Document

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

FORM 10-Q 
(Mark One)

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2019
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
 
 
 
 
 
 
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]
 
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
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, 2019
Common Stock, $.01 par value per share
 
35,121,930 shares
Non-voting Common Stock, $.01 par value per share
 
 
 
 
 
39,192 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, 2019 and December 31, 2018
 
 
Consolidated Statements of Operations for the Three Months Ended March 31, 2019 and 2018
 
 
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2019 and 2018
 
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2019 and the Year Ended December 31, 2018
 
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2018
 
 
Selected Notes to the Consolidated Financial Statements
 
 
Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Executive Overview
 
 
Comparison of Financial Condition at March 31, 2019 and December 31, 2018
 
 
Comparison of Results of Operations for the Three Months Ended March 31, 2019 and 2018
 
 
Asset Quality
 
 
Liquidity and Capital Resources
 
 
Capital Requirements
 
 
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Market Risk and Asset/Liability Management
 
 
Sensitivity Analysis
 
 
Item 4 – Controls and Procedures
 
 
PART II – OTHER INFORMATION
 
 
 
Item 1 – Legal Proceedings
 
 
Item 1A – Risk Factors
 
 
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
 
 
Item 3 – Defaults upon Senior Securities
 
 
Item 4 – Mine Safety Disclosures
 
 
Item 5 – Other Information
 
 
Item 6 – Exhibits
 
 
SIGNATURES

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: expected revenues, cost savings, synergies and other benefits from the merger of Banner and Skagit Bancorp, Inc. (Skagit) might not be realized within the expected time frames or at all and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; 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 loan 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 loan losses not being adequate to cover actual losses and require a material increase in reserves; 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 loan 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; 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; 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, 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, 2019 and December 31, 2018
ASSETS
March 31
2019

 
December 31
2018

Cash and due from banks
$
218,458

 
$
231,029

Interest bearing deposits
43,080

 
41,167

Total cash and cash equivalents
261,538

 
272,196

Securities—trading, amortized cost $27,203 and $27,203, respectively
25,838

 
25,896

Securities—available-for-sale, amortized cost $1,599,347 and $1,648,421, respectively
1,603,804

 
1,636,223

Securities—held-to-maturity, fair value $220,112 and $232,537, respectively
218,993

 
234,220

     Total securities
1,848,635

 
1,896,339

Federal Home Loan Bank (FHLB) stock
27,063

 
31,955

Loans held for sale (includes $37.4 million and $164.8 million, at fair value, respectively)
45,865

 
171,031

Loans receivable
8,692,657

 
8,684,595

Allowance for loan losses
(97,308
)
 
(96,485
)
Net loans receivable
8,595,349

 
8,588,110

Accrued interest receivable
41,220

 
38,593

Real estate owned (REO), held for sale, net
2,611

 
2,611

Property and equipment, net
171,057

 
171,809

Goodwill
339,154

 
339,154

Other intangibles, net
30,647

 
32,924

Bank-owned life insurance (BOLI)
178,202

 
177,467

Deferred tax assets, net
69,642

 
75,020

Other assets
129,302

 
74,108

Total assets
$
11,740,285

 
$
11,871,317

LIABILITIES
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
3,676,984

 
$
3,657,817

Interest-bearing transaction and savings accounts
4,535,969

 
4,498,966

Interest-bearing certificates
1,163,276

 
1,320,265

Total deposits
9,376,229

 
9,477,048

Advances from FHLB
418,000

 
540,189

Other borrowings
121,719

 
118,995

Junior subordinated debentures at fair value (issued in connection with Trust Preferred Securities)
113,917

 
114,091

Accrued expenses and other liabilities
158,669

 
102,061

Deferred compensation
40,560

 
40,338

Total liabilities
10,229,094

 
10,392,722

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, 2019 and December 31, 2018

 

Common stock and paid in capital - $0.01 par value per share, 50,000,000 shares authorized; 35,113,554 shares issued and outstanding at March 31, 2019; 35,107,839 shares issued and outstanding at December 31, 2018
1,337,592

 
1,336,030

Common stock (non-voting) and paid in capital - $0.01 par value per share, 5,000,000 shares authorized; 39,192 shares issued and outstanding at March 31, 2019; 74,933 shares issued and outstanding at December 31, 2018
794

 
1,406

Retained earnings
152,911

 
134,055

Carrying value of shares held in trust for stock-based compensation plans
(7,294
)
 
(7,289
)
Liability for common stock issued to stock related compensation plans
7,294

