Columbia Banking System - Q4 2023

Transcript

Operator (participant)

Welcome to the Columbia Banking System Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are on a listen only mode. After the speaker's presentations, there will be a question and answer session. To enter a question at that time, please press star one one on your telephone. Please be advised today's call is being recorded. At this time, I'd like to introduce Jacque Bohlen, Investor Relations Director, to begin the call. Please go ahead.

Jacque Bohlen (Director of Investor Relations)

Thank you, Valerie. Good afternoon, everyone. Thank you for joining us as we review our Fourth Quarter 2023 Results, which we released shortly after the market closed today. The earnings release and corresponding presentation, which we will refer to during our remarks this afternoon, are available on our website at columbiabankingsystem.com. With me this afternoon are Clint Stein, President and CEO of Columbia Banking System, Chris Merrywell and Tory Nixon, the presidents of Umpqua Bank, Ron Farnsworth, Chief Financial Officer, and Frank Namdar, Chief Credit Officer. After our prepared remarks, we will take your questions. During today's call, we will make forward-looking statements which are subject to risks and uncertainties and are intended to be covered by the safe harbor provisions of federal securities law.

For a list of factors that may cause actual results to differ materially from expectations, please refer to slide two of our earnings presentation, as well as the disclosures contained within our SEC filings. We will also reference non-GAAP financial measures alongside our discussion of GAAP results. We encourage you to review the GAAP to non-GAAP reconciliations provided in our earnings release and throughout the earnings presentation. I will now turn the call over to Clint.

Clint Stein (President and CEO)

Thank you, Jacque. Good afternoon, everyone. 2023 was a tremendous year for Columbia. We closed and integrated our transformational merger with Umpqua Bank, expanding our footprint to encompass 8 Western states and creating one of the largest banks headquartered in the West. We achieved targeted net cost savings ahead of schedule and 6.6% above our original projections, even after taking franchise reinvestment into account. With the integration behind us, our priorities in 2024 and beyond have shifted to focus more fully on optimizing performance and driving shareholder value. The fourth quarter was noisy and our results reflect that. The FDIC special assessment and other elevated expense items brought our quarterly expense run rate above prior guidance. Our cost of funds reflects the rate environment and the associated impacts of repricing CDs and higher priced funding sources like public deposits and brokered funds.

While these items mask the quality of our core deposit base, they do not dilute it. Relationship banking drives our franchise value, and it's the value proposition we bring to new and existing customers. Our fourth quarter results do not reflect this value, and we are focused on improving controllable variables to offset macro-driven headwinds. Looking to the year ahead, the competitive environment for deposits and impact of higher rates is likely to persist, and the macro credit environment will likely normalize at minimum. We are well situated to benefit during times of stress should they emerge. Our talented associates, scaled franchise and offerings, and customer-focused business model provide us with the resources to win business and long-term, drive consistent, repeatable performance. I'll now turn the call over to Ron.

Ron Farnsworth (CFO)

Okay, thank you, Clint. For those on the call who want to follow along, I will be referring to certain page numbers from our earnings presentation. Slide 4 lays out our Q4 performance ratios, noting the decline in the quarter was driven primarily by the decline in non-interest-bearing demand deposits as customers continue to utilize cash. Higher provision for credit loss based on slightly worsening economic forecasts and higher expense, including the FDIC special assessment. These are 5-quarter views, and recall we closed the combination at the end of February. Slide 5 shows our summary balance sheet, noting our deposits in total were flat from Q3, giving seasonal inflows primarily on public deposits, mostly offset customers' use of cash. Our tangible book value is up 13% as our accumulated other comprehensive loss was halved during the quarter as bond markets rallied.

On slide six, we highlight the income statement trends. GAAP earnings were $0.45 per share, impacted by declining merger expense as we completed the integration, along with fair value changes due to market yield changes. On an operating basis, we earned $0.44 per share in Q4, lower than expectations again, driven again, given non-interest bearing deposit flows, higher costs on interest-bearing deposits, and an increased provision with slightly worse economic forecasts and higher expense, driven primarily by the FDIC special assessment, which at $33 million, reduced GAAP and operating EPS by $0.12 per share. Turning to slide seven, we break out Q4 GAAP earnings to help investors understand the non-operating and merger-related impacts on results. The first column represents our Q4 GAAP results, with net income of $94 million or $0.45 per diluted share, and return on tangible common equity at 12%.

The second column includes our non-operating designation for income statement changes, mostly related to fair value swings, along with merger and exit and disposal costs included in non-interest expense, which are detailed out in the appendix. These net to $2 million of income in Q4 earnings, resulting in the third column for operating income. Again, our operating income for Q4 was $91 million or 44 cents per share, and results were impacted by the FDIC special assessment and reserve build, given again, slightly worsening economic forecasts. The appendix shows trending on each of these columns, and the fourth column includes discount accretion and CDI amortization, noting this discount accretion will be a steady and reliable source of interest income over time, as the majority is driven by rate, not credit, providing us with a steady build of capital over time.

Recall, the CDI amortization does not impact tangible book value. So the 13 cents per share net from merger accounting was the equivalent of 25 cents per share added to tangible book value in Q4. We'll continue to highlight and trend it here to aid investors in valuing all our earning streams. Our tangible book value, excluding AOCI, increased 27 cents during the quarter to $17.75 per share. Moving to the next section on slide 9, we highlight net interest income and margin. Our NIM declined to 3.78% for the quarter, driven primarily by a higher cost of interest-bearing deposits, more than offsetting increased loan yields and lower costs from term debt. Slide 10 breaks out the repricing and maturity characteristics of the loan portfolio, noting 41% is fixed, 30% is floating, and 29% are adjustable.

Now, slide 11 provides an updated view of our interest rate sensitivity under both ramp and shock scenarios. We've taken proactive measures to reduce the balance sheet sensitivity to a future declining rate environment. You can see here the trending over the past year, where our rates down risk has been reduced significantly. And noted below, we calculate our cycle-to-date funding betas, which are calculated on a combined company basis over the periods presented for comparability. As of the fourth quarter, our interest bearing deposit portfolio has priced in 47% of the Fed funds rate increases. Notable here is the cost of interest bearing deposits, which was 2.54% for Q4 and 2.71% for the month of December. The lift this quarter was influenced by several factors.

