and 2019, the Company did not record any impairment charges or recoveries against mortgage servicing rights. The unpaid principal balance for loans which mortgage servicing rights have been recorded totaled $2.53 billion and $2.48 billion at March 31, 2020 and December 31, 2019, respectively.  Custodial accounts maintained in connection with this servicing totaled $3.4 million and $12.0 million at March 31, 2020 and December 31, 2019, respectively.

An analysis of our mortgage servicing rights for the three months ended March 31, 2020 and 2019 is presented below (in thousands):
 
Three Months Ended
March 31,
 
2020
 
2019
Balance, beginning of the period
$
14,148

 
$
14,638

Additions—amounts capitalized
1,420

 
672

Additions—through purchase
63

 
47

Amortization (1)
(1,354
)
 
(940
)
Balance, end of the period (2)
$
14,277

 
$
14,417


(1) 
Amortization of mortgage servicing rights is recorded as a reduction of loan servicing income within mortgage banking operations and any unamortized balance is fully amortized if the loan repays in full.
(2) 
There was no valuation allowance as of March 31, 2020 and 2019.


41


Note 8:  DEPOSITS

Deposits consisted of the following at March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
December 31, 2019
Non-interest-bearing accounts
$
4,107,262

 
$
3,945,000

Interest-bearing checking
1,331,860

 
1,280,003

Regular savings accounts
1,997,265

 
1,934,041

Money market accounts
1,846,844

 
1,769,194

Total interest-bearing transaction and saving accounts
5,175,969

 
4,983,238

Certificates of deposit:
 
 
 
Certificates of deposit less than or equal to $250,000
972,667

 
936,940

Certificates of deposit greater than $250,000
193,639

 
183,463

Total certificates of deposit(1)
1,166,306

 
1,120,403

Total deposits
$
10,449,537

 
$
10,048,641

Included in total deposits:
 

 
 

Public fund transaction and savings accounts
$
246,312

 
$
244,418

Public fund interest-bearing certificates
48,232

 
35,184

Total public deposits
$
294,544

 
$
279,602

Total brokered deposits
$
250,977

 
$
202,884



(1)
Certificates of deposit include $206,000 and $269,000 of acquisition premiums at March 31, 2020 and December 31, 2019, respectively.

At March 31, 2020 and December 31, 2019, the Company had certificates of deposit of $198.6 million and $189.0 million, respectively, that were equal to or greater than $250,000.

Scheduled maturities and weighted average interest rates of certificates of deposit at March 31, 2020 are as follows (dollars in thousands):
 
March 31, 2020
 
Amount
 
Weighted Average Rate
Maturing in one year or less
$
887,586

 
1.24
%
Maturing after one year through two years
175,730

 
1.76

Maturing after two years through three years
76,073

 
1.81

Maturing after three years through four years
11,742

 
1.97

Maturing after four years through five years
12,652

 
1.97

Maturing after five years
2,523

 
1.14

Total certificates of deposit
$
1,166,306

 
1.37
%

 
 
 
 
 
 
 
 


42


Note 9:  FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents estimated fair values of the Company’s financial instruments as of March 31, 2020 and December 31, 2019, whether or not measured at fair value in the Consolidated Statements of Financial Condition (dollars in thousands):
 
 
 
March 31, 2020
 
December 31, 2019
 
Level
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
1
 
$
295,001

 
$
295,001

 
$
307,735

 
$
307,735

Securities—trading
3
 
21,040

 
21,040

 
25,636

 
25,636

Securities—available-for-sale
2
 
1,608,224

 
1,608,224

 
1,551,557

 
1,551,557

Securities—held-to-maturity
2
 
435,119

 
446,412

 
233,241

 
234,952

Securities—held-to-maturity
3
 
2,825

 
2,825

 
2,853

 
2,853

Loans held for sale
2
 
182,428

 
182,766

 
210,447

 
210,670

Loans receivable
3
 
9,285,744

 
9,272,174

 
9,305,357

 
9,304,340

FHLB stock
3
 
20,247

 
20,247

 
28,342

 
28,342

Bank-owned life insurance
1
 
193,140

 
193,140

 
192,088

 
192,088

Mortgage servicing rights
3
 
14,277

 
20,931

 
14,148

 
22,611

Derivatives:
 
 


 


 


 


Interest rate swaps
2
 
42,687

 
42,687

 
15,202

 
15,202

Interest rate lock and forward sales commitments
2,3
 
3,325

 
3,325

 
1,108

 
1,108

Liabilities:
 
 
 

 
 

 
 

 
 

Demand, interest checking and money market accounts
2
 
7,285,966

 
7,285,966

 
6,994,197

 
6,994,197

Regular savings
2
 
1,997,265

 
1,997,265

 
1,934,041

 
1,934,041

Certificates of deposit
2
 
1,166,306

 
1,173,126

 
1,120,403

 
1,117,921

FHLB advances
2
 
247,000

 
251,978

 
450,000

 
452,720

Other borrowings
2
 
128,764

 
128,764

 
118,474

 
118,474

Junior subordinated debentures
3
 
99,795

 
99,795

 
119,304

 
119,304

Derivatives:
 
 


 


 


 


Interest rate swaps
2
 
23,280

 
23,280

 
10,966

 
10,966

Interest rate lock and forward sales commitments
2
 
4,448

 
4,448

 
674

 
674



The Company measures and discloses certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (that is, not a forced liquidation or distressed sale). GAAP establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the accounting standard requires the reporting entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data.

Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs from non-binding single dealer quotes not corroborated by observable market data.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize at a future date. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for certain financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Transfers between levels of the fair value hierarchy are deemed to occur at the end of the reporting period.


43


Items Measured at Fair Value on a Recurring Basis:

The following tables present financial assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy of the fair value measurements for those assets and liabilities as of March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Securities—trading
 
 
 
 
 
 
 
Corporate bonds (Trust Preferred Securities)
$

 
$

 
$
21,040

 
$
21,040

 
 
 
 
 
 
 
 
Securities—available-for-sale
 
 
 
 
 
 
 
U.S. Government and agency obligations

 
81,763

 

 
81,763

Municipal bonds

 
181,039

 

 
181,039

Corporate bonds

 
30,986

 

 
30,986

Mortgage-backed or related securities

 
1,306,799

 

 
1,306,799

Asset-backed securities

 
7,637

 

 
7,637

 

 
1,608,224

 

 
1,608,224

 
 
 
 
 
 
 
 
Loans held for sale

 
169,239

 

 
169,239

 
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
Interest rate swaps

 
42,687

 

 
42,687

Interest rate lock and forward sales commitments

 
808

 
2,517

 
3,325

 
$

 
$
1,820,958

 
$
23,557

 
$
1,844,515

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Junior subordinated debentures, net of unamortized deferred issuance costs
$

 
$

 
$
99,795

 
$
99,795

Derivatives
 
 
 
 
 
 
 
Interest rate swaps

 
23,280

 

 
23,280

Interest rate lock and forward sales commitments

 
4,448

 

 
4,448

 
$

 
$
27,728

 
$
99,795

 
$
127,523



44


 
December 31, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Securities—trading
 
 
 
 
 
 
 
Corporate bonds (Trust Preferred Securities)
$

 
$

 
$
25,636

 
$
25,636

 
 
 
 
 
 
 
 
Securities—available-for-sale
 
 
 
 
 
 
 
U.S. Government and agency obligations

 
89,598

 

 
89,598

Municipal bonds

 
107,157

 

 
107,157

Corporate bonds

 
4,365

 

 
4,365

Mortgage-backed securities

 
1,342,311

 

 
1,342,311

Asset-backed securities

 
8,126

 

 
8,126

 

 
1,551,557

 

 
1,551,557

 
 
 
 
 
 
 
 
Loans held for sale

 
199,397

 

 
199,397

Equity securities

 

 

 

 
 
 
 
 
 
 
 
Derivatives
 
 
 
 
 
 
 
Interest rate swaps

 
15,202

 

 
15,202

Interest rate lock and forward sales commitments

 
317

 
791

 
1,108

 
$

 
$
1,766,473

 
$
26,427

 
$
1,792,900

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Junior subordinated debentures, net of unamortized deferred issuance costs
$

 
$

 
$
119,304

 
$
119,304

Derivatives
 
 
 
 
 
 
 
Interest rate swaps

 
10,966

 

 
10,966

Interest rate lock and forward sales commitments

 
674

 

 
674

 
$

 
$
11,640

 
$
119,304

 
$
130,944



The following methods were used to estimate the fair value of each class of financial instruments above:

Securities:  The estimated fair values of investment securities and mortgaged-backed securities are priced using current active market quotes, if available, which are considered Level 1 measurements.  For most of the portfolio, matrix pricing based on the securities’ relationship to other benchmark quoted prices is used to establish the fair value.  These measurements are considered Level 2.  Due to the continued limited activity in the trust preferred markets that have limited the observability of market spreads for some of the Company’s TPS securities, management has classified these securities as a Level 3 fair value measure. Management periodically reviews the pricing information received from third-party pricing services and tests those prices against other sources to validate the reported fair values.

Loans Held for Sale: Fair values for residential mortgage loans held for sale are determined by comparing actual loan rates to current secondary market prices for similar loans. Fair values for multifamily loans held for sale are calculated based on discounted cash flows using as a discount rate a combination of market spreads for similar loan types added to selected index rates.

Mortgage Servicing Rights: Fair values are estimated based on an independent dealer analysis of discounted cash flows.  The evaluation utilizes assumptions market participants would use in determining fair value including prepayment speeds, delinquency and foreclosure rates, the discount rate, servicing costs, and the timing of cash flows.  The mortgage servicing portfolio is stratified by loan type and fair value estimates are adjusted up or down based on the serviced loan interest rates versus current rates on new loan originations since the most recent independent analysis.

Junior Subordinated Debentures:  The fair value of junior subordinated debentures is estimated using an income approach technique. The significant inputs included in the estimation of fair value are the credit risk adjusted spread and three month LIBOR. The credit risk adjusted spread represents the nonperformance risk of the liability. The Company utilizes an external valuation firm to validate the reasonableness of the credit risk adjusted spread used to determine the fair value. The junior subordinated debentures are carried at fair value which represents the estimated amount that would be paid to transfer these liabilities in an orderly transaction amongst market participants. Due to inactivity in the trust preferred markets that have limited the observability of market spreads, management has classified this as a Level 3 fair value measure.

Derivatives: Derivatives include interest rate swap agreements, interest rate lock commitments to originate loans held for sale and forward sales contracts to sell loans and securities related to mortgage banking activities. Fair values for these instruments, which generally change as a result of changes in the level of market interest rates, are estimated based on dealer quotes and secondary market sources.


45


Off-Balance Sheet Items: Off-balance sheet financial instruments include unfunded commitments to extend credit, including standby letters of credit, and commitments to purchase investment securities. The fair value of these instruments is not considered to be material.

Limitations: The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2020 and December 31, 2019.  The factors used in the fair values estimates are subject to change subsequent to the dates the fair value estimates are completed, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3):

The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable inputs for certain of the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring and non-recurring basis at March 31, 2020 and December 31, 2019:
 
 
 
 
 
 
Weighted Average Rate / Range
Financial Instruments
 
Valuation Techniques
 
Unobservable Inputs
 
March 31, 2020
 
December 31, 2019
Corporate bonds (TPS securities)
 
Discounted cash flows
 
Discount rate
 
6.70
%
 
5.91
%
Junior subordinated debentures
 
Discounted cash flows
 
Discount rate
 
6.70
%
 
5.91
%
Loans individually evaluated
 
Collateral valuations
 
Discount to appraised value
 
0.0% to 20.0%

 
0.0% to 20.0%

REO
 
Appraisals
 
Discount to appraised value
 
52.03
%
 
58.50
%
Interest rate lock commitments
 
Pricing model
 
Pull-through rate
 
84.19
%
 
89.61
%


TPS securities: Management believes that the credit risk-adjusted spread used to develop the discount rate utilized in the fair value measurement of TPS securities is indicative of the risk premium a willing market participant would require under current market conditions for instruments with similar contractual rates and terms and conditions and issuers with similar credit risk profiles and with similar expected probability of default. Management attributes the change in fair value of these instruments, compared to their par value, primarily to perceived general market adjustments to the risk premiums for these types of assets subsequent to their issuance.

Junior subordinated debentures: Similar to the TPS securities discussed above, management believes that the credit risk-adjusted spread utilized in the fair value measurement of the junior subordinated debentures is indicative of the risk premium a willing market participant would require under current market conditions for an issuer with Banner's credit risk profile. Management attributes the change in fair value of the junior subordinated debentures, compared to their par value, primarily to perceived general market adjustments to the risk premiums for these types of liabilities subsequent to their issuance. Future contractions in the risk adjusted spread relative to the spread currently utilized to measure the Company's junior subordinated debentures at fair value as of March 31, 2020, or the passage of time, will result in negative fair value adjustments. At March 31, 2020, the discount rate utilized was based on a credit spread of 550 basis points and three-month LIBOR of 120 basis points.

Interest rate lock commitments: The fair value of the interest rate lock commitments is based on secondary market sources adjusted for an estimated pull-through rate. The pull-through rate is based on historical loan closing rates for similar interest rate lock commitments. An increase or decrease in the pull-through rate would have a corresponding, positive or negative fair value adjustment.

46


The following tables provide a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three months ended March 31, 2020 and 2019 (in thousands):
 
Three Months Ended
 
March 31, 2020
 
Level 3 Fair Value Inputs
 
TPS Securities
 
Borrowings—Junior Subordinated Debentures
Beginning balance
$
25,636

 
$
119,304

Total gains or losses recognized
 
 
 
Assets losses
(4,596
)
 

Liabilities gains

 
(19,509
)
Ending balance at March 31, 2020
$
21,040

 
$
99,795

 
 
 
 
 
Three Months Ended
 
March 31, 2019
 
Level 3 Fair Value Inputs
 
TPS Securities
 
Borrowings—Junior Subordinated Debentures
Beginning balance
$
25,896

 
$
114,091

Total gains or losses recognized
 
 
 
Assets gains
(58
)
 

Liabilities losses

 
(174
)
Ending balance at March 31, 2019
$
25,838

 
$
113,917



Interest income and dividends from the TPS securities are recoded as a component of interest income. Interest expense related to the junior subordinated debentures is measured based on contractual interest rates and reported in interest expense.  The change in fair value of the junior subordinated debentures, which represents changes in instrument specific credit risk, is recorded in other comprehensive income.

Items Measured at Fair Value on a Non-recurring Basis:

The following tables present financial assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy of the fair value measurements for those assets as of March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
Level 1
 
Level 2
 
Level 3
 
Total
Loans individually evaluated
$

 
$

 
$
19,954

 
$
19,954

REO

 

 
2,402

 
2,402

 
 
 
 
 
 
 
 
 
December 31, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
Impaired loans
$

 
$

 
$
14,853

 
$
14,853

REO

 

 
814

 
814



47


The following table presents the losses resulting from non-recurring fair value adjustments for the three months ended March 31, 2020 and 2019 (in thousands):
 
 
Three Months Ended March 31,
 
 
2020
 
2019
Loans individually evaluated
 
$

 
$
(300
)
REO
 

 

Total loss from non-recurring measurements
 
$

 
$
(300
)


Loans individually evaluated: Expected credit losses for loans evaluated individually are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate or when the Bank determines that foreclosure is probable, the expected credit loss is measured based on the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. As a practical expedient, the Bank measures the expected credit loss for a loan using the fair value of the collateral, if repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty based on the Bank’s assessment as of the reporting date. In both cases, if the fair value of the collateral is less than the amortized cost basis of the loan, the Bank will recognize an allowance as the difference between the fair value of the collateral, less costs to sell (if applicable), at the reporting date and the amortized cost basis of the loan. If the fair value of the collateral exceeds the amortized cost basis of the loan, any expected recovery added to the amortized cost basis will be limited to the amount previously charged-off by the subsequent changes in the expected credit losses for loans evaluated individually are included within the provision for credit losses in the same manner in which the expected credit loss initially was recognized or as a reduction in the provision that would otherwise be reported.
 
REO: The Company records REO (acquired through a lending relationship) at fair value on a non-recurring basis. Fair value adjustments on REO are based on updated real estate appraisals which are based on current market conditions. All REO properties are recorded at the lower of the estimated fair value of the real estate, less expected selling costs, or the carrying amount of the defaulted loans. From time to time, non-recurring fair value adjustments to REO are recorded to reflect partial write-downs based on an observable market price or current appraised value of property. Banner considers any valuation inputs related to REO to be Level 3 inputs. The individual carrying values of these assets are reviewed for impairment at least annually and any additional impairment charges are expensed to operations.

Note 10:  INCOME TAXES AND DEFERRED TAXES
 
 
 
 
The Company files a consolidated income tax return including all of its wholly-owned subsidiaries on a calendar year basis. Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change. A valuation allowance is recognized as a reduction to deferred tax assets when management determines it is more likely than not that deferred tax assets will not be available to offset future income tax liabilities.

Accounting standards for income taxes prescribe a recognition threshold and measurement process for financial statement recognition and measurement of uncertain tax positions taken or expected to be taken in a tax return, and also provide guidance on the de-recognition of previously recorded benefits and their classification, as well as the proper recording of interest and penalties, accounting in interim periods, disclosures and transition. The Company periodically reviews its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations of the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment.