 
7,289

Accumulated other comprehensive loss
19,894

 
7,104

Total shareholders' equity
1,511,191

 
1,478,595

Total liabilities and shareholders' equity
$
11,740,285

 
$
11,871,317

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, 2019 and 2018
 
Three Months Ended
March 31,
 
2019

 
2018

INTEREST INCOME:
 
 
 
Loans receivable
$
115,455

 
$
94,022

Mortgage-backed securities
10,507

 
7,331

Securities and cash equivalents
4,034

 
3,467

Total interest income
129,996

 
104,820

INTEREST EXPENSE:
 
 
 
Deposits
8,643

 
3,358

FHLB advances
3,476

 
677

Other borrowings
60

 
70

Junior subordinated debentures
1,713

 
1,342

Total interest expense
13,892

 
5,447

Net interest income
116,104

 
99,373

PROVISION FOR LOAN LOSSES
2,000

 
2,000

Net interest income after provision for loan losses
114,104

 
97,373

NON-INTEREST INCOME:
 
 
 
Deposit fees and other service charges
12,618

 
11,296

Mortgage banking operations
3,415

 
4,864

Bank-owned life insurance (BOLI)
1,276

 
853

Miscellaneous
804

 
1,037

 
18,113

 
18,050

Net gain on sale of securities
1

 
4

Net change in valuation of financial instruments carried at fair value
11

 
3,308

Total non-interest income
18,125

 
21,362

NON-INTEREST EXPENSE:
 
 
 
Salary and employee benefits
54,640

 
50,067

Less capitalized loan origination costs
(4,849
)
 
(4,011
)
Occupancy and equipment
13,766

 
11,766

Information/computer data services
5,326

 
4,381

Payment and card processing expenses
3,984

 
3,700

Professional and legal expenses
2,434

 
4,428

Advertising and marketing
1,529

 
1,830

Deposit insurance
1,418

 
1,341

State/municipal business and use taxes
945

 
713

REO operations
(123
)
 
439

Amortization of core deposit intangibles
2,052

 
1,382

Miscellaneous
6,744

 
5,670

 
87,866

 
81,706

Acquisition-related expenses
2,148

 

Total non-interest expense
90,014

 
81,706

Income before provision for income taxes
42,215

 
37,029

PROVISION FOR INCOME TAXES
8,869

 
8,239

NET INCOME
$
33,346

 
$
28,790

Earnings per common share:
 
 
 
Basic
$
0.95

 
$
0.89

Diluted
$
0.95

 
$
0.89

Cumulative dividends declared per common share
$
0.41

 
$
0.35

Weighted average number of common shares outstanding:
 
 
 
Basic
35,050,376

 
32,397,568

Diluted
35,172,056

 
32,516,456

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, 2019 and 2018

 
Three Months Ended
March 31,
 
2019

 
2018

NET INCOME
$
33,346

 
$
28,790

OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES:
 
 
 
Unrealized holding gain (loss) on available-for-sale securities arising during the period
16,656

 
(14,768
)
Reclassification for net gains on available-for-sale securities realized in earnings
(1
)
 
(2
)
Changes in fair value of junior subordinated debentures related to instrument specific credit risk
174

 
(13,809
)
Income tax related to other comprehensive income (loss)
(4,039
)
 
6,802

Other comprehensive income (loss)
12,790

 
(21,777
)
COMPREHENSIVE INCOME
$
46,136

 
$
7,013


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, 2019 and the Year Ended December 31, 2018

 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive (Loss) Income
 
Shareholders’
Equity
 
Shares
 
Amount
 
 
 
Balance, January 1, 2018
32,726,485

 
$
1,187,127

 
$
90,535

 
$
(5,036
)
 
$
1,272,626

 
 
 
 
 
 
 
 
 
 
Cumulative effect of reclassification of the instrument-specific credit risk portion of junior subordinated debentures fair value adjustments and reclassification of equity securities from available-for-sale
 
 
 
 
(28,203
)
 
28,203

 

Net income
 
 
 
 
28,790

 
 
 
28,790

Other comprehensive loss, net of income tax
 
 
 
 
 
 
(21,777
)
 
(21,777
)
Repurchase of common stock
(269,711
)
 
(15,359
)
 
 
 
 
 
(15,359
)
Accrual of dividends on common stock ($0.35/share)
 
 
 
 
(11,349
)
 
 
 
(11,349
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(33,101
)
 
1,192

 
 
 
 
 
1,192

 
 
 
 
 
 
 
 
 
 