The decision in Q3 to replace maturing Federal Home Loan Bank advances with broker deposits was essentially neutral to the cost of interest-bearing liabilities. But it drove nearly 30% of the increase in interest-bearing deposit costs between Q3 and Q4. Approximately 15% of the quarter's increase relates to an increase in the average balance and rate paid on public deposits. Approximately $900 million in customer CDs, with largely 12 and 13-month terms, matured during the quarter, with many repricing upwards of 200 basis points higher. The cost of interest-bearing liabilities normalizes for balance sheet management decisions, and the quarter's 30 basis point increase was significantly lower than the increase in interest-bearing deposit costs.

Cost of interest-bearing liabilities was 3.02% in Q4, compared to 3.15% for the month of December and 3.19% as of December 31. Slide 12 breaks out non-interest income items, noting the largest changes in Q4 relate to interest rate-driven line items. The changes in loans held at fair value at the bottom was a direct result of decreasing long-term yields this quarter. Next up on slide 13, we note we achieved $143 million in cost synergies guided last quarter, exceeding our original target of $135 million by 6%. This amount is net of reinvestments made in various areas. While we will continue to target efficiency improvements, with the integration now largely complete, we no longer consider future cost-saving opportunities to be merger related.

Q4 expense was above our previously guided range due to several elevated expense items. Noted on the right side is a waterfall from the prior quarter, with increases driven by higher repairs and maintenance, equipment purchases, a branding campaign, and most notably, the $33 million FDIC special assessment. On slide 14, we introduce our outlook for 2024 on several key financial statement items. Our net interest margin remains sensitive to customer deposit balances, with growth driving margin stability and perhaps expansion as we replace wholesale funding and outflows driving contraction. Our interest rate outlook, which incorporates three rate cuts in the back half of the year, does not meaningfully impact prepayment assumptions related to purchase accounting. Our expense outlook incorporates a low single-digit level of growth from Q4's adjusted run rate. We see areas for efficiency improvement to offset the costs associated with franchise reinvestment and inflation.

To that end, we consolidated five branches this month. Moving ahead to the next section on the balance sheet. On slide 16, we detail out the investment portfolio. The table takes you from current par to amortized cost to fair value, noting the difference between current par and amortized cost is a combined net discount, which will be accreted to interest income over time. The increase in market value this quarter, of course, resulted from lower market yields given the bond market rally, again, with the unrealized loss halving. Just over half of the portfolio is now sitting with an unrealized gain at year-end, which gives us significant flexibility to manage the balance sheet moving forward. As you can tell, I'm excited about this portfolio as it gives us a significantly higher and stable earnings stream with greater optionality.

The overall book yield was 3.59%, with an effective duration of 5.4 at quarter end. Slide 17 covers our liquidity, including deposit flows during the quarter. Total deposits were essentially flat in the fourth quarter. Seasonal and targeted increases in public deposits nearly offset contraction in small business balances, as other categories were relatively unchanged. The upper right table details our off-balance sheet liquidity, with $11.7 billion available as of quarter end. Below that, we add cash and excess bond collateral not pledged for lines to arrive at total available liquidity of $18.7 billion. Slide 18 provides the driver of 3% annualized loan growth in Q4. Turning now to slide 19, we present the remaining balance of discount marks as compared to the prior quarter and at closing.

For the AFS portfolio, the acquired discount was reduced $21 million via accretion to interest income. In our earnings release detail, we include this $21 million, along with $16 million of higher bond interest income from the portfolio restructure we completed post-close, to arrive at the $37 million of total accretion for bonds. On the loan side, we had $27 million of weighted accretion, $5.4 million for credit. The total marks declined $69 million in Q4 through accretion to interest income. And finally, in the back on slide 26, we highlight our regulatory capital position, noting our risk-based capital ratios increased 20 basis points as expected in Q4. We do expect to quickly approach our long-term capital target of 12% on total risk-based capital, which will provide for enhanced flexibility to return excess capital to shareholders. With that, I will now turn the call over to Frank.

Frank Namdar (Chief Credit Officer)

Thank you, Ron. Slides 20 through 22 provide select characteristics of our loan portfolio, including composition of our commercial book and an overview of our office portfolio, which continues to perform well. Moving on, slide 23 highlights our reserve coverage by loan category. Also, the remaining credit discount on loans provides for an additional 21 basis points of loss-absorbing capacity. The $55 million provision expense recorded in the quarter was primarily driven by a slight worsening in the economic forecast used in the credit models, along with credit migration. Delinquency and non-performing loan movements over the past two quarters suggest a move toward a more standard credit environment following a phase of exceptional high quality. Slide 24 provides an overview of our consolidated credit trends. In general, our credit performance is and has remained positive, excluding the anticipated trend in FinPac.

FinPac charge-offs remain elevated during the fourth quarter, still centered in the trucking portion of the portfolio. We continue to expect a slow recovery timeline over multiple quarters for this portfolio. Excluding FinPac, charge-off activity at the bank remains at a low level. I will now, I will now turn the call over to Tory.

Tory Nixon (President)

Thank you, Frank. Turning to deposits. Slide 25 highlights the quality of our granular deposit base. As Ron noted, small businesses' use of cash drove a reduction in customer deposits during the fourth quarter, as other commercial balances and consumer accounts were relatively stable in aggregate. The fourth quarter included normal course of business use of cash, like distributions, dividends, and year-end tax payments, while public balances experienced a related increase. Public deposits were positively impacted by targeted efforts by our teams to grow public relationships in local communities as we work to reduce wholesale funding balances. Our teams remain focused on driving balance growth in deposits, loans, and core fee income as they work to expand existing relationships throughout the bank, bringing new prospects into the bank. We see tremendous opportunity with our existing customer base to grow fee income.

We launched SmartLeads in 2020 as a way to capture additional business with our existing customer base through predictive analytics. We've generated an additional $11 million in revenue since 2020, with $5 million generated in 2023 alone, highlighting increased traction with our teams and the benefits of our scaled organization. We will continue to selectively invest in talent, technology, and locations that enable us to profitably expand our businesses as the efficiency opportunities Ron noted maintain our dedication to growing in a cost-effective manner. And lastly, our loan, deposit, and core fee income pipelines remain robust. I will now turn the call back over to Clint.