As of March 31, 2020, the Company had $275,000 of unrecognized tax benefits for uncertain tax positions, none of which would materially affect the effective tax rate if recognized. The Company does not anticipate that the amount of unrecognized tax benefits will significantly increase or decrease in the next twelve months. The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in the income tax expense. The Company files consolidated income tax returns in the U.S. federal jurisdiction and in the Oregon, California, Utah, Idaho and Montana state jurisdictions.

Tax credit investments: The Company invests in low income housing tax credit funds that are designed to generate a return primarily through the realization of federal tax credits. The Company accounts for these investments by amortizing the cost of tax credit investments over the life of the investment using a proportional amortization method and tax credit investment amortization expense is a component of the provision for income taxes.

The following table presents the balances of the Company’s tax credit investments and related unfunded commitments at March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
December 31, 2019
Tax credit investments
$
33,811

 
$
29,620

Unfunded commitments—tax credit investments
24,409

 
20,235



48


The following table presents other information related to the Company's tax credit investments for the three months ended March 31, 2020 and 2019 (in thousands):
 
Three Months Ended
March 31,
 
2020
 
2019
Tax credits and other tax benefits recognized
$
1,007

 
$
494

Tax credit amortization expense included in provision for income taxes
809

 
405



Note 11:  CALCULATION OF WEIGHTED AVERAGE SHARES OUTSTANDING FOR EARNINGS PER SHARE (EPS)

The following table reconciles basic to diluted weighted average shares outstanding used to calculate earnings per share data for the three months ended March 31, 2020 and 2019 (in thousands, except shares and per share data):
 
Three Months Ended
March 31,
 
2020
 
2019
Net income
$
16,882

 
$
33,346

 
 
 


Basic weighted average shares outstanding
35,463,541

 
35,050,376

Plus unvested restricted stock
176,922

 
121,680

Diluted weighted shares outstanding
35,640,463

 
35,172,056

Earnings per common share
 

 
 

Basic
$
0.48

 
$
0.95

Diluted
$
0.47

 
$
0.95



Note 12:  STOCK-BASED COMPENSATION PLANS

The Company operates the following stock-based compensation plans as approved by its shareholders:
2014 Omnibus Incentive Plan (the 2014 Plan).
2018 Omnibus Incentive Plan (the 2018 Plan).

The purpose of these plans is to promote the success and enhance the value of the Company by providing a means for attracting and retaining highly skilled employees, officers and directors of Banner Corporation and its affiliates and linking their personal interests with those of the Company's shareholders. Under these plans the Company currently has outstanding restricted stock share grants and restricted stock unit grants.

2014 Omnibus Incentive Plan

The 2014 Plan was approved by shareholders on April 22, 2014. The 2014 Plan provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, other stock-based awards and other cash awards, and provides for vesting requirements which may include time-based or performance-based conditions. The Company reserved 900,000 shares of its common stock for issuance under the 2014 Plan in connection with the exercise of awards. As of March 31, 2020, 295,318 restricted stock shares and 398,986 restricted stock units have been granted under the 2014 Plan of which 265,381 restricted stock shares and 134,848 restricted stock units have vested.

2018 Omnibus Incentive Plan

The 2018 Plan was approved by shareholders on April 24, 2018. The 2018 Plan provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, other stock-based awards and other cash awards, and provides for vesting requirements which may include time-based or performance-based conditions. The Company reserved 900,000 shares of common stock for issuance under the 2018 Plan in connection with the exercise of awards. As of March 31, 2020, no shares and 365,063 units have been granted under the 2018 Plan.

The expense associated with all restricted stock grants (including restricted stock shares and restricted stock units) was $1.9 million and $1.2 million for the three month periods ended March 31, 2020 and March 31, 2019, respectively. Unrecognized compensation expense for these awards as of March 31, 2020 was $20.5 million and will be amortized over the next 36 months.


49


Note 13:  COMMITMENTS AND CONTINGENCIES

Financial Instruments with Off-Balance-Sheet Risk — The Company has financial instruments with off-balance-sheet risk generated in the normal course of business to meet the financing needs of our customers.  These financial instruments include commitments to extend credit, commitments related to standby letters of credit, commitments to originate loans, commitments to sell loans, commitments to buy and sell securities.  These instruments involve, to varying degrees, elements of credit and interest rate risk similar to the risk involved in on-balance-sheet items recognized in our Consolidated Statements of Financial Condition.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument from commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.  We use the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments.

Outstanding commitments for which no asset or liability for the notional amount has been recorded consisted of the following at the dates indicated (in thousands):
 
Contract or Notional Amount
 
March 31, 2020
 
December 31, 2019
Commitments to extend credit
$
2,975,390

 
$
3,051,681

Standby letters of credit and financial guarantees
15,619

 
14,298

Commitments to originate loans
75,180

 
39,676

Risk participation agreement
41,004

 
41,022

 
 
 
 
Derivatives also included in Note 14:
 
 
 
Commitments to originate loans held for sale
191,119

 
66,196

Commitments to sell loans secured by one- to four-family residential properties
81,429

 
70,895

Commitments to sell securities related to mortgage banking activities
229,000

 
239,320



In addition to the commitments disclosed in the table above, the Company is committed to funding its' unfunded tax credit investments (see Note 10, Income Taxes). During 2019, the Company entered into an agreement to invest $10 million in a limited partnership. The Company had funded $467,000 of the commitment, with $9.5 million of the commitment remaining to be funded at both March 31, 2020 and December 31, 2019.

Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments may expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the customer. The type of collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties. The Company's allowance for credit losses - unfunded loan commitments at March 31, 2020 and December 31, 2019 was $11.5 million and $2.7 million, respectively.

Standby letters of credit are conditional commitments issued to guarantee a customer’s performance or payment to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Through the acquisition of AmericanWest Bank, Banner Bank assumed a risk participation agreement. Under the risk participation agreement, Banner Bank guarantees the financial performance of a borrower on the participated portion of an interest rate swap on a loan.

Interest rates on residential one- to four-family mortgage loan applications are typically rate locked (committed) to customers during the application stage for periods ranging from 30 to 60 days, the most typical period being 45 days. Traditionally, these loan applications with rate lock commitments had the pricing for the sale of these loans locked with various qualified investors under a best-efforts delivery program at or near the time the interest rate is locked with the customer. The Company then attempts to deliver these loans before their rate locks expired. This arrangement generally required delivery of the loans prior to the expiration of the rate lock. Delays in funding the loans required a lock extension. The cost of a lock extension at times was borne by the customer and at times by the Company. These lock extension costs have not had a material impact to the Company's operations. The Company enters into forward commitments at specific prices and settlement dates to deliver either: (1) residential mortgage loans for purchase by secondary market investors (i.e., Freddie Mac or Fannie Mae), or (2) mortgage-backed securities to broker/dealers. The purpose of these forward commitments is to offset the movement in interest rates between the execution of its residential mortgage rate lock commitments with borrowers and the sale of those loans to the secondary market investor. There were no counterparty default losses on forward contracts during the three months ended March 31, 2020 or March 31, 2019. Market risk with respect to forward contracts arises principally from changes in the value of contractual positions due to changes in interest rates. The Company limits its exposure to market risk by monitoring differences between commitments to customers and forward contracts with market investors and securities broker/dealers. In the event the Company has forward delivery contract commitments in excess of available mortgage loans, the transaction is completed by either paying or receiving a fee to or from the investor or broker/dealer equal to the increase or decrease in the market value of the forward contract.


50


In the normal course of business, the Company and/or its subsidiaries have various legal proceedings and other contingent matters outstanding.  These proceedings and the associated legal claims are often contested and the outcome of individual matters is not always predictable.  These claims and counter-claims typically arise during the course of collection efforts on problem loans or with respect to action to enforce liens on properties in which the Banks hold a security interest.  Based upon the information known to management at this time, the Company and the Banks are not a party to any legal proceedings that management believes would have a material adverse effect on the results of operations or consolidated financial position at March 31, 2020.

In connection with certain asset sales, the Banks typically make representations and warranties about the underlying assets conforming to specified guidelines.  If the underlying assets do not conform to the specifications, the Banks may have an obligation to repurchase the assets or indemnify the purchaser against any loss.  The Banks believe that the potential for material loss under these arrangements is remote.  Accordingly, the fair value of such obligations is not material.

NOTE 14: DERIVATIVES AND HEDGING

The Company, through its Banner Bank subsidiary, is party to various derivative instruments that are used for asset and liability management and customer financing needs. Derivative instruments are contracts between two or more parties that have a notional amount and an underlying variable, require no net investment and allow for the net settlement of positions. The notional amount serves as the basis for the payment provision of the contract and takes the form of units, such as shares or dollars. The underlying variable represents a specified interest rate, index, or other component. The interaction between the notional amount and the underlying variable determines the number of units to be exchanged between the parties and influences the market value of the derivative contract. The Company obtains dealer quotations to value its derivative contracts.

The Company's predominant derivative and hedging activities involve interest rate swaps related to certain term loans and forward sales contracts associated with mortgage banking activities. Generally, these instruments help the Company manage exposure to market risk and meet customer financing needs. Market risk represents the possibility that economic value or net interest income will be adversely affected by fluctuations in external factors such as market-driven interest rates and prices or other economic factors.

Derivatives Designated in Hedge Relationships

The Company's fixed-rate loans result in exposure to losses in value or net interest income as interest rates change. The risk management objective for hedging fixed-rate loans is to effectively convert the fixed-rate received to a floating rate. The Company has hedged exposure to changes in the fair value of certain fixed-rate loans through the use of interest rate swaps. For a qualifying fair value hedge, changes in the value of the derivatives are recognized in current period earnings along with the corresponding changes in the fair value of the designated hedged item attributable to the risk being hedged.

Under a prior program, customers received fixed interest rate commercial loans and Banner Bank subsequently hedged that fixed-rate loan by entering into an interest rate swap with a dealer counterparty. Banner Bank receives fixed-rate payments from the customers on the loans and makes similar fixed-rate payments to the dealer counterparty on the swaps in exchange for variable-rate payments based on the one-month LIBOR index. Some of these interest rate swaps are designated as fair value hedges. Through application of the “short cut method of accounting,” there is an assumption that the hedges are effective. Banner Bank discontinued originating interest rate swaps under this program in 2008.

As of March 31, 2020 and December 31, 2019, the notional values or contractual amounts and fair values of the Company's derivatives designated in hedge relationships were as follows (in thousands):
 
Asset Derivatives
 
Liability Derivatives
 
March 31, 2020
 
December 31, 2019
 
March 31, 2020
 
December 31, 2019
 
Notional/
Contract Amount
 
Fair
   Value (1)
 
Notional/
Contract Amount
 
Fair
   Value (1)
 
Notional/
Contract Amount
 
Fair
   Value (2)
 
Notional/
Contract Amount
 
Fair
   Value (2)
Interest rate swaps
$
2,253

 
$
155

 
$
3,567

 
$
220

 
$
2,253

 
$
155

 
$
3,567

 
$
220


(1) 
Included in Loans receivable on the consolidated statements of financial condition.
(2) 
Included in Other liabilities on the consolidated statements of financial condition.

Derivatives Not Designated in Hedge Relationships

Interest Rate Swaps: Banner Bank uses an interest rate swap program for commercial loan customers, that provides the client with a variable-rate loan and enters into an interest rate swap in which the client receives a variable-rate payment in exchange for a fixed-rate payment. The Bank offsets its risk exposure by entering into an offsetting interest rate swap with a dealer counterparty for the same notional amount and length of term as the client interest rate swap providing the dealer counterparty with a fixed-rate payment in exchange for a variable-rate payment. These swaps do not qualify as designated hedges; therefore, each swap is accounted for as a free standing derivative.

Mortgage Banking: The Company sells originated one- to four-family and multifamily mortgage loans into the secondary mortgage loan markets. During the period of loan origination and prior to the sale of the loans in the secondary market, the Company has exposure to movements in

51


interest rates associated with written interest rate lock commitments with potential borrowers to originate one- to four-family loans that are intended to be sold and for closed one- to four-family and multifamily mortgage loans held for sale that are awaiting sale and delivery into the secondary market. The Company economically hedges the risk of changing interest rates associated with these mortgage loan commitments by entering into forward sales contracts to sell one- to four-family and multifamily mortgage loans or mortgage-backed securities to broker/dealers at specific prices and dates.

As of March 31, 2020 and December 31, 2019, the notional values or contractual amounts and fair values of the Company's derivatives not designated in hedge relationships were as follows (in thousands):
 
Asset Derivatives
 
Liability Derivatives
 
March 31, 2020
 
December 31, 2019
 
March 31, 2020
 
December 31, 2019
 
Notional/
Contract Amount
 
Fair
   Value (1)
 
Notional/
Contract Amount
 
Fair
   Value (1)
 
Notional/
Contract Amount
 
Fair
   Value (2)
 
Notional/
Contract Amount
 
Fair
   Value (2)
Interest rate swaps
$
404,492

 
$
42,532

 
$
371,957

 
$
14,982

 
$
404,492

 
$
23,125

 
$
371,957

 
$
10,746

Mortgage loan commitments
170,207

 
2,517

 
50,755

 
791

 
51,063

 
2

 
65,855

 
190

Forward sales contracts
81,429

 
808

 
70,895

 
317

 
229,000

 
4,446

 
239,320

 
484

 
$
656,128

 
$
45,857

 
$
493,607

 
$
16,090

 
$
684,555

 
$
27,573

 
$
677,132

 
$
11,420


(1) 
Included in Other assets on the Consolidated Statements of Financial Condition, with the exception of certain interest swaps and mortgage loan commitments (with a fair value of $959,000 at March 31, 2020 and $347,000 at December 31, 2019), which are included in Loans receivable.
(2) 
Included in Other liabilities on the Consolidated Statements of Financial Condition.

Gains (losses) recognized in income on derivatives not designated in hedge relationships for the three months ended March 31, 2020 and 2019 were as follows (in thousands):
 
Location on Consolidated
Statements of Operations
 
Three Months Ended
March 31,
 
 
2020
 
2019
Mortgage loan commitments
Mortgage banking operations
 
$
1,726

 
$
7

Forward sales contracts
Mortgage banking operations
 
(3,068
)
 
150

 
 
 
$
(1,342
)
 
$
157



The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements. Credit risk of the financial contract is controlled through the credit approval, limits, and monitoring procedures and management does not expect the counterparties to fail their obligations.

In connection with the interest rate swaps between Banner Bank and the dealer counterparties, the agreements contain a provision where if Banner Bank fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions and Banner Bank would be required to settle its obligations. Similarly, Banner Bank could be required to settle its obligations under certain of its agreements if specific regulatory events occur, such as a publicly issued prompt corrective action directive, cease and desist order, or a capital maintenance agreement that required Banner Bank to maintain a specific capital level. If Banner Bank had breached any of these provisions at March 31, 2020 or December 31, 2019, it could have been required to settle its obligations under the agreements at the termination value. As of March 31, 2020 and December 31, 2019, the termination value of derivatives in a net liability position related to these agreements was $42.7 million and $15.2 million, respectively. The Company generally posts collateral against derivative liabilities in the form of cash, government agency-issued bonds, mortgage-backed securities, or commercial mortgage-backed securities. Collateral posted against derivative liabilities was $42.3 million and $28.1 million as of March 31, 2020 and December 31, 2019, respectively.

Derivative assets and liabilities are recorded at fair value on the balance sheet. Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis and to offset net derivative positions with related collateral where applicable. In addition, some of interest rate swap derivatives between Banner Bank and the dealer counterparties are cleared through central clearing houses. These clearing houses characterize the variation margin payments as settlements of the derivative's market exposure and not as collateral. The variation margin is treated as an adjustment to our cash collateral, as well as a corresponding adjustment to our derivative liability. As of March 31, 2020 and December 31, 2019, the variation margin adjustment was a negative adjustment of $19.4 million and $4.3 million, respectively.