Balance, March 31, 2018
32,423,673

 
$
1,172,960

 
$
79,773

 
$
1,390

 
$
1,254,123


Balance, April 1, 2018
32,423,673

 
$
1,172,960

 
$
79,773

 
$
1,390

 
$
1,254,123

 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
32,424

 
 
 
32,424

Other comprehensive loss, net of income tax
 
 
 
 
 
 
(6,521
)
 
(6,521
)
Accrual of dividends on common stock ($0.85/share)
 
 
 
 
(27,712
)
 
 
 
(27,712
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(17,977
)
 
696

 
 
 
 
 
696

 
 
 
 
 
 
 
 
 
 
Balance, June 30, 2018
32,405,696

 
$
1,173,656

 
$
84,485

 
$
(5,131
)
 
$
1,253,010


Continued on next page


7





 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive (Loss) Income
 
Shareholders’
Equity
 
Shares
 
Amount
 
 
 
Balance, July 1, 2018
32,405,696

 
$
1,173,656

 
$
84,485

 
$
(5,131
)
 
$
1,253,010

 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
37,773

 
 
 
37,773

Other comprehensive loss, net of income tax
 
 
 
 
 
 
(7,863
)
 
(7,863
)
Accrual of dividends on common stock ($0.38/share)
 
 
 
 
(12,316
)
 
 
 
(12,316
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(2,939
)
 
1,594

 
 
 
 
 
1,594

 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2018
32,402,757

 
$
1,175,250

 
$
109,942

 
$
(12,994
)
 
$
1,272,198


Balance, October 1, 2018
32,402,757

 
$
1,175,250

 
$
109,942

 
$
(12,994
)
 
$
1,272,198

 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
37,527

 
 
 
37,527

Other comprehensive income, net of income tax
 
 
 
 
 
 
20,098

 
20,098

Accrual of dividends on common stock ($0.38/share)
 
 
 
 
(13,414
)
 
 
 
(13,414
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(3,056
)
 
1,519

 
 
 
 
 
1,519

Repurchase of common stock
(325,000
)
 
(19,042
)
 
 
 
 
 
(19,042
)
Business acquisition
3,108,071

 
179,709

 
 
 
 
 
179,709

 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2018
35,182,772

 
$
1,337,436

 
$
134,055

 
$
7,104

 
$
1,478,595


Continued on next page





8






 
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



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, 2019 and 2018
 
Three Months Ended
March 31,
 
2019

 
2018

OPERATING ACTIVITIES:
 
 
 
Net income
$
33,346

 
$
28,790

Adjustments to reconcile net income to net cash provided from operating activities:
 
 
 
Depreciation
4,481

 
3,584

Deferred income and expense, net of amortization
(895
)
 
(608
)
Amortization of core deposit intangibles
2,052

 
1,382

Gain on sale of securities
(1
)
 
(4
)
Net change in valuation of financial instruments carried at fair value
(11
)
 
(3,308
)
Decrease (increase) in deferred taxes
5,379

 
(5,416
)
Increase in current taxes payable
7,243

 
6,569

Stock-based compensation
1,219

 
1,320

Increase in cash surrender value of BOLI
(1,267
)
 
(844
)
Gain on sale of loans, net of capitalized servicing rights
(2,063
)
 
(3,375
)
Loss on disposal of real estate held for sale and property and equipment
371

 
58

Provision for loan losses
2,000

 
2,000

Provision for losses on real estate held for sale

 
160

Origination of loans held for sale
(134,747
)
 
(222,168
)
Proceeds from sales of loans held for sale
261,978

 
124,460

Net change in:
 
 
 
Other assets
(984
)
 
(5,100
)
Other liabilities
(12,847
)
 
(2,311
)
Net cash provided from (used in) operating activities
165,254

 
(74,811
)
INVESTING ACTIVITIES:
 
 
 
Purchases of securities—available-for-sale
(5,140
)
 
(537,864
)
Principal repayments and maturities of securities—available-for-sale
51,910

 
28,839

Proceeds from sales of securities—available-for-sale
516

 

Purchases of securitiesheld-to-maturity

 
(5,312
)
Principal repayments and maturities of securities—held-to-maturity
14,744

 
2,358

Loan originations, net of principal repayments
(8,988
)
 
45,574

Purchases of loans and participating interest in loans

 
(1,340
)
Proceeds from sales of other loans
3,186

 
1,750

Purchases of property and equipment
(4,435
)
 
(5,024
)
Proceeds from sale of real estate held for sale and sale of other property, net
876

 
192

Proceeds from FHLB stock repurchase program
52,372

 
32,558

Purchase of FHLB stock
(47,480
)
 