Clint Stein (President and CEO)

Hey, thanks, Tory. Our regulatory capital position is outlined on slide 26, and as Ron discussed, we expect capital to continue to accrete quickly in the coming quarters, providing us with ample flexibility for future shareholder return. This concludes our prepared comments, and our team is available to answer your questions. So Valerie, please open the call for Q&A.

Operator (participant)

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star one one on your telephone. Again, to ask a question, please press star one one. One moment for our first question. Our first question comes from the line of David Feaster, Raymond James. Your line is open.

David Feaster (Managing Director)

Hey, good afternoon, everybody.

Clint Stein (President and CEO)

Hey, David.

David Feaster (Managing Director)

Appreciate all the guidance and maybe just talking about starting on the margin and digging into some of the impacts of rate cuts. I'm curious how you think about the NIM trajectory. Obviously, you guys include three cuts in your forecast. How do you think about the impacts and cuts? You guys have done a great job managing the downside in the rate sensitivity scenarios. I'm just curious how you think about the trajectory and of the margin and how quickly you'll be able to reprice some of those core deposits on the way down.

Ron Farnsworth (CFO)

Yeah, David. Hey, this is Ron. Great question. You know, as I look into 2024, I mean, if that were to come true, and we see rate—3 rate cuts in the back half of the year or X number of rate changes as the market's predicting. Really key with that is gonna be what happens to the deposit betas. And, and in those rate down scenarios, I think we're pretty conservative in these numbers with betas in the low-to mid-30% range. Whereas on the rate upside, you know, we, we're now at 47%, and we model 53%-54% on rates up. So something tells me you're gonna see most banks probably be north of their model results on the rate downside, just given nature and the fact that deposits moved up so quickly. So with that, I would suggest that there could be potential upside on it.

But again, under all of it is gonna be what's going on with underlying customer deposit flows, right?

Tory Nixon (President)

So that's still the main driver versus betas, I would suggest.

Chris Merrywell (President)

Hey, David, this is Chris. I'll add to the rate part of that discussion, that between Tory and myself and our teams, we're already looking at the competitive market. We're looking at where rates are trending. I think you'll start to see us start moving potentially ahead of any sort of rate cut scenario, and putting in place the long-term kind of more plan of, if we get a rate cut and pick your month, what are we planning to do? So all of that's being laid out right now, and we should be launching that relatively soon here. But yeah, just trying to get ahead of that aspect of it. And I think you see the market is already kind of moving in that direction.

So it'll just be a matter of, historically, can we follow or can we lead as we've done in the past? And that would be the ideal situation.

David Feaster (Managing Director)

Okay, that's helpful. And maybe kind of just a follow-up to some of this, just staying on the deposit side. You know, in the compared to March, it was alluded to some of the declines being attributed to small business declines. I'm curious, maybe, what are some of the drivers of that from your standpoint? Obviously, there's some seasonality, but how much of it's activating deposits versus paying down debt, using cash to fund growth or just less profitability at this point for some of the small businesses? And just curious, it's early in the first quarter, just curious, how are you seeing things stabilize? And how do you think about core deposit growth going forward?

Chris Merrywell (President)

Yeah, you got a lot in there, David. I would say the uses that you mentioned, absolutely, you're seeing that completely across the board. You are seeing some small businesses that good operators have the ability to increase their prices and things of that nature. But for many of them, you know, inflation is certainly taking a big impact, and that goes across all items, from products to service to the employment inputs and things of that nature. You know, we move into really kind of more of a seasonality type of situation in the first quarter as well. I would say we're in contact with the small business customers through our local presence, mainly through the branches.

People are positive, but you know, they're also, let's say, looking down the road for when something's gonna take place that's gonna provide them some relief. We haven't seen that quite yet. And, you know, I think Tory can speak to a little bit more onto the commercial side there.

Tory Nixon (President)

Yeah. David, it's Tory. On the commercial side, it's pretty kind of typical with the end of the year in Q4. The one difference is you saw people that took—they take excess cash that they have in their operating accounts and wanna reposition that into some interest-bearing account. Just it's kind of good course of business on their point from their standpoint. But, you know, it's a typical use of cash of, you know, dividends, distributions, tax payments, those types of things. Investments, you know, had some customers that were making investments and doing it with cash, instead of, you know, borrowing for it. So kind of some typical stuff that we've seen in the last year or so.

Chris Merrywell (President)

Yeah. And David, I'd say, Tory and I talked quite a bit about the momentum that's building and our teams getting excited about being out in the market, integration's behind them, and we're seeing new business start to come on with some of the other things that are going on out there. Now, it's coming on at a, you know, a higher cost than we've seen in the past, but we're driving those operating accounts. We're getting the full relationships with the focus. And like I say, Tory and myself see stories almost every day about somebody somewhere in the footprint bringing in a new name into the bank.

David Feaster (Managing Director)

That's great. That's great. And I guess to that point, I'm curious on the, the C&I growth. Curious, where are you having success driving growth? How much of it's from client acquisition versus increased utilization or, or deeper relationships or, or even the new hires that you've made? And just curious, your, your, your appetite for growth and whether you'd expect C&I to, to be the key driver of loan growth going forward.

Tory Nixon (President)

Yeah, David, it's Tory again. Definitely see C&I growth as the place that we will grow the lending side of the house with full relationship banking. So like we said, I think in, very consistently, we're in eight western states, great markets. We've got great people. They have very strong pipelines. We saw C&I growth, kind of a mixture between new client acquisition, as Chris was talking about, plus, you know, lending to existing customers, you know, doing their normal course of business. So, it's, it was spread throughout the footprint, so there's not one place where I can say we got most of our growth. It was kind of spread throughout our footprint. As Chris said, I mean, feel very good about the pipelines and the activity that's occurring out in the field, so.

David Feaster (Managing Director)

Okay, that's great. Thanks, everybody.

Ron Farnsworth (CFO)

Thank you, David.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line, Timur Braziler of Wells Fargo. Your line is open.