52


The following tables present additional information related to the Company's derivative contracts, by type of financial instrument, as of March 31, 2020 and December 31, 2019 (in thousands):
 
March 31, 2020
 
 
 
 
 
 
 
Gross Amounts of Financial Instruments Not Offset in the Consolidated Statements of Financial Condition
 
 
 
Gross Amounts Recognized
 
Amounts offset
in the Statement
of Financial Condition
 
Net Amounts
in the Statement
of Financial Condition
 
Netting Adjustment Per Applicable Master Netting Agreements
 
Fair Value
of Financial Collateral
in the Statement
of Financial Condition
 
Net Amount
Derivative assets
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
42,687

 
$

 
$
42,687

 
$

 
$

 
$
42,687

 
$
42,687

 
$

 
$
42,687

 
$

 
$

 
$
42,687

 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
42,687

 
$
(19,407
)
 
$
23,280

 
$

 
$
(23,285
)
 
$
(5
)
 
$
42,687

 
$
(19,407
)
 
$
23,280

 
$

 
$
(23,285
)
 
$
(5
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
 
 
 
 
 
 
Gross Amounts of Financial Instruments Not Offset in the Consolidated Statements of Financial Condition
 
 
 
Gross Amounts Recognized
 
Amounts offset
in the Statement
of Financial Condition
 
Net Amounts
in the Statement
of Financial Condition
 
Netting Adjustment Per Applicable Master Netting Agreements
 
Fair Value
of Financial Collateral
in the Statement
of Financial Condition
 
Net Amount
Derivative assets
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
15,242

 
$
(40
)
 
$
15,202

 
$

 
$

 
$
15,202

 
$
15,242

 
$
(40
)
 
$
15,202

 
$

 
$

 
$
15,202

 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
15,242

 
$
(4,276
)
 
$
10,966

 
$

 
$
(15,209
)
 
$
(4,243
)
 
$
15,242

 
$
(4,276
)
 
$
10,966

 
$

 
$
(15,209
)
 
$
(4,243
)



53


NOTE 15: REVENUE FROM CONTRACTS WITH CUSTOMERS

Disaggregation of Revenue:

Deposit fees and other service charges for the three months ended March 31, 2020 and 2019 are summarized as follows (in thousands):
 
Three Months Ended
March 31,
 
2020
 
2019
Deposit service charges
$
4,832

 
$
4,586

Debit and credit card interchange fees
4,884

 
7,931

Debit and credit card expense
(1,932
)
 
(2,449
)
Merchant services income
3,002

 
2,856

Merchant services expense
(2,436
)
 
(2,319
)
Other service charges
1,453

 
2,013

Total deposit fees and other service charges
$
9,803

 
$
12,618



Deposit fees and other service charges

Deposit fees and other service charges include transaction and non-transaction based deposit fees. Transaction based fees on deposit accounts are charged to deposit customers for specific services provided to the customer. These fees include such items as wire fees, official check fees, and overdraft fees. These are contract specific to each individual transaction and do not extend beyond the individual transaction. The performance obligation is completed and the fees are recognized at the time the specific transactional service is provided to the customer. Non-transactional deposit fees are typically monthly account maintenance fees charged on deposit accounts. These are day-to-day contracts that can be canceled by either party without notice. The performance obligation is satisfied and the fees are recognized on a monthly basis after the service period is completed.

Debit and credit card interchange income and expenses

Debit and credit card interchange income represent fees earned when a debit or credit card issued by the Banks is used to purchase goods or services at a merchant. The merchant's bank pays the Banks a default interchange rate set by MasterCard on a transaction by transaction basis. The merchant acquiring bank can stop accepting the Banks’ cards at any time and the Banks can stop further use of cards issued by them at any time. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the Banks cardholders’ card. Direct expenses associated with the credit and debit card are recorded as a net reduction against the interchange income.

Merchant services income

Merchant services income represents fees earned by the Banks for card payment services provided to its merchant customers. The Banks have a contract with a third party to provide card payment services to the Banks’ merchants that contract for those services. The third party provider has contracts with the Banks’ merchants to provide the card payment services. The Banks do not have a direct contractual relationship with its merchants for these services. The Banks set the rates for the services provided by the third party. The third party provider passes the payments made by the Banks’ merchants through to the Banks. The Banks, in turn, pay the third party provider for the services it provides to the Banks’ merchants. These payments to the third party provider are recorded as expenses as a net reduction against fee income. In addition, a portion of the payment received by the Banks represents interchange fees which are passed through to the card issuing bank. Income is primarily earned based on the dollar volume and number of transactions processed. The performance obligation is satisfied and the related fee is earned when each payment is accepted by the processing network.

NOTE 16: LEASES

The Company leases 105 buildings and offices under non-cancelable operating leases. The leases contain various provisions for increases in rental rates, based either on changes in the published Consumer Price Index or a predetermined escalation schedule. Substantially all of the leases provide the Company with the option to extend the lease term one or more times following expiration of the initial term.


54


Lease Position as of March 31, 2020 and December 31, 2019

The table below presents the lease right-of-use assets and lease liabilities recorded on the balance sheet at March 31, 2020 and December 31, 2019 (dollars in thousands):

 
 
Classification on the Balance Sheet
 
March 31, 2020
 
December 31, 2019
Assets
 
 
 
 
 
 
Operating right-of-use lease assets
 
Other assets
 
$
59,620

 
$
61,766

 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
Operating lease liabilities
 
Accrued expenses and other liabilities
 
$
63,757

 
$
65,818



Weighted-average remaining lease term
 
 
 
 
Operating leases
 
6.0 years

 
6.2 years

 
 
 
 
 
Weighted-average discount rate
 
 
 
 
Operating leases
 
3.6
%
 
3.7
%

Lease Costs

The table below presents certain information related to the lease costs for operating leases for the three months ended March 31, 2020 and 2019 (in thousands):
 
 
Three Months Ended
March 31,
 
 
2020
 
2019
Operating lease cost (1)
 
$
4,164

 
$
3,975

Short-term lease cost (1)
 
21

 
121

Variable lease cost (1)
 
811

 
561

Less sublease income (1)
 
(254
)
 
(237
)
Total lease cost
 
$
4,742

 
$
4,420

(1) Lease expenses and sublease income are classified within occupancy and equipment expense on the Consolidated Statements of Operations.

Supplemental Cash Flow Information

Operating cash flows paid for operating lease amounts included in the measurement of lease liabilities were $4.1 million and $3.9 million for the three months ended March 31, 2020 and March 31, 2019, respectively. During the three months ended March 31, 2020 and March 31, 2019, the Company recorded $1.6 million and $61.0 million, respectively, of right-of-use lease assets in exchange for operating lease liabilities.


55


Undiscounted Cash Flows

The table below reconciles the undiscounted cash flows for each of the next five years beginning with 2020 and the total of the remaining years to the operating lease liabilities recorded on the Consolidated Statements of Financial Position (in thousands):

 
 
Operating Leases
Remainder of 2020
 
$
12,180

2021
 
15,370

2022
 
11,764

2023
 
8,675

2024
 
6,756

Thereafter
 
16,489

Total minimum lease payments
 
71,234

Less: amount of lease payments representing interest
 
(7,477
)
Lease obligations
 
$
63,757



As of March 31, 2020 and December 31, 2019, the Company had no undiscounted lease payments under an operating lease that had not yet commenced.


ITEM 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Overview

We are a bank holding company incorporated in the State of Washington which owns 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 March 31, 2020, it had 173 branch offices and 18 loan production offices located in Washington, Oregon, California, Idaho and Utah.  Islanders Bank is a Washington-chartered commercial bank and conducts its business from three locations in San Juan County, Washington.  Banner Corporation is subject to regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board).  Banner Bank and Islanders Bank (the Banks) are subject to regulation by the Washington State Department of Financial Institutions, Division of Banks and the Federal Deposit Insurance Corporation (the FDIC).  As of March 31, 2020, we had total consolidated assets of $12.78 billion, total loans of $9.29 billion, total deposits of $10.45 billion and total shareholders’ equity of $1.60 billion.

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, California and Idaho.  Banner Bank is also an active participant in secondary loan markets, engaging in mortgage banking operations largely through the origination and sale of one- to four-family and multifamily residential loans.  Lending activities include commercial business and commercial real estate loans, agriculture business loans, construction and land development loans, one- to four-family and multifamily residential loans and consumer loans.

Banner Corporation's successful execution of its super community bank model and strategic initiatives have delivered solid core operating results and profitability. Highlights of this success have included solid asset quality, client acquisition and account growth, which have resulted in increased core deposit balances and strong revenue generation while maintaining the Company's moderate risk profile.

Our financial results for the quarter ended March 31, 2020 reflects the impact of the COVID-19 pandemic which resulted in a substantial reduction in business activity or the closing of businesses in all the western states Banner operates. In response to COVID-19, Banner is offering payment and financial relief programs for borrowers impacted by the economic decline. These programs include loan payment deferrals for up to 90 days, waived late fees, and, on a more limited basis, waived interest or allowed interest only loan payments and we have suspended foreclosure proceedings. As of April 30, 2020, Banner had modified 2,582 loans with a balance of $837.0 million under these programs. Since these loans were performing loans that were current on their payments prior to COVID-19, these modifications are not considered to be troubled debt restructurings. In addition, the U.S. Small Business Administration (SBA) provided assistance to small businesses impacted by COVID-19 through the Paycheck Protection Program (PPP), which is designed to provide near term relief to help small businesses sustain operations.  Banner offered small businesses loans to clients in its service area through this program.  As of April 30, 2020, Banner had received approval from the SBA on approximately 7,000 PPP loan applications with a balance of over $1.1 billion.  Banner is also planning to assist our clients with accessing other borrowing options as they become available, including the Main Street Lending Program and other government sponsored lending programs, as appropriate.

Banner has taken various steps to ensure the safety of customers and staff by limiting branch activities to appointment only and use of our drive-up facilities, and by encouraging the use of our digital and electronic banking channels, all the while adjusting for evolving State and Federal

56


stay-at-home guidelines. To protect the well-being of staff and customers, Banner implemented measures to allow employees to work from home to the extent practicable. To facilitate this approach, Banner purchased additional computer equipment to staff and enhanced the Company's network capabilities with several upgrades. These expenses plus other expenses incurred in response to the COVID-19 pandemic resulted in $239,000 of related costs during the quarter ended March 31, 2020.

For the quarter ended March 31, 2020, our net income was $16.9 million, or $0.47 per diluted share, compared to net income of $33.3 million, or $0.95 per diluted share, for the quarter ended March 31, 2019. The current quarter was positively impacted by growth in residential mortgage loan production, which was offset by an increase in the provision for credit losses, a decrease in deposit fees and other service charges, the recognition of a net loss for fair value adjustments as a result of changes in the valuation of financial instruments carried at fair value, as well as an increase in non-interest expense. Compared to the same quarter a year ago, we had a decrease in net interest income, due to an increase in the provision for credit losses for the current quarter primarily reflecting expected lifetime credit losses due to the COVID-19 pandemic based upon the financial conditions and economic outlook that existed as of March 31, 2020. The probability for further decline in economic conditions, including higher unemployment rates and lower gross domestic product, has increased since quarter end and should they materialize, an additional provision for expected credit losses will be necessary that may materially adversely affect our earnings.

Our operating results depend primarily on our net interest income, which is the difference between interest income on interest-earning assets, consisting primarily of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of customer deposits, FHLB advances, other borrowings and junior subordinated debentures. 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, interest-bearing liabilities and non-interest-bearing funding sources including non-interest-bearing deposits. Our net interest income increased $3.2 million, or 3%, to $119.3 million for the quarter ended March 31, 2020, compared to $116.1 million for the same quarter one year earlier. This increase in net interest income is a result of growth in total loans receivable and core deposits.

Our net income is also affected by the level of our non-interest income, including deposit fees and other service charges, results of mortgage banking operations, which includes gains and losses on the sale of loans and servicing fees, gains and losses on the sale of securities, as well as our non-interest expenses and provisions for loan losses and income taxes. In addition, our net income is affected by the net change in the value of certain financial instruments carried at fair value.

Our total revenues (net interest income before the provision for loan losses plus total non-interest income) for the first quarter of 2020 increased $4.2 million, or 3%, to $138.4 million, compared to $134.2 million for the same period a year earlier, largely as a result of increased net interest income.  Our total non-interest income, which is a component of total revenue and includes the net gain on sale of securities and changes in the value of financial instruments carried at fair value, was $19.2 million for the quarter ended March 31, 2020, compared to $18.1 million for the quarter ended March 31, 2019.

Our non-interest expense increased in the first quarter of 2020 compared to a year earlier largely as a result of the higher salary and employee benefits due to additional staffing related to the operations acquired from the acquisition of AltaPacific on November 1, 2019 and normal salary and wage adjustments, as well as the $1.7 million provision for credit losses - unfunded loan commitments recorded in the first quarter of 2020. Non-interest expense was $95.2 million for the quarter ended March 31, 2020, compared to $90.0 million for the same quarter a year earlier.

We recorded a $21.7 million provision for credit losses - loans in the quarter ended March 31, 2020, compared to a $2.0 million provision for loan losses for the quarter ended March 31, 2019 due to the COVID-19 pandemic. The provision for the current quarter primarily reflects expected lifetime credit losses due to the COVID-19 pandemic based upon the financial conditions and economic outlook that existed as of March 31, 2020. The allowance for credit losses - loans at March 31, 2020 was $130.5 million, representing 299% of non-performing loans compared to $100.6 million, or 254% of non-performing loans at December 31, 2019. In addition to the allowance for credit losses - loans, Banner maintains an allowance for credit losses - unfunded loan commitments which was $11.5 million at March 31, 2020 compared to $2.7 million at December 31, 2019. Non-performing loans were $43.7 million at March 31, 2020, compared to $39.6 million at December 31, 2019 and $19.3 million a year earlier. (See Note 5, Loans Receivable and the Allowance for Credit Losses, as well as “Asset Quality” below in this Form 10-Q.)

*Non-GAAP financial measures: Net income, revenues and other earnings and expense information excluding fair value adjustments, gains or losses on the sale of securities, acquisition-related expenses, COVID-19 expenses, amortization of CDI, REO gain (loss) and state/municipal business and use taxes are non-GAAP financial measures.  Management has presented these and other non-GAAP financial measures in this discussion and analysis 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 Three Months Ended March 31, 2020 and 2019” for more detailed information about our financial performance.

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


57


 
For the Three Months Ended
March 31,
 
2020
 
2019
ADJUSTED REVENUE
 
 
 
Net interest income
$
119,258

 
$
116,104

Total non-interest income
19,165

 
18,125

Total GAAP revenue
138,423

 
134,229

Exclude net gain on sale of securities
(78
)
 
(1
)
Exclude change in valuation of financial instruments carried at fair value
4,596

 
(11
)
Adjusted Revenue (non-GAAP)
$
142,941

 
$
134,217


 
For the Three Months Ended
March 31,
 
2020
 
2019
ADJUSTED EARNINGS
 
 
 
Net income (GAAP)
$
16,882

 
$
33,346

Exclude net gain on sale of securities
(78
)
 
(1
)
Exclude change in valuation of financial instruments carried at fair value
4,596

 
(11
)
Exclude acquisition-related expenses
1,142

 
2,148

Exclude COVID-19 expenses
239

 

Exclude related tax benefit
(1,405
)
 
(513
)
Total adjusted earnings (non-GAAP)
$
21,376

 
$
34,969

Diluted earnings per share (GAAP)
$
0.47

 
$
0.95

Diluted adjusted earnings per share (non-GAAP)
$
0.60

 
$
0.99


58


 
For the Three Months Ended
March 31,
 
2020
 
2019
ADJUSTED EFFICIENCY RATIO
 
 
 
Non-interest expense (GAAP)
$
95,185

 
$
90,014

Exclude acquisition-related expenses
(1,142
)
 
(2,148
)
Exclude COVID-19 expenses
(239
)
 

Exclude CDI amortization
(2,001
)
 
(2,052
)
Exclude state/municipal tax expense
(984
)
 
(945
)
Exclude REO loss
(100
)
 
123

Adjusted non-interest expense (non-GAAP)
$
90,719

 
$
84,992

 
 
 
 
Net interest income (GAAP)
$
119,258

 
$
116,104

Non-interest income (GAAP)
19,165

 
18,125

Total revenue
138,423

 
134,229

Exclude net gain on sale of securities
(78
)
 
(1
)
Exclude net change in valuation of financial instruments carried at fair value
4,596

 
(11
)
Adjusted revenue (non-GAAP)
$
142,941

 
$
134,217

 
 
 
 
Efficiency ratio (GAAP)
68.76
%
 
67.06
%
Adjusted efficiency ratio (non-GAAP)
63.47
%
 
63.32
%




59


The ratio of tangible common shareholders’ equity to tangible assets is also a non-GAAP financial measure. We calculate tangible common equity by excluding goodwill and other intangible assets from shareholders’ equity. We calculate tangible assets by excluding the balance of goodwill and other intangible assets from total assets. We believe that this is consistent with the treatment by our bank regulatory agencies, which exclude goodwill and other intangible assets from the calculation of risk-based capital ratios. Management believes that this non-GAAP financial measure provides information to investors that is useful in understanding the basis of our capital position (dollars in thousands).
TANGIBLE COMMON SHAREHOLDERS' EQUITY TO TANGIBLE ASSETS
 
 
 
 
 
March 31, 2020
 
December 31, 2019
 
March 31, 2019
Shareholders’ equity (GAAP)
$
1,601,700

 
$
1,594,034

 
$
1,511,191

   Exclude goodwill and other intangible assets, net
400,278

 
402,279

 
369,801

Tangible common shareholders’ equity (non-GAAP)
$
1,201,422

 
$
1,191,755

 
$
1,141,390

Total assets (GAAP)
$
12,780,950

 
$
12,604,031

 
$
11,740,285

   Exclude goodwill and other intangible assets, net
400,278

 
402,279

 
369,801

Total tangible assets (non-GAAP)
$
12,380,672

 
$
12,201,752

 
$
11,370,484

Common shareholders’ equity to total assets (GAAP)
12.53
%
 
12.65
%
 
12.87
%
Tangible common shareholders’ equity to tangible assets (non-GAAP)
9.70
%
 
9.77
%
 
10.04
%
 
 
 
 
 
 
TANGIBLE COMMON SHAREHOLDERS' EQUITY PER SHARE
 
 
 
 
 
Tangible common shareholders' equity (non-GAAP)
$
1,201,422

 
$
1,191,755

 
$
1,141,390

Common shares outstanding at end of period
35,102,459

 
35,751,576

 
35,152,746

Common shareholders' equity (book value) per share (GAAP)
$
45.63

 
$
44.59

 
$
42.99

Tangible common shareholders' equity (tangible book value) per share (non-GAAP)
$
34.23

 
$
33.33

 
$
32.47


Management’s Discussion and Analysis of Financial Condition and 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 Selected Notes to the Consolidated Financial Statements contained in Item 1 of this Form 10-Q.