(40,260
)
Other
485

 
228

Net cash provided from (used in) investing activities
58,046

 
(478,301
)
FINANCING ACTIVITIES:
 
 
 
(Decrease) increase in deposits, net
(100,819
)
 
359,631

Proceeds from long term FHLB advances
300,000

 

Repayment of long term FHLB advances
(189
)
 
(2
)
(Repayment) proceeds from overnight and short term FHLB advances, net
(422,000
)
 
192,000

Increase in other borrowings, net
2,724

 
5,984

Cash dividends paid
(13,405
)
 
(8,165
)
Taxes paid related to net share settlement of equity awards
(269
)
 
(129
)
Cash paid for the repurchase of common stock

 
(15,359
)
Net cash (used in) provided from financing activities
(233,958
)
 
533,960

NET CHANGE IN CASH AND CASH EQUIVALENTS
(10,658
)
 
(19,152
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
272,196

 
261,200

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
261,538

 
$
242,048




10


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited) (In thousands)
For the Three Months Ended March 31, 2019 and 2018
 
Three Months Ended
March 31,
 
2019

 
2018

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Interest paid in cash
$
13,812

 
$
5,185

Tax refunds received, net
(71
)
 
(3
)
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

 
976

    Dividends accrued but not paid until after period end
14,863

 
11,450


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, 2019 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 2018 Consolidated Financial Statements and/or schedules to conform to the 2019 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 loan losses, (iii) the valuation of financial assets and liabilities recorded at fair value, including other-than-temporary impairment (OTTI) losses, (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, 2018 filed with the SEC (2018 Form 10-K).  There have been no significant changes in our application of these accounting policies during the first three months of 2019, except as described in Note 2.

The information included in this Form 10-Q should be read in conjunction with our 2018 Form 10-K.  Interim results are not necessarily indicative of results for a full year or any other interim period.

Note 2:  ACCOUNTING STANDARDS RECENTLY ISSUED OR ADOPTED

Leases (Topic 842)

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). The amendments in this ASU require lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date; a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. In July 2018, FASB issued ASU No. 2018-11, Targeted Improvements. The amendments in this ASU provide entities with an additional (and optional) transition method to adopt the new leases standard. The Company adopted the requirements of Topic 842 effective January 1, 2019. The Company elected the transition option provided in ASU No. 2018-11 and applied the modified retrospective approach for leases that existed as of January 1, 2019, or were entered into thereafter.  The Company elected certain relief options for practical expedients: the option to not separate lease and non-lease components and instead to account for them as a single lease component, and the option to not recognize right-of-use assets and lease liabilities that arise from short-term leases (i.e. lease terms of twelve months or less). In addition, the Company elected the package of practical expedients in transition, which permitted us to not reassess our prior conclusions pertaining to lease identification, lease classification, and initial direct costs on leases that commenced prior to our adoption of the new standard. In connection with the adoption of this ASU, as of January 1, 2019, the Company recorded a $56 million right-of-use asset and a $59 million lease liability on its Consolidated Statements of Financial Condition.
 

12


Financial Instruments—Credit Losses (Topic 326)

In June 2016, FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. 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 current GAAP with 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 will be 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. This ASU will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is still evaluating the effects this ASU will have on the Company’s Consolidated Financial Statements. The Company has formed an internal committee to oversee the project, engaged a third-party vendor to assist with the project and has completed its gap analysis phase of the project. In addition, the Company has selected a second third-party vendor to assist with building and developing the required models and has completed the initial build out of the required models. The Company has also selected a different third party to provide a reasonable and supportable forecast. Next the Company will begin to incorporate the reasonable and supportable forecast and qualitative factors into the models. Upon adoption, the Company expects changes in the processes and procedures used to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. The new guidance may result in an increase in the allowance for loan losses which will also reflect the new requirement to include the nonaccretable principal differences on purchased credit-impaired loans; however, the Company is still in the process of determining the magnitude of the change and its impact on the Consolidated Financial Statements. In addition, the current accounting policy and procedures for other-than-temporary impairment on investment securities available-for-sale will be replaced with an allowance approach.

Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20)

In March 2017, FASB issued ASU No. 2017-08, Premium Amortization on Purchased Callable Debt Securities. The amendments in this ASU shorten the premium amortization period for callable debt securities purchased at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. Under current GAAP, premiums and discounts on callable debt securities generally are amortized to the maturity date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to the maturity date. The amendments in this ASU more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company adopted this ASU effective January 1, 2019. The adoption of this ASU has not had a material impact on the Company’s Consolidated Financial Statements.