Timur Braziler (Director and Mid-Cap Bank Equity Research)

Hi, good afternoon. Following up on the net interest income, net interest margin commentary, just with the expectation for deposits and funding to remain a source of pressure here in the near term, and then the expectation for rate cuts in the back end of the year, is there an outcome where NII inflects and grows in 2024, or is that more likely a 2025 event?

Ron Farnsworth (CFO)

Well, Timur, this is Ron. Good question, and again, it's going to be really a function of the cost of that deposit growth. I could definitely see a scenario where you see you know, a little on the lower end of the front end if we do continue to see pressure on noninterest-bearing demand, specifically within that guide range. But then once they start moving, again, I talked about earlier that deposit beta, I think that's pretty conservative, and I would suggest probably most of the regional banks think their model betas on the rates downside are going to be close to what they were on the upside. So you could see that scenario exactly where you get some pickup in the second half.

Timur Braziler (Director and Mid-Cap Bank Equity Research)

Okay. And then I guess, looking at the deposit costs and some of the December 31 spot rates, is that a good ceiling here? Is that kind of where we expect the funding, funding base to, to stall out? Or is there going to be some more mix shift in, in the first half of the year to some of these higher cost categories, which could keep that lag around and costs for a little bit longer?

Ron Farnsworth (CFO)

Yeah, I obviously, it's an estimate, but we'd expect the lag to continue there. And that's probably why, you know, we show the 47% beta to date, but we model the 53 on the rates upside, so you got that additional piece. We also have, you know, in this past quarter, we had about $900 million of CDs repricing that were 12-to 13-month tenor. So they had been sitting there for a year, and those all repriced up close to 200 basis points. In the first quarter, I want to say it's around $650 million-$700 million of CDs maturing, which we'll reprice, but it'll be less than 200, just given the timing of those compared to when the Fed was raising rates, you know, earlier in 2023.

Timur Braziler (Director and Mid-Cap Bank Equity Research)

Okay. And I guess, what's the thought process or the rationale for maintaining all of those balances rather than being more aggressive with rates here and letting some of that money walk?

Ron Farnsworth (CFO)

Just overall liquidity levels, where we feel comfortable sitting with cash, you know, on the balance sheet and sweep cash at the Fed. Keep in mind, too, I mean, we've got an incredible amount of optionality, again, compared to the average regional bank with a little over half of our bond portfolio sitting in an unrealized gain. But then again, too, the goal will be to accrete that remaining discount up to par over the life of that book, because that's, you know, that's all government rate from that standpoint. So we've taken the approach of maintaining that flexibility so we earn back that discount, which reduced capital, you know, a year back at the combination closing.

By utilizing that, we utilize overnight or wholesale funding in that two-four month tenor to maintain, you know, that overall level of liquidity. We have reduced the overall level of on-balance sheet liquidity, where we were sitting up closer to, you know, $3 billion early-mid 2023 in spring cash. We've now taken that down into the, you know, call it $1.5 billion-$2 billion range. I could see that probably dropping a little bit more into 2025, but probably, you know, not too much more.

Timur Braziler (Director and Mid-Cap Bank Equity Research)

Okay, great. Thank you. I'll step back.

Ron Farnsworth (CFO)

Thanks.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Brandon King of Truist. Your line is open.

Brandon King (Equity Research Analyst)

Hey, good afternoon.

Ron Farnsworth (CFO)

Good afternoon.

Brandon King (Equity Research Analyst)

I wanted to talk about leaning into those public deposits. Could you just elaborate on the thought process behind that? And, you know, if you're able to achieve that just based off a rate or primarily relationships, just give us the push and takes there.

Tory Nixon (President)

Hey, Brandon, this is Tory. So we have a lot of existing customers in the bank that are municipalities spread throughout the footprint. Most of them are smaller rural communities and, you know, they're—we have strong relationships with them and just, you know, made a very significant effort to go out and call on that group and ask for more deposits in the bank. And we, you know, to—it says a lot about the capability of the teams, both in the branches and in commercial banking, to have those relationships and to call on them to further deepen and strengthen those relationships. That was the effort. You know, it's that time of year as tax payments come in, so they have more money and distributing to us would, we thought, was a really good idea.

Clint Stein (President and CEO)

Yeah, Brandon, I'll add to that, as Tory mentioned, that local presence and working together, it's not just existing customers and then, you know, maybe getting a little bit of a priced up on some of their reserve money. That can lead you into, we're talking about full relationships, we're talking to them about their operating accounts. That sales cycle takes a little longer, but we're already seeing positive momentum into new names that came on board in a money market type of account that are, I want to investigate my operating account with you. That's when that relationship really gets cemented. And that is, Tory said, that's due to people that, you know, they live, they work in the communities, they know the individuals that are at the public entities, and they're building relationships, and they're asking for the business.

And with our capabilities with the new TM capabilities that came on board for a lot of our footprint as well, we're getting looks, and we're winning that. We're gonna win that business, and that momentum is building. And it's a great funding alternative to, you know, not on the operating, you know, we get the operating account, but then with their surplus liquidity, you know, we provide an alternative to the local government pools. And it's a way of providing bringing in deposit balances without cannibalizing our core deposit base or repricing a whole sector of our deposit base. And so it's kind of a different lever that we can pull.

Now, it creates noise, and in my prepared remarks, I made a reference to, you know, the results of the quarter don't necessarily reflect the quality of our deposit base. But that's what I was really getting at, is that, you know, this is just a lever we can pull. And the fall, when tax proceeds are coming in for municipalities, is a great time to pull that lever.

Brandon King (Equity Research Analyst)

Got it. Got it. And just my follow-up would be: Could you, do you care to quantify the level of the amount of public funds deposits you have? And would you consider these deposits higher beta relative to, to maybe some of your more core deposits?

Clint Stein (President and CEO)

I think you have to bifurcate it because we do have the operating relationship with virtually all of these public entities. And so that's gonna behave more like a traditional part of our portfolio. And then you have the what I reference as a alternative to the local government pools. And so I think Ron's got the the detail you're looking for.

Ron Farnsworth (CFO)

Yeah, and again, we do highlight that in those trends on page 17 of the earnings presentation. But in total, $2.9 billion of total public deposits, and that was up roughly $500 million, a little under $500 million for the quarter. And of that, you're gonna be probably in the 10%-15% range, would be the core operating accounts, 20%, probably tops. But you know, a good stable base.