Summary of Critical Accounting Policies and Estimates

In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of Operations, Comprehensive Income, Changes in Shareholders’ Equity and Cash Flows reflect all adjustments (which include reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with 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 credit losses, (iii) the valuation of financial assets and liabilities recorded at fair value, (iv) the valuation of intangibles, such as goodwill, core deposit intangibles and mortgage servicing rights, (v) the valuation of real estate held for sale, (vi) the valuation of assets and liabilities acquired in business combinations and subsequent recognition of related income and expense, and (vii) 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, 2019 except for the change related to the adoption of Financial Instruments - Credit Losses (Topic 326) as described below and in Notes 1 and 2 to the Consolidated Financial Statements.  For additional information concerning critical accounting policies, see the Selected Notes to the Consolidated Financial Statements and the following:


60


Interest Income: (Notes 4 and 5) 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.  Management's assessment of the likelihood of full repayment involves judgment including determining the fair value of the underlying collateral which can be impacted by the economic environment. 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. Loans modified due to the COVID-19 pandemic are considered current if they are less than 30 days past due on the contractual payments at the time the loan modification program was put in place and therefore continue to accrue interest unless the interest is being waived.

Provision and Allowance for Credit Losses - Loans: (Note 5) The methodology for determining the allowance for credit losses - loans is considered a critical accounting policy by management because of the high degree of judgment involved, the subjectivity of the assumptions used, and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for credit losses. Among the material estimates required to establish the allowance for credit losses - loans are: a reasonable and supportable forecast; a reasonable and supportable forecast period and the reversion period; value of collateral; strength of guarantors; the amount and timing of future cash flows for loans individually evaluated; and determination of the qualitative loss factors. All of these estimates are susceptible to significant change. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. The Banks have elected to exclude accrued interest receivable from the amortized cost basis in their estimate of the allowance for credit losses. The provision for credit losses reflects the amount required to maintain the allowance for credit losses at an appropriate level based upon management’s evaluation of the adequacy of collective and individual loss reserves.  The Company has established systematic methodologies for the determination of the adequacy of the Company’s allowance for credit losses.  The methodologies are set forth in a formal policy and take into consideration the need for a valuation allowance for loans evaluated on a collective (pool) basis which have similar risk characteristics as well as allowances that are tied to individual loans that do not share risk characteristics.  The Company increases its allowance for credit losses by charging provisions for credit losses on its consolidated statement of operations. Losses related to specific assets are applied as a reduction of the carrying value of the assets and charged against the allowance for credit loss reserve when management believes the uncollectibility of a loan balance is confirmed.  Recoveries on previously charged off loans are credited to the allowance for credit losses.  

Management estimates the allowance for credit losses using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The allowance for credit losses is maintained at a level sufficient to provide for expected credit losses over the life of the loan based on evaluating historical credit loss experience and making adjustments to historical loss information for differences in the specific risk characteristics in the current loan portfolio.  These factors include, among others, changes in the size and composition of the loan portfolio, differences in underwriting standards, delinquency rates, actual loss experience and current economic conditions.

The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. In estimating the component of the allowance for credit losses for loans that share common risk characteristics, loans are pooled based on loan type and areas of risk concentration. For loans evaluated collectively, the allowance for credit losses is calculated using life of loan historical losses adjusted for economic forecasts and current conditions.

For commercial real estate, multifamily real estate, construction and land, commercial business and agricultural loans with risk rating segmentation, historical credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and risk rating. For one- to four- family residential loans, historical credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and delinquency status. These models calculate an expected life-of-loan loss percentage for each loan category by calculating the probability of default, based on the migration of loans from performing to loss by risk rating or delinquency categories using historical life-of-loan analysis and the severity of loss, based on the aggregate net lifetime losses incurred for each loan pool. For commercial real estate, commercial business, and consumer loans without risk rating segmentation, historical credit loss assumptions are estimated using a model that calculates an expected life-of-loan loss percentage for each loan category by considering the historical cumulative losses based on the aggregate net lifetime losses incurred for each loan pool. The model captures historical loss data back to the first quarter of 2008. For loans evaluated collectively, management uses economic indicators to adjust the historical loss rates so that they better reflect management’s expectations of future conditions over the remaining lives of the loans in the portfolio based on reasonable and supportable forecasts. These economic indicators are selected based on correlation to the Company’s historical credit loss experience and are evaluated for each loan category. The economic indicators evaluated include unemployment, gross domestic product, real estate price indices and growth, yield curve spreads, treasury yields, the corporate yield, the market volatility index, the Dow Jones index, the consumer confidence index, and the prime rate. Management considers various economic scenarios and forecasts when evaluating the economic indicators and probability weights the various scenarios to arrive at the forecast that most reflects management’s expectations of future conditions. The allowance for credit losses is then adjusted for the period in which those forecasts are considered to be reasonable and supportable. To the extent the lives of the loans in the portfolio extend beyond the period for which a reasonable and supportable forecast can be made, the adjustments discontinue to be applied so that the model reverts back to the historical loss rates using a straight line reversion method. Management selected an initial reasonable and supportable forecast period of 12 months with a reversion period of 12 months. Both the reasonable and supportable forecast period and the reversion period are periodically reviewed by Management.

Further, for loans evaluated collectively, management also considers qualitative and environmental factors for each loan category to adjust for differences between the historical periods used to calculate historical loss rates and expected conditions over the remaining lives of the loans in

61


the portfolio. In determining the aggregate adjustment needed management considers the financial condition of the borrowers, the nature and volume of the loans, the remaining terms and the extent of prepayments on the loans, the volume and severity of past due and classified loans as well as the value of the underlying collateral on loans in which the collateral dependent practical expedient has not been used. Management also considers the Company’s lending policies, the quality of the Company’s credit review system, the quality of the Company’s management and lending staff, and the regulatory and economic environments in the areas in which the Company’s lending activities are concentrated.

Loans that do not share risk characteristics with other loans in the portfolio are individually evaluated for impairment are not included in the collective evaluation.  Factors involved in determining whether a loan should be individually evaluated include, but are not limited to, the financial condition of the borrower and the value of the underlying collateral.  Expected credit losses for loans evaluated individually are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate or when the Banks determine that foreclosure is probable, the expected credit loss is measured based on the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. As a practical expedient, the Banks measure the expected credit loss for a loan using the fair value of the collateral, if repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty based on the Banks' assessment as of the reporting date.

In both cases, if the fair value of the collateral is less than the amortized cost basis of the loan, the Banks will recognize an allowance as the difference between the fair value of the collateral, less costs to sell (if applicable), at the reporting date and the amortized cost basis of the loan. If the fair value of the collateral exceeds the amortized cost basis of the loan, any expected recovery added to the amortized cost basis will be limited to the amount previously charged-off. Subsequent changes in the expected credit losses for loans evaluated individually are included within the provision for credit losses in the same manner in which the expected credit loss initially was recognized or as a reduction in the provision that would otherwise be reported.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Banks.

Some of the Banks’ loans are reported as troubled debt restructures (TDRs).  Loans are reported as TDRs when the Banks grant a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider.  Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk.  The allowance for credit losses on a TDR is determined using the same method as all other loans held for investment, except when the value of the concession cannot be measured using a method other than the discounted cash flow method. When the value of a concession is measured using the discounted cash flow method the allowance for credit losses is determined by discounting the expected future cash flows at the original interest rate of the loan. The Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act if they are less than 30 days past due on their contractual payments at the time a modification program is implemented.

Fair Value Accounting and Measurement: (Note 9) We use fair value measurements to record fair value adjustments to certain financial assets and liabilities and to determine fair value disclosures.  We include in the Notes to the Consolidated Financial Statements information about the extent to which fair value is used to measure financial assets and liabilities, the valuation methodologies used and the impact on our results of operations and financial condition.  Additionally, for financial instruments not recorded at fair value we disclose, where required, our estimate of their fair value.  

Loans Acquired in Business Combinations: (Notes 3 and 5) Loans acquired in business combinations, are recorded at their fair value at the acquisition date. Establishing the fair value of acquired loans involves a significant amount of judgment, including determining the credit discount based upon historical data adjusted for current economic conditions and other factors. If any of these assumptions are inaccurate actual credit losses could vary significantly from the credit discount used to calculate the fair value of the acquired loans. Acquired loans are evaluated upon acquisition and classified as either purchased credit deteriorated or purchased non-credit-deteriorated. Purchased credit deteriorated (PCD) loans have experienced more than insignificant credit deterioration since origination. For PCD loans, an allowance for credit losses is determined at the acquisition date using the same methodology as other loans held for investment. The initial allowance for credit losses determined on a collective basis is allocated to individual loans. The loan’s fair value grossed up for the allowance for credit losses becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through a provision for credit losses.

For purchased non-credit deteriorated loans, the difference between the fair value and unpaid principal balance of the loan at the acquisition date is amortized or accreted to interest income over the life of the loans. While credit discounts are included in the determination of the fair value for non-credit deteriorated loans, since these discounts are expected to be accreted over the life of the loans, they cannot be used to offset the allowance for credit losses that must be recorded at the acquisition date. As a result, an allowance for credit losses is determined at the acquisition date using the same methodology as other loans held for investment and is recognized as a provision for credit losses. Any subsequent deterioration (improvement) in credit quality is recognized by recording (recapturing) a provision for credit losses.


62


Goodwill: (Note 7) Goodwill represents the excess of the purchase consideration paid over the fair value of the assets acquired, net of the fair values of liabilities assumed in a business combination and is not amortized but is reviewed annually, or more frequently as current circumstances and conditions warrant, for impairment. An assessment of qualitative factors is completed to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The qualitative assessment involves judgment by management on determining whether there have been any triggering events that have occurred which would indicate potential impairment. If the qualitative analysis concludes that further analysis is required, then a quantitative impairment test would be completed. The quantitative goodwill impairment test is used to identify the existence of impairment and the amount of impairment loss and compares the reporting unit's estimated fair values, including goodwill, to its carrying amount. If the fair value exceeds the carry amount then goodwill is not considered impaired. If the carrying amount exceeds its fair value, an impairment loss would be recognized equal to the amount of excess, limited to the amount of total goodwill allocated to the reporting unit. The impairment loss would be recognized as a charge to earnings.

Other Intangible Assets: (Note 7) Other intangible assets consists primarily of core deposit intangibles (CDI), which are amounts recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the customer relationships associated with the deposits.  Core deposit intangibles are being amortized on an accelerated basis over a weighted average estimated useful life of eight years.  The determination of the estimated useful life of the core deposit intangible involves judgment by management. The actual life of the core deposit intangible could vary significantly from the estimated life. These assets are reviewed at least annually for events or circumstances that could impact their recoverability.  These events could include loss of the underlying core deposits, increased competition or adverse changes in the economy.  To the extent other identifiable intangible assets are deemed unrecoverable, impairment losses are recorded in other non-interest expense to reduce the carrying amount of the assets.

Mortgage Servicing Rights: (Note 7) Mortgage servicing rights (MSRs) are recognized as separate assets when rights are acquired through purchase or through sale of loans.  Generally, purchased MSRs are capitalized at the cost to acquire the rights.  For sales of mortgage loans, the value of the MSR is estimated and capitalized.  Fair value is based on market prices for comparable mortgage servicing contracts.  The fair value of the MSRs includes an estimate of the life of the underlying loans which is affected by estimated prepayment speeds. The estimate of prepayment speeds is based on current market conditions. Actual market conditions could vary significantly from current conditions which could result in the estimated life of the underlying loans being different which would change the fair value of the MSR. Capitalized MSRs are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Real Estate Owned Held for Sale: (Note 6) Property acquired by foreclosure or deed in lieu of foreclosure is recorded at the estimated fair value of the property, less expected selling costs.  Development and improvement costs relating to the property may be capitalized, while other holding costs are expensed.  The carrying value of the property is periodically evaluated by management. Property values are influenced by current economic and market conditions, changes in economic conditions could result in a decline in property value. To the extent that property values decline, allowances are established to reduce the carrying value to net realizable value.  Gains or losses at the time the property is sold are charged or credited to operations in the period in which they are realized.  The amounts the Banks will ultimately recover from real estate held for sale may differ substantially from the carrying value of the assets because of market factors beyond the Banks’ control or because of changes in the Banks’ strategies for recovering the investment.

Income Taxes and Deferred Taxes: (Note 10) The Company and its wholly-owned subsidiaries file consolidated U.S. federal income tax returns, as well as state income tax returns in Oregon, California, Utah, Idaho and Montana.  Income taxes are accounted for using the asset and liability method.  Under this method a deferred tax asset or liability is determined based on the enacted tax rates which are expected to be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns.  The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.  We assess the appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other pertinent information and maintain tax accruals consistent with our evaluation. Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations by the tax authorities and newly enacted statutory, judicial and regulatory guidance that could impact the relative merits of tax positions. These changes, when they occur, impact accrued taxes and can materially affect our operating results. A valuation allowance is required to be recognized if it is more likely than not that all or a portion of our deferred tax assets will not be realized. The evaluation pertaining to the tax expense and related deferred tax asset and liability balances involves a high degree of judgment and subjectivity around the measurement and resolution of these matters. The ultimate realization of the deferred tax assets is dependent upon the existence, or generation, of taxable income in the periods when those temporary differences and net operating loss and credit carryforwards are deductible.


63


Comparison of Financial Condition at March 31, 2020 and December 31, 2019

General:  Total assets increased $176.9 million, to $12.78 billion at March 31, 2020, from $12.60 billion at December 31, 2019. The increase was largely the result of increases in both held to maturity and available for sale securities.

Loans and lending: Loans are our most significant and generally highest yielding earning assets. We attempt to maintain a portfolio of loans in a range of 90% to 95% of total deposits to enhance our revenues, while adhering to sound underwriting practices and appropriate diversification guidelines in order to maintain a moderate risk profile. 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. Total loans receivable decreased $19.6 million during the three months ended March 31, 2020, primarily reflecting decreased one-to-four family, construction, land and land development, agricultural and consumer loan balances due to seasonal and other market factors, partially offset by increased commercial real estate, multifamily real estate, and commercial business loan balances. At March 31, 2020, our loans receivable totaled $9.29 billion compared to $9.31 billion at December 31, 2019 and $8.69 billion at March 31, 2019. The growth over the year ago period includes the impact of the acquisition of AltaPacific during the fourth quarter of 2019 which included $332.4 million of portfolio loans.

The following table sets forth the composition of the Company's loans receivable by type of loan as of the dates indicated (dollars in thousands):
 
 
 
 
 
 
 
Percentage Change
 
Mar 31, 2020
 
Dec 31, 2019
 
Mar 31, 2019
 
Prior Year End
 
Prior Year
Commercial real estate:
 
 
 
 
 
 
 
 
 
Owner-occupied
$
1,024,089

 
$
980,021

 
$
869,634

 
4.5
 %
 
17.8
 %
Investment properties
2,007,537

 
2,024,988

 
1,838,328

 
(0.9
)
 
9.2

Small balance CRE
591,783

 
613,484

 
619,646

 
(3.5
)
 
(4.5
)
Multifamily real estate
400,206

 
388,388

 
300,684

 
3.0

 
33.1

Construction, land and land development:
 
 
 
 
 
 
 
 
 
Commercial construction
205,476

 
210,668

 
181,888

 
(2.5
)
 
13.0

Multifamily construction
250,410

 
233,610

 
183,203

 
7.2

 
36.7

One- to four-family construction
534,956

 
544,308

 
514,410

 
(1.7
)
 
4.0

Land and land development
232,506

 
245,530

 
271,038

 
(5.3
)
 
(14.2
)
Commercial business:
 
 
 
 
 
 

 

Commercial business
1,357,817

 
1,364,650

 
1,199,930

 
(0.5
)
 
13.2

Small business scored
807,539

 
772,657

 
738,665

 
4.5

 
9.3

Agricultural business, including secured by farmland
330,257

 
337,271

 
339,472

 
(2.1
)
 
(2.7
)
One- to four-family residential
881,387

 
925,531

 
942,477

 
(4.8
)
 
(6.5
)
Consumer:
 
 
 
 
 
 
 
 
 
Consumer—home equity revolving lines of credit
521,618

 
519,336

 
532,600

 
0.4

 
(2.1
)
Consumer—other
140,163

 
144,915

 
160,682

 
(3.3
)
 
(12.8
)
Total loans receivable
$
9,285,744

 
$
9,305,357

 
$
8,692,657

 
(0.2
)%
 
6.8
 %

Our commercial real estate loans for owner-occupied, investment properties, and small balance CRE totaled $3.62 billion, or 39% of our loan portfolio at March 31, 2020. In addition, multifamily residential real estate loans totaled $400.2 million and comprised 4% of our loan portfolio. Commercial real estate loans increased by $4.9 million during the first three months of 2020 while multifamily real estate loans increased by $11.8 million. Although multifamily real estate loans remain a modest portion of our held-for-investment loan portfolio, originations and sales of multifamily real estate loans held for sale have made a contribution to our mortgage banking revenue.

We also originate commercial, multifamily, and residential construction, land and land development loans, which totaled $1.22 billion, or 13% of our loan portfolio at March 31, 2020. Residential construction balances decreased $9.4 million, or 2%, to $535.0 million at March 31, 2020 compared to $544.3 million at December 31, 2019 and increased $20.5 million, or 4%, compared to $514.4 million at March 31, 2019. We also originate residential construction loans for owner occupants, although construction balances for these loans are modest as the loans convert to one- to four-family real estate loans upon completion of the homes and are often sold in the secondary market. Residential construction loans represented approximately 6% of our total loan portfolio at March 31, 2020.

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.  In recent years, our commercial business lending has also included participation in certain syndicated loans, including shared national credits, which totaled $183.7 million at March 31, 2020. Our commercial and agricultural business loans increased $21.0 million to $2.50 billion at March 31, 2020, compared to $2.47 billion at December 31, 2019, and increased $217.5 million, or 10%, compared to $2.28 billion at March 31, 2019. The increase in the current quarter primarily reflects growth in commercial

64


business loans as commercial line of credit usage increased as a result of COVID-19 offset partially by seasonal decreases in agricultural loan balances. Commercial and agricultural business loans represented approximately 27% of our portfolio at March 31, 2020.

Our one- to four-family real estate loan originations have been relatively strong, as interest rates have declined during the current year. We are active originators of one- to four-family real estate loans in most communities where we have established offices in Washington, Oregon, California and Idaho. Most of the one- to four-family real estate loans that we originate are sold in secondary markets with net gains on sales and loan servicing fees reflected in our revenues from mortgage banking. At March 31, 2020, our outstanding balance of one- to four-family real estate loans retained in our portfolio decreased $44.1 million, to $881.4 million, compared to $925.5 million at December 31, 2019, and decreased $61.1 million, or 6%, compared to $942.5 million at March 31, 2019. One- to four-family real estate loans represented 10% of our loan portfolio at March 31, 2020.

Our consumer loan activity is primarily directed at meeting demand from our existing deposit customers. At March 31, 2020, consumer loans, including home equity revolving lines of credit, decreased $2.5 million to $661.8 million, compared to $664.3 million at December 31, 2019, and decreased $31.5 million compared to $693.3 million at March 31, 2019.

The following table shows loan origination (excluding loans held for sale) activity for the three months ended March 31, 2020 and March 31, 2019 (in thousands):
 
Three Months Ended
 
Mar 31, 2020
 
Mar 31, 2019
Commercial real estate
$
76,359

 
$
92,183

Multifamily real estate
10,171

 
3,733

Construction and land
369,613

 
231,744

Commercial business
199,873

 
137,142

Agricultural business
31,261

 
30,483

One-to four- family residential
31,041

 
31,186

Consumer
67,357

 
62,370

Total loan originations (excluding loans held for sale)
$
785,675

 
$
588,841


The origination table above includes loan participations and loan purchases. There were no loan purchases during the three months ended March 31, 2020 or March 31, 2019.

Loans held for sale decreased to $182.4 million at March 31, 2020, compared to $210.4 million at December 31, 2019, as sales of held-for-sale loans exceeded the origination of held-for-sale loans during the three months ended March 31, 2020. Loans held for sale were $45.9 million at March 31, 2019. Origination of loans held for sale increased to $296.7 million for the three months ended March 31, 2020 compared to $134.7 million for the same period last year. The volume of one- to four-family residential mortgage loans sold was $204.0 million during the three months ended March 31, 2020, compared to $107.2 million in the same period a year ago. During the three months ended March 31, 2020, we sold $119.7 million in multifamily loans compared to $149.9 million for the same period last year. Loans held for sale at March 31, 2020 included $105.4 million of multifamily loans and $77.1 million of one- to four-family loans compared to $3.3 million of multifamily loans and $42.5 million of one- to four-family loans at March 31, 2019.

The following table presents loans by geographic concentration at March 31, 2020, December 31, 2019 and March 31, 2019 (dollars in thousands):
 
Mar 31, 2020
 
Dec 31, 2019
 
Mar 31, 2019
 
Percentage Change
 
Amount
 
Percentage
 
Amount
 
Amount
 
Prior Year End
 
Prior Year Qtr
Washington
$
4,350,273

 
46.7
%
 
$
4,364,764

 
$
4,329,759

 
(0.3
)%
 
0.5
 %
California
2,140,895

 
23.1

 
2,129,789

 
1,581,654

 
0.5

 
35.4

Oregon
1,664,652

 
17.9

 
1,650,704

 
1,639,427

 
0.8

 
1.5

Idaho
524,663

 
5.7

 
530,016

 
524,705

 
(1.0
)
 

Utah
52,747

 
0.6

 
60,958

 
59,940

 
(13.5
)
 
(12.0
)
Other
552,514

 
6.0

 
569,126

 
557,172

 
(2.9
)
 
(0.8
)
Total loans receivable
$
9,285,744

 
100.0
%
 
$
9,305,357

 
$
8,692,657

 
(0.2
)%
 
6.8
 %

Investment Securities: Our total investment in securities increased $253.8 million to $2.07 billion at March 31, 2020 from December 31, 2019. Securities purchases made towards the end of the quarter as balance sheet liquidity increased and market spreads widened exceeded sales,

65


paydowns and maturities during the three-month period. Purchases were primarily in securities issued by government-sponsored entities. The average effective duration of Banner's securities portfolio was approximately 2.9 years at March 31, 2020. Net fair value adjustments to the portfolio of securities held for trading, which were included in net income, were a decrease of $4.6 million in the three months ended March 31, 2020 primarily as the result of increased market spreads on certain types of securities. In addition, fair value adjustments for securities designated as available-for-sale reflected an increase of $42.2 million for the three months ended March 31, 2020, which was included net of the associated tax expense of $10.1 million as a component of other comprehensive income, and largely occurred as a result of decreased market interest rates. (See Note 4 of the Selected Notes to the Consolidated Financial Statements in this Form 10-Q.)

Deposits: 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. Increasing core deposits (non-interest-bearing and interest-bearing transaction and savings accounts) is a fundamental element of our business strategy. Much of the focus of our branch strategy and current marketing efforts have been directed toward attracting additional deposit customer relationships and balances.  This effort has been particularly directed towards emphasizing core deposit activity in non-interest-bearing and other transaction and savings accounts. The long-term success of our deposit gathering activities is reflected not only in the growth of core deposit balances, but also in the level of deposit fees, service charges and other payment processing revenues compared to prior periods.

The following table sets forth the Company's deposits by type of deposit account as of the dates indicated (dollars in thousands):
 
 
 
 
 
 
 
Percentage Change
 
Mar 31, 2020
 
Dec 31, 2019
 
Mar 31, 2019
 
Prior Year End
 
Prior Year Quarter
Non-interest-bearing
$
4,107,262

 
$
3,945,000

 
$
3,676,984

 
4.1
%
 
11.7
%
Interest-bearing checking
1,331,860

 
1,280,003

 
1,174,169

 
4.1

 
13.4

Regular savings accounts
1,997,265

 
1,934,041

 
1,865,852

 
3.3

 
7.0

Money market accounts
1,846,844

 
1,769,194

 
1,495,948

 
4.4

 
23.5

Interest-bearing transaction & savings accounts
5,175,969

 
4,983,238

 
4,535,969

 
3.9

 
14.1

Total core deposits
9,283,231

 
8,928,238

 
8,212,953

 
4.0

 
13.0

Interest-bearing certificates
1,166,306

 
1,120,403

 
1,163,276

 
4.1

 
0.3

Total deposits
$
10,449,537

 
$
10,048,641

 
$
9,376,229

 
4.0
%
 
11.4
%

Total deposits were $10.45 billion at March 31, 2020, compared to $10.05 billion at December 31, 2019 and $9.38 billion a year ago. The $400.9 million increase in total deposits compared to December 31, 2019 primarily reflects a $355.0 million increase in core deposits and a $48.1 million increase in brokered deposits. The year-over-year increase in deposits included $313.4 million in deposits acquired in the AltaPacific acquisition which closed in the fourth quarter of 2019. Non-interest-bearing account balances increased 4.1% to $4.11 billion at March 31, 2020, compared to $3.95 billion at December 31, 2019, and increased 12% compared to $3.68 billion a year ago. Interest-bearing transaction and savings accounts increased 4% to $5.18 billion at March 31, 2020, compared to $4.98 billion at December 31, 2019, and increased 14% compared to $4.54 billion a year ago. Certificates of deposit increased 4% to $1.17 billion at March 31, 2020, compared to $1.12 billion at December 31, 2019 and increased slightly compared to $1.16 billion a year ago. Brokered deposits totaled $251.0 million at March 31, 2020, compared to $202.9 million at December 31, 2019 and $239.4 million a year ago. Core deposits represented 89% of total deposits at both March 31, 2020 and December 31, 2019.

The following table presents deposits by geographic concentration at March 31, 2020, December 31, 2019 and March 31, 2019 (dollars in thousands):
 
Mar 31, 2020
 
Dec 31, 2019
 
Mar 31, 2019
 
Percentage Change
 
Amount
 
Percentage
 
Amount
 
Amount
 
Prior Year End
 
Prior Year Quarter
Washington(1)
$
6,037,864

 
57.8
%
 
$
5,861,809

 
$
5,604,567

 
3.0
%
 
7.7
%
Oregon
2,093,738

 
20.0

 
2,006,163

 
1,906,132

 
4.4

 
9.8

California
1,828,064

 
17.5

 
1,698,289

 
1,402,213

 
7.6

 
30.4

Idaho
489,871

 
4.7

 
482,380

 
463,317

 
1.6

 
5.7

Total deposits
$
10,449,537

 
100.0
%
 
$
10,048,641

 
$
9,376,229

 
4.0
%
 
11.4
%

(1) 
Includes brokered deposits.


66


Borrowings: FHLB advances decreased to $247.0 million at March 31, 2020 from $450.0 million at December 31, 2019 as core deposits were used to reduce borrowings and fund growth in the securities portfolio. Other borrowings, consisting of retail repurchase agreements primarily related to customer cash management accounts, increased $10.3 million, or 9%, to $128.8 million at March 31, 2020, compared to $118.5 million at December 31, 2019. No additional junior subordinated debentures were issued or matured during the three months ended March 31, 2020; however, the estimated fair value of these instruments decreased by $19.5 million, reflecting wider market spreads. Junior subordinated debentures totaled $99.8 million at March 31, 2020 compared to $119.3 million at December 31, 2019.

Shareholders' Equity: Total shareholders' equity increased $7.7 million to $1.60 billion at March 31, 2020 compared to $1.59 billion at December 31, 2019. The increase in shareholders' equity primarily reflects $16.9 million of year-to-date net income and a $46.8 million increase in accumulated other comprehensive income primarily representing the decrease in the fair value of junior subordinated debentures and the increase in unrealized gains on securities available-for-sale, net of tax. These increases were partially offset by the accrual of $14.6 million of cash dividends to common shareholders and the repurchase of 624,780 shares of common stock at a total cost of $31.8 million. The share repurchases during the current quarter were completed prior to the COVID-19 pandemic outbreak. To preserve capital, Banner has discontinued any additional repurchase of shares until further notice and will closely monitor capital levels going forward. In addition, the adoption of CECL on January 1, 2020, resulted in a $7.8 million increase to our allowance for credit losses - loans and a $7.0 million increase to our allowance for credit losses - unfunded loan commitments. The combined increases were recorded net of tax as an $11.2 million reduction to shareholders' equity as of the adoption date. During the three months ended March 31, 2020, 20,282 shares of restricted stock were forfeited and 21,592 shares were surrendered by employees to satisfy tax withholding obligations upon the vesting of restricted stock grants. (See Part II, Item 2, "Unregistered Sales of Equity Securities and Use of Proceeds" in this Form 10-Q.) Tangible common shareholders' equity, which excludes goodwill and other intangible assets, increased $9.7 million to $1.20 billion, or 9.70% of tangible assets at March 31, 2020, compared to $1.19 billion, or 9.77% of tangible assets at December 31, 2019.

Comparison of Results of Operations for the Three Months Ended March 31, 2020 and 2019

For the quarter ended March 31, 2020, our net income was $16.9 million, or $0.47 per diluted share, compared to $33.3 million, or $0.95 per diluted share, for the quarter ended March 31, 2019. Our net income for the quarter ended March 31, 2020 included a $21.7 million provision for credit losses and a $5.9 million increase in non-interest expense, including a $1.7 million provision for credit losses - unfunded loan commitments and $1.1 million of acquisition-related expenses, partially offset by growth in interest-earning assets, due to the acquisition of AltaPacific as well as organic growth.

Growth in average interest-earning assets and decreased funding costs produced increased net interest income. This resulted in increases in revenues in the three months ended March 31, 2020 compared to the same period a year earlier. The results for the quarter ended March 31, 2020 included the operations acquired in the AltaPacific acquisition which closed in the fourth quarter of 2019. Banner recorded a $21.7 million provision for credit losses, compared to $2.0 million in the same quarter a year ago, primarily reflecting expected lifetime credit losses due to the COVID-19 pandemic based upon the financial conditions and economic outlook that existed as of March 31, 2020. Non-interest expenses increased in the three months ended March 31, 2020 compared to the same period a year ago, reflecting acquisition-related expenses as well as additional expenses associated with the ongoing operations acquired in the AltaPacific acquisition. Net income for the current year reflects the impact of the COVID-19 pandemic resulting in a substantial reduction in business activity or the closing of businesses in all the western states Banner operates.

Our adjusted earnings, which excludes net gains or losses on sales of securities, changes in the valuation of financial instruments carried at fair value, acquisition-related expenses, COVID-19 expenses and related tax expenses or benefits, were $21.4 million, or $0.60 per diluted share, for the quarter ended March 31, 2020, compared to $35.0 million, or $0.99 per diluted share, for the quarter ended March 31, 2019.

Net Interest Income. Net interest income increased by $3.2 million, or 3%, to $119.3 million for the quarter ended March 31, 2020, compared to $116.1 million for the same quarter one year earlier, as an increase of $670.1 million in the average balance of interest-earning assets produced growth for this key source of revenue. The growth in the average balance of interest-earning assets reflects organic growth as well as the AltaPacific acquisition. Net interest margin was enhanced by the amortization of acquisition accounting discounts on purchased loans which is accreted into loan interest income. The net interest margin of 4.19% for the quarter ended March 31, 2020 was enhanced by ten basis points as a result of acquisition accounting adjustments. This compares to a net interest margin of 4.37% for the quarter ended March 31, 2019, which included seven basis points from acquisition accounting adjustments. The decrease in net interest margin compared to a year earlier primarily reflects lower yields on average interest-earning assets, partially offset by decreases in the cost of funding liabilities. The lower yields on average interest-earning assets compared to a year earlier was largely due to the impact of decreases to the targeted Fed Funds Rate on floating rate loan yields indexed to prime and LIBOR rates. Beginning in August 2019, the Federal Reserve reduced the targeted Fed Funds Rate by 25 basis points three times in 2019 and 150 basis points during the current quarter to a range of 0.00% to 0.25% at March 31, 2020. The 150 basis-point decrease in the Fed Funds target rate did not occur until late in the quarter in March 2020, and the full effect of the lower interest rate environment had not yet been realized at quarter end. The decreases in the costs of funding liabilities compared to a year earlier was also largely due to the impact of decreases to the targeted Fed Funds Rate, however, the effect of recent changes in the targeted Fed Funds rate on the cost of funding liabilities typically lags the effect on the yield earned on interest-earning assets because rates on many deposit accounts are decision-based, not tied to a specific market-based index, and are based on competition for deposits while most interest-earning assets adjust earlier because they are tied to a specific market-based index.

Interest Income. Interest income for the quarter ended March 31, 2020 was $131.7 million, compared to $130.0 million for the same quarter in the prior year, an increase of $1.7 million, or 1%.  The increase in interest income occurred as a result of increases in the average balances of loans, partially offset by the decrease in the yield on interest-earning assets, as well as a slight decrease in the average balance of investment

67


securities. The average balance of interest-earning assets was $11.44 billion for the quarter ended March 31, 2020, compared to $10.77 billion for the same period a year earlier. The average yield on interest-earning assets was 4.63% for quarter ended March 31, 2020, compared to 4.89% for the same quarter one year earlier. The decrease in yield between periods reflects a 28 basis point decrease in the average yield on loans and a 37 basis point decrease in the average yield on investment securities. Average loans receivable for the quarter ended March 31, 2020 increased $691.0 million, or 8%, to $9.51 billion, compared to $8.82 billion for the same quarter in the prior year. Interest income on loans increased by $3.5 million, or 3%, to $118.9 million for the current quarter from $115.5 million for the quarter ended March 31, 2019, reflecting the impact of the previously mentioned increases in average loans receivable.  The decrease in average loan yields reflects the impact of lower index interest rates over the last year. The acquisition accounting loan discount accretion and the related balance sheet impact added 12 basis points to the current quarter loan yield, compared to nine basis points for the same quarter one year earlier.