Brandon King (Equity Research Analyst)

Okay. And just lastly, Ron, I know you're working to kind of reduce, you know, asset sensitivity, just given the full rate curve and the potential for rates to come down. Are there any actions that you're considering or looking at that would make sense at this point to achieve that?

Ron Farnsworth (CFO)

Yeah, great question. It's, it's really difficult on the, on the, you know, derivative side, just given pricing and expectations. But, but we, we, you know, we took that shot, and we did that. You can see the trending there, too, on page 11 of the presentation, with how we repositioned a portion of the bond portfolio in that first week post-close, back in Q1. And then also the utilization of shorter-term, wholesale funding, be it the broker deposits or Home Loan Bank advances, to help offset the, you know, deposit flows during the year. Those two items, in and of themselves, basically act as a, like a swap. The benefit you can write down because you, you, you locked out cash flows on the bond portfolio, and you'll have fully floating down cash flows on the right side of the balance sheet.

So that was really the majority of the change from a year back to now, where in the past, a year back, we had a more traditional asset-sensitive profile, and today we're relatively neutral.

Brandon King (Equity Research Analyst)

Got it. Thanks. Those are my questions.

Ron Farnsworth (CFO)

Yeah, thank you.

Clint Stein (President and CEO)

Thanks.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Chris McGratty of KBW. Your line is open.

Chris McGratty (Managing Director and Head of US Bank Research)

Oh, great! Thanks for the question. Ron, maybe on your expense guide for a minute, the $1 billion-$1.1 billion, what I'm interested in your comments on what the revenue environment would be at different points of that guide.

Ron Farnsworth (CFO)

Good question, Chris. Generally, historically, the movement on the expense side, directly tied to revenue, would've had to do with, you know, home lending back in a different, much lower rate environment, right? You'd see seasonality over the course of the year, which would drive higher revenue in the, you know, second and third quarter, lower seasonal in first and fourth. You'd have corresponding expense trends along the lines. I'd say, you know, in this, our outlook here is not, you know, for a significant rate down world to where our home lending is, you know, picking up significantly in volume. So, you know, it's gonna be, it's gonna be really range bound within that NIM. It's gonna be the driver of the revenue side.

I think over the course of the year, ex any legacy home lending seasonality, you're generally gonna see higher, you know, payroll tax type items in the first two quarters of the year, and then those tail off in the second two quarters of the year. You also generally see annual merit cycles, which, you know, basically approximates inflation rates at the start of the second quarter. You see a little bit of a lift and then stabilization over the course of the year.

Chris McGratty (Managing Director and Head of US Bank Research)

Okay. That's, that's helpful. Thank you. And Clint, maybe on capital, you noted in the release, CET1 of 9.6% is above your 9% target, and your total is within 20 basis points. Is it—could you help us on when the buyback would be more of a discussion or announcement? Is it when you hit 12? Do you have to build a buffer to 12? How are you thinking about the buyback, given the outlook?

Clint Stein (President and CEO)

Yeah, you know, I think that, I mean, 12's kind of like, like, like the Fed trying to stick the landing on the economy. You know, it's difficult to just get to 12 and keep it there. And so, you know, I think that we'd want a little bit of a buffer before we implemented the buyback. You know, probably not a huge buffer, but enough that we could do a meaningful buyback and still be above 12%, you know, after you took that into account. So, I know I'm not giving you, like, a hard and fast timeline or number, but we do see, you know, and you can see the trend over the last three quarters of how capital builds. You know, there are some things as the rate environment, you know, we do get three cuts.

You know, I think that gives us some additional optionality, even over and above what we already have on our balance sheet, and some flexibility that can put us in a position to do a buyback sooner than later. But we're probably really talking, is it one quarter or two quarters, before we would do it just naturally through steady state with the, you know, the 25 basis points of capital increase in each quarter.

Chris McGratty (Managing Director and Head of US Bank Research)

Okay, that's helpful. And then just a follow-up. Would that be the top use of capital beyond growing your business that you've talked about? Or is there an alternative use? I know you have the dividend that's pretty competitive, but inorganic growth at all on the table?

Clint Stein (President and CEO)

Yeah, the regular dividend, obviously, is something that we have talked about, that we want to be consistent and provide that. For some of our investors, that's a very important component of their investment in our company. The organic growth component of it, you know, Tory mentioned in his prepared remarks, the pipelines. You know, I've had the opportunity to meet with some of our market leaders over the past 30 days. And, you know, when they talk about what their pipelines look like and the opportunities they have in front of them, from a business perspective, you know, many of you have seen Ron in person when he talks about the bond portfolio, and he just gets giddy. That's the same type of reaction that our bankers have, you know, with the opportunities that they're currently in the middle of pursuing.

But even with that said, I think the capital generation is so strong that any level of reasonable organic growth, I don't think it outstrips the building of those ratios between the regular dividend, organic growth. And so it does leave us with, you know, buyback options. You know, potentially, depending on if buybacks were, you know, didn't make sense, then we could always look at whether there's a special dividend makes sense. And then, to your question, inorganic growth. You know, I think that we're—it feels like we're in a time period like we were in mid-2020, where the M&A markets are kind of frozen. You know, the math is very hard right now. I know there's been a few things announced, but those aren't healthy, thriving franchises that would be of interest to us.

We don't feel like that it'd be additive to our long-term value. But that will change with the passage of time.And so, so I do think that there's going to be, some opportunities to at least look at things. But as we've said before, you know, the, the size, size company we are, the eight states that we're in, there's, there's not a, there's not a, a plethora of, of opportunities that move the needle for us. So we'd be very selective, and disciplined about, looking at any type of inorganic opportunities.

Chris McGratty (Managing Director and Head of US Bank Research)

Great. Thanks for the call. Appreciate it.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Jeff Rulis of D.A. Davidson. Your line is open.

Jeff Rulis (Managing Director and Senior Research Analyst)

Thanks. Good afternoon. Wanted to clarify, is it safe to assume a loan growth expectation would mirror your balance sheet growth expectation of no growth to 3% or possibly outstrip that?