The combined average balance of mortgage-backed securities, other investment securities, daily interest-bearing deposits and FHLB stock (total investment securities or combined portfolio) decreased to $1.93 billion for the quarter ended March 31, 2020 (excluding the effect of fair value adjustments), compared to $1.95 billion for the quarter ended March 31, 2019; and the interest and dividend income from those investments decreased by $1.8 million compared to the same quarter in the prior year. The average yield on the combined portfolio decreased to 2.65% for the quarter ended March 31, 2020, from 3.02% for the same quarter one year earlier.

Interest Expense. Interest expense for the quarter ended March 31, 2020 was $12.4 million, compared to $13.9 million for the same quarter in the prior year. The interest expense decrease between periods reflects a ten basis point decrease in the average cost of all funding liabilities, partially offset by a $667.7 million, or 7%, increase in the average balance of funding liabilities.

Deposit interest expense increased $107,000, or 1%, to $8.8 million for the quarter ended March 31, 2020, compared to $8.6 million for the same quarter in the prior year, primarily as a result of an increase in the average balances, partially offset by a slight decrease in the cost of deposits. Average deposit balances increased to $10.14 billion for the quarter ended March 31, 2020, from $9.36 billion for the quarter ended March 31, 2019, while the average rate paid on total deposits decreased to 0.35% in the first quarter of 2020 from 0.37% for the quarter ended March 31, 2019, primarily reflecting decreases in the costs of interest-bearing checking, money market and savings accounts, partially offset by increases in the cost of certificates of deposits and in non-interest-bearing deposit balances. The cost of interest-bearing deposits decreased by four basis points to 0.57% for the quarter ended March 31, 2020 compared to 0.61% in the same quarter a year earlier. The decrease in the cost of interest-bearing deposits between the periods was driven by market and competitive factors as a result of decreases in the target Fed Funds Rate over the last year.

Average total borrowings were $678.1 million for the quarter ended March 31, 2020, compared to $792.5 million for the same quarter one year earlier and the average rate paid on total borrowings for the quarter ended March 31, 2020 decreased to 2.17% from 2.69% for the same quarter one year earlier. The decrease in the average total borrowings balance for the quarter ended March 31, 2020 from the same period a year earlier was primarily due to a $128.8 million decrease in average FHLB advances, coupled with a 59 basis point decrease in the cost of FHLB advances. Interest expense on total borrowings decreased to $3.7 million for the quarter ended March 31, 2020 from $5.2 million for the quarter ended March 31, 2019.

68


Analysis of Net Interest Spread. The following tables present for the periods indicated our condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities with additional comparative data on our operating performance (dollars in thousands):
 
Three Months Ended March 31, 2020
 
Three Months Ended March 31, 2019
 
Average Balance
 
Interest and Dividends
 
Yield/
   Cost (3)
 
Average Balance
 
Interest and Dividends
 
Yield/
   Cost (3)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Held for sale loans
$
152,627

 
$
1,520

 
4.01
%
 
$
98,005

 
$
1,121

 
4.64
%
Mortgage loans
7,310,115

 
92,454

 
5.09

 
6,833,933

 
88,602

 
5.26

Commercial/agricultural loans
1,884,006

 
22,357

 
4.77

 
1,703,503

 
22,812

 
5.43

Consumer and other loans
163,098

 
2,595

 
6.40

 
183,451

 
2,920

 
6.46

Total loans (1)
9,509,846

 
118,926

 
5.03

 
8,818,892

 
115,455

 
5.31

Mortgage-backed securities
1,354,585

 
9,137

 
2.71

 
1,392,118

 
10,507

 
3.06

Other securities
458,116

 
2,887

 
2.53

 
484,134

 
3,479

 
2.91

Interest-bearing deposits with banks
92,659

 
393

 
1.71

 
44,757

 
289

 
2.62

FHLB stock
26,522

 
322

 
4.88

 
31,761

 
266

 
3.40

Total investment securities
1,931,882

 
12,739

 
2.65

 
1,952,770

 
14,541

 
3.02

Total interest-earning assets
11,441,728

 
131,665

 
4.63

 
10,771,662

 
129,996

 
4.89

Non-interest-earning assets
1,193,256

 
 
 
 
 
1,031,591

 
 
 
 
Total assets
$
12,634,984

 
 
 
 
 
$
11,803,253

 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing checking accounts
$
1,266,647

 
469

 
0.15

 
$
1,153,949

 
475

 
0.17

Savings accounts
2,039,857

 
1,755

 
0.35

 
1,854,123

 
1,920

 
0.42

Money market accounts
1,743,118

 
2,439

 
0.56

 
1,490,326

 
2,251

 
0.61

Certificates of deposit
1,124,994

 
4,087

 
1.46

 
1,253,613

 
3,997

 
1.29

Total interest-bearing deposits
6,174,616

 
8,750

 
0.57

 
5,752,011

 
8,643

 
0.61

Non-interest-bearing deposits
3,965,380

 

 

 
3,605,922

 

 

Total deposits
10,139,996

 
8,750

 
0.35

 
9,357,933

 
8,643

 
0.37

Other interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
FHLB advances
405,429

 
2,064

 
2.05

 
534,238

 
3,476

 
2.64

Other borrowings
124,771

 
116

 
0.37

 
118,008

 
60

 
0.21

Junior subordinated debentures
147,944

 
1,477

 
4.02

 
140,212

 
1,713

 
4.95

Total borrowings
678,144

 
3,657

 
2.17

 
792,458

 
5,249

 
2.69

Total funding liabilities
10,818,140

 
12,407

 
0.46

 
10,150,391

 
13,892

 
0.56

Other non-interest-bearing liabilities (2)
212,162

 
 
 
 
 
151,937

 
 
 
 
Total liabilities
11,030,302

 
 
 
 
 
10,302,328

 
 
 
 
Shareholders’ equity
1,604,682

 
 
 
 
 
1,500,925

 
 
 
 
Total liabilities and shareholders’ equity
$
12,634,984

 
 
 
 
 
$
11,803,253

 
 
 
 
Net interest income/rate spread
 
 
$
119,258

 
4.17
%
 
 
 
$
116,104

 
4.33
%
Net interest margin
 
 
 
 
4.19
%
 
 
 
 
 
4.37
%
Additional Key Financial Ratios:
 
 
 
 
 
 
 
 
 
 
 
Return on average assets
 
 
 
 
0.54
%
 
 
 
 
 
1.15
%
Return on average equity
 
 
 
 
4.23

 
 
 
 
 
9.01

Average equity / average assets
 
 
 
 
12.70

 
 
 
 
 
12.72

Average interest-earning assets / average interest-bearing liabilities
 
 
 
 
166.97

 
 
 
 
 
164.59

Average interest-earning assets / average funding liabilities
 
 
 
 
105.76

 
 
 
 
 
106.12

Non-interest income / average assets
 
 
 
 
0.61

 
 
 
 
 
0.62

Non-interest expense / average assets
 
 
 
 
3.03

 
 
 
 
 
3.09

Efficiency ratio (4)
 
 
 
 
68.76

 
 
 
 
 
67.06

Adjusted efficiency ratio (5)
 
 
 
 
63.47

 
 
 
 
 
63.32

(1) 
Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past due.  Amortization of net deferred loan fees/costs is included with interest on loans.
(2) 
Average other non-interest-bearing liabilities include fair value adjustments related to junior subordinated debentures.
(3) 
Yields and costs have not been adjusted for the effect of tax-exempt interest.
(4) 
Non-interest expense divided by the total of net interest income (before provision for loan losses) and non-interest income.
(5) 
Adjusted non-interest expense divided by adjusted revenue. These represent non-GAAP financial measures. See the non-GAAP reconciliation tables above under "Executive Overview—Non-GAAP Financial Measures."

69


 
 
 
 
 
 
 
 
 
 
 
 

Provision and Allowance for Credit Losses. Management estimates the allowance for credit losses using relevant information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The allowance for credit losses is maintained at a level sufficient to provide for expected credit losses over the life of the loan based on evaluating historical credit loss experience and making adjustments to historical loss information for differences in the specific risk characteristics in the current loan portfolio.  These factors include, among others, changes in the size and composition of the loan portfolio, differences in underwriting standards, delinquency rates, actual loss experience and current economic conditions. The following table sets forth an analysis of our allowance for credit losses -loans for the periods indicated (dollars in thousands):

ADDITIONAL FINANCIAL INFORMATION
 
 
 
 
 
 
(dollars in thousands)
 
 
 
 
 
 
 
 
  Quarters Ended
CHANGE IN THE
 
Mar 31, 2020
 
Dec 31, 2019
 
Mar 31, 2019
ALLOWANCE FOR CREDIT LOSSES - LOANS
 
 
 
 
 
 
Balance, beginning of period
 
$
100,559

 
$
97,801

 
$
96,485

Beginning balance adjustment for adoption of Topic 326
 
7,812

 

 

Provision for credit losses - loans
 
21,713

 
4,000

 
2,000

Recoveries of loans previously charged off:
 
 
 
 
 
 
Commercial real estate
 
167

 
199

 
21

Construction and land
 

 

 
22

One- to four-family real estate
 
148

 
159

 
43

Commercial business
 
205

 
225

 
23

Agricultural business, including secured by farmland
 
1,750

 
10

 

Consumer
 
96

 
61

 
110

 
 
2,366

 
654

 
219

Loans charged off:
 
 
 
 
 
 
Commercial real estate
 
(100
)
 

 
(431
)
Multifamily real estate
 
(66
)
 

 

Construction and land
 

 
(45
)
 

One- to four-family real estate
 
(64
)
 

 

Commercial business
 
(1,384
)
 
(1,180
)
 
(590
)
Agricultural business, including secured by farmland
 

 
(4
)
 
(4
)
Consumer
 
(348
)
 
(667
)
 
(371
)
 
 
(1,962
)
 
(1,896
)
 
(1,396
)
Net charge-offs
 
404

 
(1,242
)
 
(1,177
)
Balance, end of period
 
$
130,488

 
$
100,559

 
$
97,308

Net charge-offs / Average loans receivable
 
0.004
%
 
(0.013
)%
 
(0.013
)%

The provision for credit losses - loans reflects the amount required to maintain the allowance for credit losses - loans at an appropriate level based upon management’s evaluation of the adequacy of collective and individual loss reserves. During the three months ended March 31, 2020, we recorded a provision for credit losses of $21.7 million, compared to provision for loan losses of $2.0 million during the quarter a year ago. The current quarter provision for loan credit losses was primarily due to the impacts of COVID-19 due to higher forecasted unemployment rates and lower gross domestic product, as well as other economic metrics in our reasonable and supportable forecast. The reasonable and supportable forecast used was based upon economic forecast data available as of March 31, 2020. The probability for further decline in economic conditions, including higher unemployment rates and lower gross domestic product, has increased since quarter end and should they materialize, an additional provision for expected credit losses will be necessary in the second quarter of 2020. Future assessments of the expected credit losses will not only be impacted by changes to the reasonable and supportable forecast, but will also include an updated assessment of qualitative factors, as well as, consideration of any required changes in the reasonable and supportable forecast reversion period.

Net loan recoveries were $404,000 for the quarter ended March 31, 2020 compared to net loan charge-offs of $1.2 million for the same quarter in the prior year. The allowance for credit losses - loans was $130.5 million at March 31, 2020 compared to $100.6 million at December 31, 2019 and $97.3 million at March 31, 2019. The allowance for credit losses - loans as a percentage of total loans (loans receivable excluding allowance for loan losses) was 1.41% at March 31, 2020 as compared to 1.12% at March 31, 2019. The increase the allowance for credit losses - loans as a percentage of loans reflects the adoption of Financial Instruments - Credit Losses (Topic 326) as well as the increased provision for credit losses - loans recorded during the current quarter primarily as the result of forecasted credit deterioration due to the COVID-19 pandemic.

70


The provision for credit losses - unfunded loan commitments reflects the amount required to maintain the allowance for credit losses - unfunded loan commitments at an appropriate level based upon management’s evaluation of the adequacy of collective and individual loss reserves. The following table sets forth an analysis of our allowance for credit losses - unfunded loan commitments for the periods indicated (dollars in thousands):
 
 
  Quarters Ended
CHANGE IN THE
 
Mar 31, 2020
 
Dec 31, 2019
 
Mar 31, 2019
ALLOWANCE FOR CREDIT LOSSES - UNFUNDED LOAN COMMITMENTS
 
 
 
 
 
 
Balance, beginning of period
 
$
2,716

 
$
2,599

 
$
2,599

Beginning balance adjustment for adoption of Topic 326
 
7,022

 

 

Provision for credit losses - unfunded loan commitments
 
1,722

 

 

Additions through acquisitions
 

 
117

 

Balance, end of period
 
$
11,460

 
$
2,716

 
$
2,599


The allowance for credit losses - unfunded loan commitments was $11.5 million at March 31, 2020 compared to $2.7 million at December 31, 2019 and $2.6 million at March 31, 2019. The increase the allowance for credit losses - unfunded loan commitments reflects the adoption of Financial Instruments - Credit Losses (Topic 326) as well as the increased provision for credit losses - unfunded loan commitments recorded during the current quarter. During the three months ended March 31, 2020, we recorded a provision for credit losses - unfunded loan commitments of $1.7 million, compared to a provision for loan losses of none during the quarter a year ago. The current quarter provision for loan credit losses - unfunded loan commitments was primarily due to the impacts of COVID-19 due to higher forecasted unemployment rates, as well as other economic metrics in our reasonable and supportable forecast.

Non-interest Income. The following table presents the key components of non-interest income for the three months ended March 31, 2020 and 2019 (dollars in thousands):
 
Three months ended March 31,
 
2020
 
2019
 
Change Amount
 
Change Percent
Deposit fees and other service charges
$
9,803

 
$
12,618

 
$
(2,815
)
 
(22.3
)%
Mortgage banking operations
10,191

 
3,415

 
6,776

 
198.4

Bank owned life insurance
1,050

 
1,276

 
(226
)
 
(17.7
)
Miscellaneous
2,639

 
804

 
1,835

 
228.2

 
23,683

 
18,113

 
5,570

 
30.8

Net gain on sale of securities
78

 
1

 
77

 
nm

Net change in valuation of financial instruments carried at fair value
(4,596
)
 
11

 
(4,607
)
 
nm

Total non-interest income
$
19,165

 
$
18,125

 
$
1,040

 
5.7


Non-interest income was $19.2 million for the quarter ended March 31, 2020, compared to $18.1 million for the same quarter in the prior year. Our non-interest income for the quarter ended March 31, 2020 included a $4.6 million net loss for fair value adjustments and a net gain of $78,000 on sales of securities. For the quarter ended March 31, 2019, fair value adjustments resulted in a net gain of $11,000 and we had a net gain of $1,000 on sale of securities. The net loss for fair value adjustments recognized for the quarter ended March 31, 2020 was due to a decrease in the value of certain securities in our held-for-trading portfolio as market spreads widened on certain types of securities. For a more detailed discussion of our fair value adjustments, please refer to Note 9 in the Selected Notes to the Consolidated Financial Statements in this Form 10-Q.

Deposit fees and other service charges decreased by $2.8 million, or 22%, for the quarter ended March 31, 2020, compared to the same period a year ago the, reflecting the impact of Banner becoming subject to the Durbin Amendment on July 1, 2019, which reduced the amount of interchange fees which can be charged for certain debit card transactions. Mortgage banking revenues, including gains on one- to four-family and multifamily loan sales and loan servicing fees, increased $6.8 million for the quarter ended March 31, 2020, compared to the same period a year ago. Gains on multifamily loans in the current quarter resulted in income of $189,000 for the quarter ended March 31, 2020, compared to net loss of $209,000 for the same period a year ago. Gains on one- to four-family loans in the current quarter resulted in income of $9.6 million for the quarter ended March 31, 2020, compared to $2.9 million in the same period a year ago. The higher mortgage banking revenue reflected an increase in residential mortgage held-for-sale loan production as well as an increase in the gain on sale spread on one- to four-family held for sale loans during the quarter compared to the same period a year ago. Home purchase activity accounted for 54% of one- to four-family mortgage banking loan originations during the quarter ended March 31, 2020 compared to 80% during the quarter ended March 31, 2019. The decrease in the percentage of home purchase activity during the current quarter reflects an increase home refinance activity as market interest rates decreased. The increase in miscellaneous income for the quarter ended March 31, 2020 compared to the same period a year ago was a

71


result of higher gains on the sales of Small Business Administration loans, an increase in interest rate swap income and a decline in losses related to the disposition of assets.

Non-interest Expense.  The following table represents key elements of non-interest expense for the three months ended March 31, 2020 and 2019 (dollars in thousands):
 
For the Three Months Ended March 31,
 
2020
 
2019
 
Change Amount
 
Change Percent
Salaries and employee benefits
$
59,908

 
$
54,640

 
$
5,268

 
9.6
 %
Less capitalized loan origination costs
(5,806
)
 
(4,849
)
 
(957
)
 
19.7

Occupancy and equipment
13,107

 
13,766

 
(659
)
 
(4.8
)
Information/computer data services
5,810

 
5,326

 
484

 
9.1

Payment and card processing expenses
4,240

 
3,984

 
256

 
6.4

Professional and legal expenses
1,919

 
2,434

 
(515
)
 
(21.2
)
Advertising and marketing
1,827

 
1,529

 
298

 
19.5

Deposit insurance expense
1,635

 
1,418

 
217

 
15.3

State/municipal business and use taxes
984

 
945

 
39

 
4.1

REO operations
100

 
(123
)
 
223

 
(181.3
)
Amortization of core deposit intangibles
2,001

 
2,052

 
(51
)
 
(2.5
)
Provision for credit losses - unfunded loan commitments
1,722

 

 
1,722

 
nm

Miscellaneous
6,357

 
6,744

 
(387
)
 
(5.7
)
 
93,804

 
87,866

 
5,938

 
6.8

COVID-19 expenses
239

 

 
239

 
nm

Acquisition-related expenses
1,142

 
2,148

 
(1,006
)
 
(46.8
)
Total non-interest expense
$
95,185

 
$
90,014

 
$
5,171

 
5.7
 %

Non-interest expenses increased by $5.2 million, to $95.2 million for the quarter ended March 31, 2020, compared to $90.0 million for the quarter ended March 31, 2019. The increase was primarily due to the increase in the provision for credit losses - unfunded commitments and increases in salaries and employee benefits and expenses related to the operations acquired in the AltaPacific acquisition and normal salary and wage adjustments, partially offset by increases in capitalized loan origination costs. In addition, the quarter ended March 31, 2020 included $239,000 of COVID-19 expenses. We expect to see an increase in these expenses in the following quarters depending on the duration of the current pandemic.

Salary and employee benefits expenses increased $5.3 million to $59.9 million for the quarter ended March 31, 2020, compared to $54.6 million for the quarter ended March 31, 2019, primarily reflecting additional staffing related to the operations acquired from the acquisition of AltaPacific on November 1, 2019 as well as normal salary and wage adjustments. Capitalized loan origination costs increased $1.0 million for the quarter ended March 31, 2020, compared to the same period in the prior year, reflecting the increase in loan originations. Occupancy and equipment expense decreased $659,000, to $13.1 million for the quarter ended March 31, 2020, compared to the same period in the prior year, reflecting decreases in occupancy expenses. Information data services expenses increased $484,000 for the quarter ended March 31, 2020, compared to the same period in the prior year, reflecting incremental costs as the Company continued to grow. Professional and legal expenses decreased $515,000 for the quarter ended March 31, 2020, compared to the same periods in the prior year, reflecting a reduction in audit expenses due to the timing of accounting and audit work as well as decreased legal matters in the first quarter of 2020.

Income Taxes. For the quarter ended March 31, 2020, we recognized $4.6 million in income tax expense for an effective tax rate of 21.4%, which reflects our normal statutory tax rate reduced by the effect of tax-exempt income, certain tax credits, and tax benefits related to restricted stock vesting. Our statutory income tax rate is 23.5%, representing a blend of the statutory federal income tax rate of 21.0% and apportioned effects of the state income tax rates. For the quarter ended March 31, 2019, we recognized $8.9 million in income tax expense for an effective tax rate of 21.0%. For more discussion on our income taxes, please refer to Note 10 in the Selected Notes to the Consolidated Financial Statements in this report on Form 10-Q.


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Asset Quality

Maintaining a moderate risk profile by employing appropriate underwriting standards, avoiding excessive asset concentrations and aggressively managing troubled assets has been and will continue to be a primary focus for us. Our allowance for credit losses reflects current market conditions as well as forecasted future economic conditions. We actively engage our borrowers to resolve problem assets and effectively manage REO as a result of foreclosures.

Non-Performing Assets:  Non-performing assets increased to $46.1 million, or 0.36% of total assets, at March 31, 2020, from $40.5 million, or 0.32% of total assets, at December 31, 2019, and increased compared to $22.0 million, or 0.19% of total assets, at March 31, 2019. The increase in non-performing loans during year-over-year was largely due to one commercial banking relationship totaling $14.7 million moving to nonaccrual. Our allowance for credit losses - loans was $130.5 million, or 299% of non-performing loans at March 31, 2020 and our allowance for loan losses was $100.6 million, or 254% of non-performing loans at December 31, 2019 and $97.3 million, or 504% of non-performing loans at March 31, 2019.  In addition to the allowance for credit losses - loans, the Company maintains an allowance for credit losses - unfunded loan commitments which was $11.5 million at March 31, 2020 compared to $2.7 million at December 31, 2019 and $2.6 million at March 31, 2019. We believe our level of non-performing loans and assets continues to be manageable at March 31, 2020. The primary components of the $46.1 million in non-performing assets were $40.3 million in nonaccrual loans, $3.4 million in loans more than 90 days delinquent and still accruing interest, and $2.4 million in REO and other repossessed assets.

Loans are reported as restructured when we grant concessions to a borrower experiencing financial difficulties that we would not otherwise consider.  If any restructured loan becomes delinquent or other matters call into question the borrower's ability to repay full interest and principal in accordance with the restructured terms, the restructured loan(s) would be reclassified as nonaccrual.  At March 31, 2020, we had $6.4 million of restructured loans performing under their restructured repayment terms.

Prior to the implementation of Financial Instruments—Credit Losses (Topic 326) on January 1, 2020, loans acquired in merger transactions with deteriorated credit quality were accounted for as purchased credit-impaired pools. Typically, this would include loans that were considered non-performing or restructured as of the acquisition date. Accordingly, subsequent to acquisition, loans included in the purchased credit-impaired pools were not reported as non-performing loans based upon their individual performance status, so the loan categories of nonaccrual, impaired and 90 days past due and accruing did not include any purchased credit-impaired loans. Purchased credit-impaired loans were $15.9 million at December 31, 2019 and $13.3 million at March 31, 2019.



73


The following table sets forth information with respect to our non-performing assets and restructured loans at the dates indicated (dollars in thousands):
 
March 31, 2020
 
December 31, 2019
 
March 31, 2019
Nonaccrual Loans: (1)
 
 
 
 
 
Secured by real estate:
 
 
 
 
 
Commercial
$
8,512

 
$
5,952

 
$
5,734

Multifamily

 
85

 

Construction and land
1,393

 
1,905

 
3,036

One- to four-family
3,045

 
3,410

 
1,538

Commercial business
25,027

 
23,015

 
3,614

Agricultural business, including secured by farmland
495

 
661

 
2,507

Consumer
1,812

 
2,473

 
2,181

 
40,284

 
37,501

 
18,610

Loans more than 90 days delinquent, still on accrual:
 

 
 

 
 

Secured by real estate:
 

 
 

 
 

Commercial
24

 
89

 

Construction and land
1,407

 
332

 

One- to four-family
1,089

 
877

 
640

Commercial business
77

 
401

 
1

Agricultural business, including secured by farmland
461

 

 

Consumer
320

 
398

 
42

 
3,378

 
2,097

 
683

Total non-performing loans
43,662

 
39,598

 
19,293

REO, net (2)
2,402

 
814

 
2,611

Other repossessed assets held for sale
47

 
122

 
50

Total non-performing assets
$
46,111

 
$
40,534

 
$
21,954

 
 
 
 
 
 
Total non-performing loans to loans before allowance for credit losses
 / allowance for loan losses
0.47
%
 
0.43
%
 
0.22
%
Total non-performing loans to total assets
0.34
%
 
0.31
%
 
0.16
%
Total non-performing assets to total assets
0.36
%
 
0.32
%
 
0.19
%
 
 
 
 
 
 
Restructured loans performing under their restructured terms (3)
$
6,423

 
$
6,466

 
$
13,036

 
 
 
 
 
 
Loans 30-89 days past due and on accrual (4)
$
39,974

 
$
20,178

 
$
28,972


(1) 
Includes $6.6 million of nonaccrual TDR loans at March 31, 2020. For the three months ended March 31, 2020, interest income was reduced by $472,000 as a result of nonaccrual loan activity, which includes the reversal of $222,000 of accrued interest as of the date the loan was placed on nonaccrual. There was no interest income recognized on nonaccrual loans for the three months ended March 31, 2020.
(2)
Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as REO until it is sold. When property is acquired, it is recorded at the estimated fair value of the property, less expected selling costs. Subsequent to foreclosure, the property is carried at the lower of the foreclosed amount or net realizable value. Upon receipt of a new appraisal and market analysis, the carrying value is written down through the establishment of a specific reserve to the anticipated sales price, less selling and holding costs.
(3)
These loans were performing under their restructured repayment terms at the dates indicated.
(4) Purchased credit-impaired loans are included at December 31, 2019 and March 31, 2019.

In addition to the non-performing loans as of March 31, 2020, we had other classified loans with an aggregate outstanding balance of $63.5 million that are not on nonaccrual status, with respect to which known information concerning possible credit problems with the borrowers or the cash flows of the properties securing the respective loans has caused management to be concerned about the ability of the borrowers to comply with present loan repayment terms.  This may result in the future inclusion of such loans in the nonaccrual loan category.

74



REO: REO was $2.4 million at March 31, 2020 and compared with $814,000 at December 31, 2019. The following table shows REO activity for the three months ended March 31, 2020 and March 31, 2019 (in thousands):
 
Three Months Ended
 
Mar 31, 2020
 
Mar 31, 2019
Balance, beginning of period
$
814

 
$
2,611

Additions from loan foreclosures
1,588

 

Balance, end of period
$
2,402

 
$
2,611


Non-recurring fair value adjustments to REO are recorded to reflect partial write-downs based on an observable market price or current appraised value of property. The individual carrying values of these assets are reviewed for impairment at least annually and any additional impairment charges are expensed to operations.

Liquidity and Capital Resources

Our primary sources of funds are deposits, borrowings, proceeds from loan principal and interest payments and sales of loans, and the maturity of and interest income on mortgage-backed and investment securities. While maturities and scheduled amortization of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions, competition and our pricing strategies.

Our primary investing activity is the origination and purchase of loans and, in certain periods, the purchase of securities.  During the three months ended March 31, 2020 and March 31, 2019, our loan originations, including originations of loans held for sale, exceeded our loan repayments by $280.1 million and $143.7 million, respectively. There were no loan purchases during the three months ended March 31, 2020 or March 31, 2019. This activity was funded primarily by increased core deposits and the sale of loans in 2020. During the three months ended March 31, 2020 and March 31, 2019, we received proceeds of $338.8 million and $265.2 million, respectively, from the sale of loans. Securities purchased during the three months ended March 31, 2020 and March 31, 2019 totaled $350.1 million and $5.1 million, respectively, and securities repayments, maturities and sales in those periods were $131.1 million and $67.2 million, respectively.
  
Our primary financing activity is gathering deposits. Total deposits increased by $400.9 million during the first three months of 2020, as core deposits increased by $355.0 million and certificates of deposits, primarily brokered deposits, increased by $45.9 million. Certificates of deposit are generally more vulnerable to competition and more price sensitive than other retail deposits and our pricing of those deposits varies significantly based upon our liquidity management strategies at any point in time.  At March 31, 2020, certificates of deposit amounted to $1.17 billion, or 11% of our total deposits, including $887.6 million which were scheduled to mature within one year.  While no assurance can be given as to future periods, historically, we have been able to retain a significant amount of our certificates of deposit as they mature.

FHLB advances decreased $203.0 million to $247.0 million during the first three months of 2020. Other borrowings increased $10.3 million to $128.8 million at March 31, 2020 from $118.5 million at December 31, 2019.

We must maintain an adequate level of liquidity to ensure the availability of sufficient funds to accommodate deposit withdrawals, to support loan growth, to satisfy financial commitments and to take advantage of investment opportunities. During the three months ended March 31, 2020 and 2019, we used our sources of funds primarily to fund loan commitments and purchase securities. At March 31, 2020, we had outstanding loan commitments totaling $3.30 billion, primarily relating to undisbursed loans in process and unused credit lines. While representing potential growth in the loan portfolio and lending activities, this level of commitments is proportionally consistent with our historical experience and does not represent a departure from normal operations.

We generally maintain sufficient cash and readily marketable securities to meet short-term liquidity needs; however, our primary liquidity management practice to supplement deposits is to increase or decrease short-term borrowings.  We maintain credit facilities with the FHLB-Des Moines, which at March 31, 2020 provided for advances that in the aggregate would equal the lesser of 45% of Banner Bank’s assets or adjusted qualifying collateral (subject to a sufficient level of ownership of FHLB stock), up to a total possible credit line of $5.54 billion, and 45% of Islanders Bank’s assets or adjusted qualifying collateral, up to a total possible credit line of $134.0 million.  Advances under these credit facilities totaled $247.0 million at March 31, 2020. In addition, Banner Bank has been approved for participation in the Borrower-In-Custody (BIC) program by the Federal Reserve Bank of San Francisco (FRBSF).  Under this program Banner Bank had available lines of credit of approximately $1.15 billion as of March 31, 2020, subject to certain collateral requirements, namely the collateral type and risk rating of eligible pledged loans.  We had no funds borrowed from the FRBSF at March 31, 2020 or December 31, 2019.  Banner Bank's liquidity is expected to be supplemented in the second quarter of 2020 by its participation in the Federal Reserve’s Paycheck Protection Program Liquidity Facility pursuant to which Banner Bank will pledge PPP loans as collateral to obtain FRBSF non-recourse loans. Management believes it has adequate resources and funding potential to meet our foreseeable liquidity requirements.

Banner Corporation is a separate legal entity from the Banks and, on a stand-alone level, must provide for its own liquidity and pay its own operating expenses and cash dividends. Banner Corporation's primary sources of funds consist of capital raised through dividends or capital

75


distributions from the Banks, although there are regulatory restrictions on the ability of the Banks to pay dividends. At March 31, 2020, the Company on an unconsolidated basis had liquid assets of $36.2 million.

As noted below, Banner Corporation and its subsidiary banks continued to maintain capital levels significantly in excess of the requirements to be categorized as “Well-Capitalized” under applicable regulatory standards.  During the three months ended March 31, 2020, total shareholders' equity increased $7.7 million, to $1.60 billion.  At March 31, 2020, tangible common shareholders’ equity, which excludes goodwill and other intangible assets, was $1.20 billion, or 9.70% of tangible assets.  See the discussion and reconciliation of non-GAAP financial information in the Executive Overview section of Management’s Discussion and Analysis of Financial Condition and Results of Operation in this Form 10-Q for more detailed information with respect to tangible common shareholders’ equity.  Also, see the capital requirements discussion and table below with respect to our regulatory capital positions.

Capital Requirements

Banner Corporation is a bank holding company registered with the Federal Reserve.  Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal Reserve.  Banner Bank and Islanders Bank, as state-chartered, federally insured commercial banks, are subject to the capital requirements established by the FDIC.

The capital adequacy requirements are quantitative measures established by regulation that require Banner Corporation and the Banks to maintain minimum amounts and ratios of capital.  The Federal Reserve requires Banner Corporation to maintain capital adequacy that generally parallels the FDIC requirements.  The FDIC requires the Banks to maintain minimum ratios of Total Capital, Tier 1 Capital, and Common Equity Tier 1 Capital to risk-weighted assets as well as Tier 1 Leverage Capital to average assets.  In addition to the minimum capital ratios, both Banner Corporation and the Banks are required to maintain a capital conservation buffer consisting of additional Common Equity Tier 1 Capital of more than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. At March 31, 2020, Banner Corporation and the Banks each exceeded all regulatory capital requirements. (See Item 1, “Business–Regulation,” and Note 15 of the Notes to the Consolidated Financial Statements included in the 2019 Form 10-K for additional information regarding regulatory capital requirements for Banner Corporation and the Banks.)

The actual regulatory capital ratios calculated for Banner Corporation, Banner Bank and Islanders Bank as of March 31, 2020, along with the minimum capital amounts and ratios, were as follows (dollars in thousands):
 
 
Actual
 
Minimum to be Categorized as "Adequately Capitalized"
 
Minimum to be Categorized as “Well-Capitalized”
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Amount
Banner Corporation—consolidated
 
 
 
 
 
 
 
 
 
 
 
 
Total capital to risk-weighted assets
 
$
1,397,202

 
12.98
%
 
$
860,978

 
8.00
%
 
$
1,076,223

 
10.00
%
Tier 1 capital to risk-weighted assets
 
1,275,806

 
11.85

 
645,734

 
6.00

 
645,734

 
6.00

Tier 1 leverage capital to average assets
 
1,275,806

 
10.45

 
488,124

 
4.00

 
n/a

 
n/a

Common equity tier 1 capital
 
1,132,306

 
10.52

 
484,300

 
4.50

 
n/a

 
n/a

Banner Bank
 
 
 
 
 
 
 
 
 
 
 
 
Total capital to risk-weighted assets
 
1,331,615

 
12.59

 
846,284

 
8.00

 
1,057,856

 
10.00

Tier 1 capital to risk-weighted assets
 
1,212,733

 
11.46

 
634,713

 
6.00

 
846,284

 
8.00

Tier 1 leverage capital to average assets
 
1,212,733

 
10.18

 
476,371

 
4.00

 
595,464

 
5.00

Common equity tier 1 capital
 
1,212,733

 
11.46

 
476,035

 
4.50

 
687,606

 
6.50

Islanders Bank
 
 
 
 
 
 
 
 
 
 
 
 
Total capital to risk-weighted assets
 
31,693

 
16.99

 
14,923

 
8.00

 
18,654

 
10.00

Tier 1 capital to risk-weighted assets
 
29,398

 
15.76

 
11,193

 
6.00

 
14,923

 
8.00

Tier 1 leverage capital to average assets
 
29,398

 
10.05

 
11,706

 
4.00

 
14,632

 
5.00

Common equity tier 1 capital
 
29,398

 
15.76

 
8,394

 
4.50

 
12,125

 
6.50



76


ITEM 3 – Quantitative and Qualitative Disclosures About Market Risk

Market Risk and Asset/Liability Management

Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve.  Our profitability is dependent to a large extent on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities.