Ron Farnsworth (CFO)

Hey, Jeff, this is Ron. Good afternoon. Good, good question. And yeah, I mean, ideally, over time, you want the deposit growth to match the loan growth. And that's our goal here over the course of 2024.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay, so loan growth at maybe no growth. I want to kind of pair that up, Clint, with kind of the feel and that giddiness out there. Is there a point where you're kind of tamping down your kind of loan officers on a, we got to true it up with deposit growth? I'm just trying to get the assumptions underlying of a pretty limited growth and kind of meet that with kind of the team, and you're going on the anniversary of the merger close. Just want to kind of get the sense for feet under those folks and starting to produce, you know, pretty significant net growth.

Clint Stein (President and CEO)

Yeah, it's a great question, and it gets back to the response I had on inorganic growth. And when we think about. There, we've talked for the last couple of quarters about being relationship centric. In a QT-type environment, you know, we're where we're holding back and being very restrained is on, you know, transactional real estate type things. Our C&I teams, small business bankers, I mean, they've got a green light and the ability to go out, but I don't think there's a single banker in this company that doesn't understand that, and I use the term banker purposefully, that, you know, we don't have lenders, we have bankers, and that they need to go get the full relationship, needs to come with deposits. You know, and they're not gonna fund dollar for dollar.

I mean, that's not the nature of it, but that's why we have our robust 300-strong retail network to help with the funding. But, you know, that's where I think the optimism is. The integration's behind us. We've shut down the integration management office, and they're ready. They're on their front foot, and they're ready to go play offense. And, Tory, I don't know if you have anything to add.

Tory Nixon (President)

Yeah, Jeff, it's Tory. I would just maybe reiterate a little bit of Clint's comments around just the sales force and the bankers in the footprint. Their strong desire to grow market share, to really manage what we have and keep what we have and continue to expand with what we have, but to grow market share. And that sometimes is a relationship that includes a loan, and sometimes it's a relationship where there's no lending activity. You know, a deposit-only or deposit and core fee income relationship is very valuable and supports this local presence that Chris always talks about and this ability to grow their book of business. And, you know, our focus is definitely on the C&I side of the house.

As you can see in the growth in real estate, it's been flattened and on purpose, and we're pushing on the C&I front. So we've got a lot of great bankers and great markets that are out, you know, pounding the pavement and looking to bring in new names into the bank.

Jeff Rulis (Managing Director and Senior Research Analyst)

Appreciate it. Wanted to maybe hop over to the credit side of things and really kind of looking at that, you know, kind of the crosshairs go to FinPac, thinking about, you know, I think mid last year, we were kind of pointing to, maybe it was hopeful or some signs forming that those trucking losses would ebb lower. It looks like we're bouncing back up. I guess kind of over the course of 2024, if you think about losses in FinPac, you know, is it safe to assume we could still be in that 5%-6% for the full year? Or do you see any trend that we could kind of come off a cliff with that?

Frank Namdar (Chief Credit Officer)

Yeah. Hey, Jeff. Yeah, I do not expect, you know, that this trend goes all through 2024. I mean, if we look at the loss curves and really the vintages that have caused this pain, the vintages were really the last half of 2021 and all of 2022. From a loss curve perspective, we're through all of 2021, and we're about halfway through 2022. So I believe we will see, you know, at the end of the second quarter, those losses start to tail off at a more rapid way than they have historically. And don't forget, I mean, the fourth quarter is a tough barometer for collecting because of all the holidays that are during that quarter.

You know, in this space, I mean, remember, I mean, FinPac is, you know, it may be a subsidiary of the bank and provides a valuable, you know, product set for the bank. But at its core, it's still a finance company, and a finance company, this type of activity and what we're seeing currently is not abnormal. And if you go out there and survey our competitors, they're experiencing the exact same thing, even at a worse clip than we are. What is encouraging is that it is isolated to the trucking portfolio, and we do see the light through the data that we have, that there is an end in sight, and I do believe it'll be halfway through this year.

Jeff Rulis (Managing Director and Senior Research Analyst)

Got it. Just to kind of get into that vintage, and I appreciate the color there. That's the thought that, as we moved into the back half of 2023 and hopeful of a decline, was it that you got into some of those 2022 vintages that were like, oh, wow, this is, this is also troublesome? Is that, is that what. Why sort of the extended?

Frank Namdar (Chief Credit Officer)

Yeah. I mean, we are coming out of 2021, and we did see that 2022 was also displaying some of the elevated loss characteristics, and so we kind of had a feeling that it would be a long, you know, dragged-out process for getting back to that 3.5% clip. But we do see it in the early returns, I will tell you, for the 2023 vintage; they're very positive.

Jeff Rulis (Managing Director and Senior Research Analyst)

Got it.

Frank Namdar (Chief Credit Officer)

So that is encouraging. The tweaks that we've made to the model and the criteria, really in the portfolio as a whole, but in particular, the trucking portfolio, is really seems to be paying off in the 2023 vintage.

Jeff Rulis (Managing Director and Senior Research Analyst)

Great. Thank you. And then one last one. Ron, I'll take another crack. I didn't really hear a response on the margin trajectory. I know it resides with deposit success, but, you know, I guess to put it more clearly, do you expect more compression in the first half of 2024 versus the second half when you layer on potential rate cuts, your three basis points of cuts?

Ron Farnsworth (CFO)

That's, that's correct. Just given the fact that we've got that conservative estimate in there for the deposit betas. And that'll really be a driver of if we do see the rate down environment. I expect we'll outperform because I expect our betas will be above the 30% on the down. I mean, they're closer to, like I said earlier, to 50 on the up. Overriding all that, of course, will be what's going on with just basic customer deposit flows, and you've heard enough, you know, conversation on that point to date, so we'll see how it plays out.

Jeff Rulis (Managing Director and Senior Research Analyst)

If we're talking 3.50-3.60 for the full year, you may shoot to that mid-year, and then kind of a coming up is sort of how you would trendline that?

Ron Farnsworth (CFO)

If in that view, over the course of the year, you saw a couple of rate cuts in the second half of the year, and we, like most banks, expected that we'll perform on our deposit betas to the rate downside, then, yeah, that's a true statement.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay, thank you.

Ron Farnsworth (CFO)

You bet. Thank you.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Brodie Preston of UBS. Your line is open.