Our activities, like all financial institutions, inherently involve the assumption of interest rate risk.  Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution’s earnings and underlying economic value.  Interest rate risk is determined by the maturity and repricing characteristics of an institution’s assets, liabilities and off-balance-sheet contracts.  Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates.  Interest rate risk is the primary market risk affecting our financial performance.

The greatest source of interest rate risk to us results from the mismatch of maturities or repricing intervals for rate sensitive assets, liabilities and off-balance-sheet contracts.  This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets, although our floating-rate assets tend to be more immediately responsive to changes in market rates than most deposit liabilities.  Additional interest rate risk results from mismatched repricing indices and formula (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to us.  An exception to this generalization is the beneficial effect of interest rate floors on a portion of our performing floating-rate loans, which help us maintain higher loan yields in periods when market interest rates decline significantly. The Company actively manages its exposure to interest rate risk through on-going adjustments to the mix of interest-earning assets and funding sources that affect the repricing speeds of loans, investments, interest-bearing deposits and borrowings.

The principal objectives of asset/liability management are: to evaluate the interest rate risk exposure; to determine the level of risk appropriate given our operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage our interest rate risk consistent with regulatory guidelines and policies approved by the Board of Directors.  Through such management, we seek to reduce the vulnerability of our earnings and capital position to changes in the level of interest rates.  Our actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members of our senior management.  The Committee closely monitors our interest sensitivity exposure, asset and liability allocation decisions, liquidity and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources to maximize earnings within acceptable risk tolerances.

Sensitivity Analysis

Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income resulting from those movements under different rate environments.  The sensitivity of net interest income to changes in the modeled interest rate environments provides a measurement of interest rate risk.  We also utilize economic value analysis, which addresses changes in estimated net economic value of equity arising from changes in the level of interest rates.  The net economic value of equity is estimated by separately valuing our assets and liabilities under varying interest rate environments.  The extent to which assets gain or lose value in relation to the gains or losses of liability values under the various interest rate assumptions determines the sensitivity of net economic value to changes in interest rates and provides an additional measure of interest rate risk.

The interest rate sensitivity analysis performed by us incorporates beginning-of-the-period rate, balance and maturity data, using various levels of aggregation of that data, as well as certain assumptions concerning the maturity, repricing, amortization and prepayment characteristics of loans and other interest-earning assets and the repricing and withdrawal of deposits and other interest-bearing liabilities into an asset/liability computer simulation model.  We update and prepare simulation modeling at least quarterly for review by senior management and oversight by the directors. We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate scenarios.  Nonetheless, the interest rate sensitivity of our net interest income and net economic value of equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used.


77


The following table sets forth, as of March 31, 2020, the estimated changes in our net interest income over one-year and two-year time horizons and the estimated changes in economic value of equity based on the indicated interest rate environments (dollars in thousands):
 
 
Estimated Increase (Decrease) in
Change (in Basis Points) in Interest Rates (1)
 
Net Interest Income
Next 12 Months
 
Net Interest Income
Next 24 Months
 
Economic Value of Equity
+400
 
$
31,287

 
7.2
 %
 
$
99,072

 
11.7
 %
 
$
(82,595
)
 
(3.6
)%
+300
 
32,230

 
7.4

 
97,861

 
11.6

 
24,300

 
1.1

+200
 
27,055

 
6.2

 
81,968

 
9.7

 
99,800

 
4.4

+100
 
17,083

 
3.9

 
51,497

 
6.1

 
109,397

 
4.8

0
 

 

 

 

 

 

-25
 
(4,816
)
 
(1.1
)
 
(14,935
)
 
(1.8
)
 
(45,973
)
 
(2.0
)
 
(1) 
Assumes an instantaneous and sustained uniform change in market interest rates at all maturities; however, no rates are allowed to go below zero.  The targeted Federal Funds Rate was between 0.00% and 0.25% at March 31, 2020.
 
Another (although less reliable) monitoring tool for assessing interest rate risk is gap analysis.  The matching of the repricing characteristics of assets and liabilities may be analyzed by examining the extent to which assets and liabilities are interest sensitive and by monitoring an institution’s interest sensitivity gap.  An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period.  The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or reprice, based upon certain assumptions, within that same time period.  A gap is considered positive when the amount of interest-sensitive assets exceeds the amount of interest-sensitive liabilities.  A gap is considered negative when the amount of interest-sensitive liabilities exceeds the amount of interest-sensitive assets.  Generally, during a period of rising rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income.  During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.

Certain shortcomings are inherent in gap analysis.  For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates.  Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset.  Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table.  Finally, the ability of some borrowers to service their debt may decrease in the event of a severe change in market rates.


78


The following table presents our interest sensitivity gap between interest-earning assets and interest-bearing liabilities at March 31, 2020 (dollars in thousands).  The table sets forth the amounts of interest-earning assets and interest-bearing liabilities which are anticipated by us, based upon certain assumptions, to reprice or mature in each of the future periods shown.  At March 31, 2020, total interest-earning assets maturing or repricing within one year exceeded total interest-bearing liabilities maturing or repricing in the same time period by $3.51 billion, representing a one-year cumulative gap to total assets ratio of 27.44%.  Management is aware of the sources of interest rate risk and in its opinion actively monitors and manages it to the extent possible.  The interest rate risk indicators and interest sensitivity gaps as of March 31, 2020 are within our internal policy guidelines and management considers that our current level of interest rate risk is reasonable.

79


 
Within
6 Months
 
After
6 Months
Within
1 Year
 
After
1 Year
Within
3 Years
 
After
3 Years
Within
5 Years
 
After
5 Years
Within
10 Years
 
Over
10 Years
 
Total
Interest-earning assets: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction loans
$
794,925

 
$
70,792

 
$
121,213

 
$
26,560

 
$
12,779

 
$
1,874

 
$
1,028,143

Fixed-rate mortgage loans
319,587

 
242,806

 
771,977

 
464,599

 
385,444

 
21,253

 
2,205,666

Adjustable-rate mortgage loans
1,216,470

 
437,462

 
1,255,110

 
607,564

 
148,629

 
11

 
3,665,246

Fixed-rate mortgage-backed securities
229,236

 
185,315

 
318,638

 
161,895

 
244,468

 
35,595

 
1,175,147

Adjustable-rate mortgage-backed securities
144,215

 
10,827

 
38,345

 
5,857

 
4,924

 

 
204,168

Fixed-rate commercial/agricultural loans
156,958

 
119,045

 
239,322

 
99,540

 
82,975

 
23,151

 
720,991

Adjustable-rate commercial/agricultural loans
1,006,593

 
25,960

 
74,566

 
40,465

 
15,333

 

 
1,162,917

Consumer and other loans
490,585

 
52,858

 
67,147

 
15,003

 
15,564

 
36,213

 
677,370

Investment securities and interest-earning deposits
129,105

 
18,430

 
65,555

 
57,548

 
295,592

 
122,399

 
688,629

Total rate sensitive assets
4,487,674

 
1,163,495

 
2,951,873

 
1,479,031

 
1,205,708

 
240,496

 
11,528,277

Interest-bearing liabilities: (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
Regular savings
207,310

 
139,722

 
451,846

 
321,149

 
462,022

 
415,215

 
1,997,264

Interest checking accounts
118,894

 
54,445

 
193,325

 
160,278

 
292,631

 
512,288

 
1,331,861

Money market deposit accounts
188,902

 
122,938

 
406,784

 
298,575

 
443,942

 
385,703

 
1,846,844

Certificates of deposit
633,477

 
254,350

 
251,773

 
24,434

 
2,478

 

 
1,166,512

FHLB advances
97,000

 
50,000

 
100,000

 

 

 

 
247,000

Junior subordinated debentures
147,944

 

 

 

 

 

 
147,944

Retail repurchase agreements
128,764

 

 

 

 

 

 
128,764

Total rate sensitive liabilities
1,522,291

 
621,455

 
1,403,728

 
804,436

 
1,201,073

 
1,313,206

 
6,866,189

Excess (deficiency) of interest-sensitive assets over interest-sensitive liabilities
$
2,965,383

 
$
542,040

 
$
1,548,145

 
$
674,595

 
$
4,635

 
$
(1,072,710
)
 
$
4,662,088

Cumulative excess of interest-sensitive assets
$
2,965,383

 
$
3,507,423

 
$
5,055,568

 
$
5,730,163

 
$
5,734,798

 
$
4,662,088

 
$
4,662,088

Cumulative ratio of interest-earning assets to interest-bearing liabilities
294.80
%
 
263.61
%
 
242.51
%
 
231.67
%
 
203.27
%
 
167.90
 %
 
167.90
%
Interest sensitivity gap to total assets
23.20
%
 
4.24
%
 
12.11
%
 
5.28
%
 
0.04
%
 
(8.39
)%
 
36.48
%
Ratio of cumulative gap to total assets
23.20
%
 
27.44
%
 
39.56
%
 
44.83
%
 
44.87
%
 
36.48
 %
 
36.48
%
 
(Footnotes on following page)

80


Footnotes for Table of Interest Sensitivity Gap

(1) 
Adjustable-rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due to mature, and fixed-rate assets are included in the period in which they are scheduled to be repaid based upon scheduled amortization, in each case adjusted to take into account estimated prepayments.  Mortgage loans and other loans are not reduced for allowances for loan losses and non-performing loans.  Mortgage loans, mortgage-backed securities, other loans and investment securities are not adjusted for deferred fees, unamortized acquisition premiums and discounts.
(2) 
Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are due to mature.  Although regular savings, demand, interest checking, and money market deposit accounts are subject to immediate withdrawal, based on historical experience management considers a substantial amount of such accounts to be core deposits having significantly longer maturities.  For the purpose of the gap analysis, these accounts have been assigned decay rates to reflect their longer effective maturities.  If all of these accounts had been assumed to be short-term, the one-year cumulative gap of interest-sensitive assets would have been $(836,000), or (6.54)% of total assets at March 31, 2020.  Interest-bearing liabilities for this table exclude certain non-interest-bearing deposits which are included in the average balance calculations in the table contained in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Comparison of Results of Operations for the Three Months Ended March 31, 2020 and 2019” of this report on Form 10-Q.

81


ITEM 4 – Controls and Procedures

The management of Banner Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (Exchange Act).  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that its objectives are met.  Also, because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.  The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  As a result of these inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Further, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

(a)
Evaluation of Disclosure Controls and Procedures:  An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management as of the end of the period covered by this report.  Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2020, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b)
Changes in Internal Controls Over Financial Reporting:  In the quarter ended March 31, 2020, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting other than the adoption of internal controls over financial reporting due to the implementation of FASB ASU 2016-13, Financial Instruments: Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended and commonly referred to as CECL.


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PART II – OTHER INFORMATION

ITEM 1 – Legal Proceedings

In the normal course of business, we have various legal proceedings and other contingent matters outstanding.  These proceedings and the associated legal claims are often contested and the outcome of individual matters is not always predictable.  These claims and counter claims typically arise during the course of collection efforts on problem loans or with respect to actions to enforce liens on properties in which we hold a security interest, although we also periodically are subject to claims related to employment matters.  We are not a party to any pending legal proceedings that management believes would have a material adverse effect on our financial condition or operations.

ITEM 1A – Risk Factors

The following risk factor supplements the "Risk Factors" section contained in Item 1A of our 2019 Annual Report on Form 10-K.

The COVID-19 pandemic has adversely affected our ability to conduct business and our financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The COVID-19 pandemic has significantly adversely affected our operations and the banking and financial services we provide, primarily to businesses and individuals in the states of Washington, Oregon, California and Idaho, all of which are currently under government issued Stay-at-Home orders.  All of our branches and most of our deposit customers are also located in these four states. As an essential business, we continue to provide banking and financial services to our customers with drive-thru access available at the majority of our branch locations and in-person services available by appointment. In addition, we continue to provide access to banking and financial services through online banking, ATMs and by telephone. If the COVID-19 pandemic worsens it could limit, or disrupt, our ability to provide banking and financial services to our customers.

In response to the Stay-at-Home Orders, currently approximately half of our employees are working remotely. Heightened cybersecurity, information security and operational risks may result from these work-from-home arrangements. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic. Further, we also rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. We have business continuity plans and other safeguards in place, however, there is no assurance that such plans and safeguards will be effective.

The COVID-19 pandemic has also resulted in declines in loan demand and loan originations, deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address the economic consequences are unknown, including recent reductions in the targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected in the near term, if not longer. Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as revenues declined precipitously, especially in businesses related to travel, hospitality, leisure, and physical personal services. Consistent with guidance provided by banking regulators we have modified loans by providing various loan payment deferral options to our borrowers affected by the COVID-19 pandemic. Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans once the COVID-19 pandemic is resolved. If the economic disruption from the COVID-19 pandemic continues for several months or worsens, it may result in increased loan delinquencies, adversely classified loans and loan charge-offs. As a result, our allowance for credit losses may prove to be insufficient to absorb losses in our loan portfolio, which would cause our results of operations, liquidity and financial condition to be adversely affected.

If we were to close and fund all PPP loans approved by the SBA as of April 30, 2020, we would hold and service a portfolio of approximately 7,000 PPP loans with a balance in excess of $1.1 billion.  The PPP loans are subject to the provisions of the CARES Act and to complex and evolving rules and guidance issued by the SBA and other government agencies.  We expect that the great majority of our PPP borrowers will seek full or partial forgiveness of their loan obligations.  As of now, the procedures and standards for determining loan forgiveness are not clear.   We could face risk in our administrative capabilities to service our PPP loans, and risk with respect to the determination of loan forgiveness, depending on the final procedures for determining loan forgiveness.
In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on our results of operations and financial condition.

We are an entity separate and distinct from our principal subsidiary, Banner Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. If the COVID-19 pandemic were to materially adversely affect Banner Bank’s regulatory capital levels or liquidity, it may result in Banner Bank being unable to pay dividends to us, which may result in our not being able to pay dividends on our common stock at the same rate or at all.


83


Even after the COVID-19 pandemic subsides, the U.S. economy may experience a recession, and we anticipate our business would be materially and adversely affected by a prolonged recession. To the extent the COVID-19 pandemic adversely affects our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled "Risk Factors" in our 2019 Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q.


ITEM 2 – Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable.

(b) Not applicable.

(c) The following table provides information about repurchases of common stock by the Company during the quarter ended March 31, 2020:
Period
 
Total Number of Common Shares Purchased
 
Average Price Paid per Common Share
 
Total Number of Shares Purchased as Part of Publicly Announced authorization
 
Maximum Number of Remaining Shares that May be Purchased as Part of Publicly Announced Authorization
January 1, 2020 - January 31, 2020
 
663

 
$
52.01

 

 
1,118,151

February 1, 2020 - February 28, 2020
 
420,249

 
53.21

 
414,780

 
703,371

March 1, 2020 - March 31, 2020
 
225,460

 
45.33

 
210,000

 
493,371

Total for quarter
 
646,372

 
50.46

 
624,780

 
493,371


Employees surrendered 21,592 shares to satisfy tax withholding obligations upon the vesting of restricted stock grants during the three months ended March 31, 2020.

On March 27, 2019, the Company announced that its Board of Directors had renewed its authorization to repurchase up to 5% of the Company's common stock, or 1,757,637 of the Company's outstanding shares. Under the authorization, shares may be repurchased by the Company in open market purchases. The extent to which the Company repurchases its shares and the timing of such repurchases will depend upon market conditions and other corporate considerations. During the quarter ended March 31, 2020, the Company repurchased 624,780 shares under the repurchase authorization, leaving 493,371 available for future repurchase.
ITEM 3 – Defaults upon Senior Securities

Not Applicable.

ITEM 4 – Mine Safety Disclosures

Not Applicable.

ITEM 5 – Other Information

Not Applicable.


84


ITEM 6 – Exhibits
Exhibit
Index of Exhibits
 
 
3{a}
 
 
3{b}
 
 
3{c}
 
 
3{d}
 
 
10{a}
 
 
10{b}
 
 
10{c}
 
 
10{d}
 
 
10{e}
 
 
10{f}
 
 
10{g}
 
 
10{h}
 
 
10{i}
 
 
10{j}
 
 
10{k}
 
 
10{l}
 
 
10{m}
 
 
10{n}

85


Exhibit
Index of Exhibits
 
 
31.1
 
 
31.2
 
 
32
 
 
101.INS
Inline XBRL Instance Document - The instance document does not appear in the interactive data file because its XBRL tags are embedded within the XBRL document
 
 
101.SCH
Inline XBRL Taxonomy Extension Schema Document
 
 
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
 
 
104
The cover page from the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, formatted in Inline XBRL (included in Exhibit 101)

86


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Banner Corporation 
 
 
 
 
May 7, 2020
/s/ Mark J. Grescovich
 
 
Mark J. Grescovich
 
 
President and Chief Executive Officer
(Principal Executive Officer)
 
 
 
 
May 7, 2020
/s/ Peter J. Conner
 
 
Peter J. Conner 
 
 
Executive Vice President, Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
 






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