Brody Preston (Equity Research Analyst)

Hey, good evening, everyone.

Ron Farnsworth (CFO)

Afternoon.

Brody Preston (Equity Research Analyst)

Ron, I just wanted to ask a few questions on NII. The $4.3 billion of loans that you have above floors, do you happen to know where those floor rates are?

Ron Farnsworth (CFO)

They're sitting more than three cuts down. We'll add that detail.

Brody Preston (Equity Research Analyst)

Okay.

Ron Farnsworth (CFO)

Into the next quarter's release, but they're, they're definitely more than three cuts down.

Brody Preston (Equity Research Analyst)

All right. Would they be more than the four curve down, the five, so maybe six, depending on the day?

Ron Farnsworth (CFO)

I don't have that in front of me. But again, recall going back over the last two and a half years, two years, as rates were increasing, it was easily more than, what, six cuts ago? 125, 150 bps. It was easily more than 150 bps ago that we started to slow down talking about loans going above their floors.

Brody Preston (Equity Research Analyst)

Yeah. Okay. I noticed that you shifted some of the borrowing base to BTFP this quarter. I think it was maybe $200 million of utilization. So you still got a lot of FHLB lines, and if I'm remembering correctly, those are pretty short from a duration perspective. I think there's like an 80-something basis point gap between the cost of your borrowings right now and what BTFP is. Would you consider shifting the rest of the borrowings to BTFP to help with the margin? And if so, is that contemplated in your guidance at all?

Ron Farnsworth (CFO)

We are looking at that. It's not the full amount of the Federal Home Loan Bank advances. It's given the capacity at the BTFP, but we are looking at that here over the course of the first quarter.

Brody Preston (Equity Research Analyst)

Okay, great. So if I look at the NII sensitivity slide that y'all provide, it looks like in either an up 100-200, down 100-200 kind of scenario, you know, it's negative for NII and all but a couple of them as of December 31. Then, you know, I don't think you have a lot in fixed asset repricing. So if we get no cuts, you know, maybe that kind of incremental deposit beta creep and lag that you've talked about would continue. So I guess I'm just struggling a little bit, Ron, to think about holistically, like, what's the best rate environment that you could foresee, just kind of looking at those pieces of the puzzle?

Ron Farnsworth (CFO)

Yeah, I mean, interesting question. I would suggest this, that in anyone's interest rate risk modeling, if they're looking at the difference between 0.7% and 1.1% and saying there's exact precision in that, they're not being truthful with you, right? There's so many assumptions that go into that over the course of the year, inclusive of customer deposit flows, betas, timing, lags. So I kind of look at all those as relatively neutral within their, if they're within a point or two of each other, just because I know that's generally the grenade range you're going to be, you know, facing over the course of the year.

Brody Preston (Equity Research Analyst)

Got it. What is the NIB mix that's contemplated within your NII guidance? I'm sorry if I missed that.

Ron Farnsworth (CFO)

Within the traditional NII guidance or interest rate sensitivity analysis, which is what this is. We generally assume a static. Yeah, you generally assume a static balance sheet, and then things reprice into themselves. So again, that's where I got to earlier, talking about within the range of the guide, if we're better on the deposit side, then we're going to be on the upper end. If we're not, we're going to be on the lower end.

Brody Preston (Equity Research Analyst)

Okay, and the last one for me, just if I, if I take the pieces of your, of your guidance, you know, $48.5 billion of average earning assets, 355 on the margin, and then, you know, factor in the expenses. If I, if I do something just like, you know, last three quarters average fee income, you know, assume that's the run rate, annualize it and, you know, grow it by low-to mid-single-digit, it kind of implies like mid-780s on PPNR. Am I, am I far off the mark there?

Ron Farnsworth (CFO)

You know, Brodie, I don't have the calculator out in front of me to run through that math with you. I'd just ask, you know, we're not providing the inputs into guidance on EPS. We're not giving an EPS guide, but there's other, you know, maybe specific questions that might help you on the modeling side. Highly suggest contacting Jacque. She's great and she'll set you straight.

Brody Preston (Equity Research Analyst)

Got it. Thank you very much for taking my questions, everyone.

Ron Farnsworth (CFO)

You bet. Thank you.

Operator (participant)

One moment, please. Our next question comes from the line of Matthew Clark of Piper Sandler. Your line is open.

Matthew Clark (Managing Director and Senior Research Analyst)

Hey, thanks for the question, questions. And Brodie, $7.80 sounds, that's kind of where I am right now. First question, just on expenses relative to the balance sheet size. If we end up at the low end of that average earning asset range, the $48 billion, I believe, is it fair to assume that noninterest expenses will be at the low end as well, $1 billion versus $1.1 billion?

Ron Farnsworth (CFO)

There's potential for that. Obviously, we have efficiency improvements that we're working through as well. But there's also just enough uncertainty when you look into the year inclusive of inflation rates to say, you know, our target's gonna be somewhere relatively in the middle of that, and there is downside, there's upside, and see which way it plays over the year. But we wanted to just make sure we recognize that there is some level of uncertainty, the timing, and flow over the course of the year. So not giving a specific guide on that by quarter or the trajectory.

Matthew Clark (Managing Director and Senior Research Analyst)

I'm just trying to be consistent with the balance sheet size relative to the expenses. Should we be consistent or not?

Ron Farnsworth (CFO)

There is a little bit of movement with the balance sheet size, but again, you know, you also have changes in, say, for example, deferred loan costs, which are influenced by the balance sheet size. Or we get, you know, leverage within deposits per branch, which, you know, doesn't necessarily have an impact on expenses other than incentives. So, it's just difficult to say with precision at this point.

Matthew Clark (Managing Director and Senior Research Analyst)

Understood. Okay. And then just to step up another non-interest expense, I think it went from, you know, excluding merger charges. So call it, I don't know, $45 and change, $45, $46 million, up from $38 million last quarter. Anything unusual in there that we should strip out going forward? I'm just trying to get a sense for.

Ron Farnsworth (CFO)

Yeah, no, good, good, good question. I take a look at slide 13. Again, Jacque did a great job showing the movement in the bridge and, you know, a good chunk of those items inclusive of the FDIC special assessment, but a good chunk of those items are, you know, elevated and not expected to continue at those levels.

Matthew Clark (Managing Director and Senior Research Analyst)

Yeah, I know the FDIC, that's obvious. But I'm talking about in the merger. We're stripping all that out. I'm just talking about anything else beyond FDIC and merger charges.

Ron Farnsworth (CFO)

Yeah, I mean, you look through, again, on that bridge on slide 13, you'll see some items written, which are small equipment, repairs, and maintenance. Those are more in the occupancy and equipment area, but then you got legal title and other; those are in the other area. So.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay.

Ron Farnsworth (CFO)

I tried to call those out on the bridge.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay, got it. Okay, fair enough. And then back on the deposit beta outlook for kind of the remainder of the cycle. Did I hear you correctly, that you're expecting the cumulative interest-bearing deposit beta to get to 53% at the peak? Is that what I heard?

Ron Farnsworth (CFO)

That is what our models would suggest, but then again, recognize that those are models.

Matthew Clark (Managing Director and Senior Research Analyst)

Understood. Okay, just want to make sure I heard that. And then just on the provision, I mean, it's obviously a moving target in any given quarter, but it looks like a decent step up in reserve build here, and I understand classified increased a little bit, but not meaningfully. I think most macro models actually improved this quarter, so I'm a little surprised in the step up in reserve build relative to the migration in the macro. But, you know, how should we think about provisioning going forward? And is this a somewhat outsized, you think, or, or not? Even, you know, we're going to assume higher charge-offs just with normalization, but I'm trying to get a sense for kind of reserve coverage and whether or not this provision might be a little elevated.

Ron Farnsworth (CFO)

Yeah, I mean, good question. I guess in terms of the models and the slightly worsened economic forecast, I mean, there's, there are dozens of variables that go into those CECL models, and not simply just GDP or, you know, CPI rates. You also have things along the lines of vacancy rates or rent changes within various markets that we operate in, which factor into those. So I would characterize it as just in total, across, again, those dozens of variables, they were just a little bit worse. But that just means they were a little bit better a quarter ago, and they're all a guess, right? They're all projections, which we factor in the models from that standpoint. So underlying trends, though, I'd refer back to Frank's comments earlier, right?

We, we do expect we'll see some abatement on the FinPac side, and then the rest is going to be what's going on with the overall economy, you know, two or three quarters from now. And then more interestingly, have those forecasts, you know, looking ahead, over the life of the portfolios at those points in time. So.

Matthew Clark (Managing Director and Senior Research Analyst)

Okay.

Ron Farnsworth (CFO)

Sorry, I have more specifics for you on that, but that's, that's what we're dealing with.

Matthew Clark (Managing Director and Senior Research Analyst)

Understood. Okay. Sounds good. I'll leave it there. Thank you.

Ron Farnsworth (CFO)

Yeah, thank you.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Jon Arfstrom of RBC Capital Markets. Your line is open.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Thanks. Good afternoon.

Ron Farnsworth (CFO)

Afternoon.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Hey, just most of my questions have been asked and answered. But on slide 9, the red bar on deposit pricing, I'm kind of looking at that over the last couple of quarters. And Ron, what do you think that bar looks like in the first and second quarter? I know there's a lot that goes into it, but you know, I guess it's this rate of change in deposit pricing, and I'm just, if you could take a stab at what you think that looks like over the next couple of quarters, that might help.

Ron Farnsworth (CFO)

Yeah, no, I mean, good question. I would, I refer back to, you know, we do disclose in here the spot rates as of year-end, so use that as your starting point for when you're looking to, you know, Q1. But I also say that, you know, this 36 bp change, as denoted in the walk on page 9, was really, you know, a good chunk of that was related to the decision we made back in late Q3, where we brought on broker deposits to help reduce Home Loan Bank advances, which are in the borrowings category, right? So, you know, I wouldn't expect as big of a move, but again, that depends on what we do with those balances over the course of the year.

That was really a good chunk of the driver there, of that 36 basis points in Q4. Now, that's, that's specific to interest-bearing deposits. I talked about, though, we saw in interest-bearing liabilities, it wasn't as big of a change, and that's just because it was a shift from, a little bit higher cost borrowings into, similar costing broker deposits.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Yep. Okay. Okay. Yeah, that, that was kind of my next question. I wanted to ask about funding costs peaking, and I think you may be saying you're reasonably close on that. Is that fair?

Ron Farnsworth (CFO)

Yeah. I mean, we again, models, right?

Jon Arfstrom (Managing Director and Associate Director of US Research)

Yes.

Ron Farnsworth (CFO)

But I also assume you generally a two-quarter lag on the back end of that.

Chris Merrywell (President)

Jon, this is Chris. As I mentioned earlier on the call, we're starting to see the market pull back a little bit, so I think towards, you know, are we at the peak? I can't tell you that. I, you know, don't know. It appears that we're somewhere there. I would expect it to start slowing down from what we experienced in the previous quarters. And you know, some of the things that are coming due on the CD side, there's not as big of a lift between their current rate and where you know, we project we might be in a month or two. So you know, all that being said, I think that the pace is going to certainly slow down, and we'll see what everybody does out there. You know, it's a fluid market as well, so, but pace should slow down.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Okay. Okay. Ron, one more crack at the most annoying question of the call, but the margin trajectory, is it safe to assume the way it sits right now with your guide, U-shaped, J-shaped type margin for 2024 with kind of a mid-year trough? Is that fair?

Ron Farnsworth (CFO)

I think, again, assumptions around that are going to be around timing and number of cuts and where the betas are, but underlying all of it's going to be where core, you know, customer deposit flows. So, just not prepared to give a guide in terms of what that looks like by quarter. We're giving you an estimate of what we feel it could be for the full year from our target standpoint.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Yeah, okay, fair enough. Thank you very much.

Ron Farnsworth (CFO)

Yeah, thank you.

Jon Arfstrom (Managing Director and Associate Director of US Research)

Yep.

Operator (participant)

Thank you. I'm showing no further questions at this time. Let's turn the call back over to Jacque Bohlen for any closing remarks.

Jacque Bohlen (Director of Investor Relations)

Thank you, Valerie. Thank you for joining this afternoon's call. Please contact me if you would like clarification on any of the items discussed today or provided in our earnings material. Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.