Derivatives and Hedging (Topic 815)

In August 2017, FASB issued ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities. The amendments in this ASU are intended to provide investors better insight into an entity's risk management hedging strategies by permitting a company to recognize the economic results of its hedging strategies in its financial statements. The amendments in this ASU permit hedge accounting for hedging relationships involving nonfinancial risk and interest rate risk by removing certain limitations in cash flow and fair value hedging relationships. In addition, the ASU requires an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. This ASU is effective for fiscal years beginning after December 15, 2018. Adoption of ASU 2017-12 did not have a material impact on the Company's Consolidated Financial Statements.

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

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. This ASU is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The amendments in this ASU should be applied either retrospectively to all implementation costs incurred after the date of adoption. Adoption of ASU 2018-15 is not expected to have a material impact on the Company’s Consolidated Financial Statements.


13


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 amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. Adoption of ASU 2018-13 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

NOTE 3: BUSINESS COMBINATION
Acquisition of Skagit Bancorp, Inc.
Effective as of the close of business on November 1, 2018, the Company acquired 100% of the outstanding common shares of Skagit Bancorp, Inc. (“Skagit”) and its wholly-owned subsidiary, Skagit Bank, a Washington State chartered commercial bank headquartered in Burlington, Washington, with 11 branches serving markets along the I-5 corridor from Seattle to the Canadian border. On that date, Skagit merged with and into Banner and Skagit Bank merged with and into Banner Bank. Pursuant to the previously announced terms of the merger, the equity holders of Skagit received an aggregate of 3.1 million shares of Banner voting common stock, plus cash in lieu of fractional shares and to cancel Skagit stock options for total consideration paid of $180.0 million. The acquisition provided $915.8 million in assets, $810.2 million in deposits and $632.4 million in loans to Banner.
The application of the acquisition method of accounting resulted in recognition of a CDI asset of $16.4 million and goodwill of $96.5 million. The acquired CDI has been determined to have a useful life of approximately nine 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.

14


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):
 
Skagit
 
November 1, 2018
Consideration to Skagit equity holders:
 
 
Cash paid
 
$
329

Fair value of common shares issued
 
179,709

Total consideration
 
$
180,038

 
 
 
Fair value of assets acquired:
 
 
Cash and cash equivalents
$
19,167

 
Securities
210,326

 
Loans receivable (contractual amount of $645.6 million)
632,374

 
Real estate owned held for sale
2,593

 
Property and equipment
15,788

 
Core deposit intangible
16,368

 
Deferred tax asset
95

 
Other assets
19,110

 
Total assets acquired
915,821

 
 
 
 
Fair value of liabilities assumed:
 
 
Deposits
810,209

 
Other liabilities
22,069

 
Total liabilities assumed
832,278

 
 
 
 
Net assets acquired
 
83,543

Goodwill
 
$
96,495

Acquired goodwill represents the premium the Company paid over the fair value of the net tangible and intangible assets acquired. The primary reason for the acquisition was to expand the Company’s presence and density in the North Sound region of the Pacific Northwest along the I-5 corridor. 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, 2018, the unpaid principal balance on purchased non-credit-impaired loans was $637.4 million. The fair value of the purchased non-credit-impaired loans was $625.2 million, resulting in a discount of $12.2 million recorded on these loans, which includes $7.9 million of a credit related discount. This discount is being accreted into income over the life of the loans on an effective yield basis.

15


The following table presents the acquired PCI loans as of the acquisition date (in thousands):
 
Skagit
 
November 1, 2018
Acquired PCI loans:
 
Contractually required principal and interest payments
$
9,897

Nonaccretable difference
(1,915
)
Cash flows expected to be collected
7,982

Accretable yield
(995
)
Fair value of PCI loans
$
6,987

The operating results of the Company include the operating results produced by the acquired assets and assumed liabilities of Skagit for the period since November 2, 2018. Disclosure of the amount of Skagit’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 Skagit acquisition to the historical financial results was determined to not be significant.

Note 4:  SECURITIES

The amortized cost, gross unrealized gains and losses and estimated fair value of securities at March 31, 2019 and December 31, 2018 are summarized as follows (in thousands):
 
March 31, 2019
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair
Value
Trading:
 
 
 
 
 
 
 
Corporate bonds
$
27,203

 
 
 
 
 
$
25,838

 
$
27,203

 
 
 
 
 
$
25,838

Available-for-Sale:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
139,621

 
$
134

 
$
(1,440
)
 
$
138,315

Municipal bonds
116,954

 
3,288

 
(187
)
 
120,055

Corporate bonds
4,057

 
4

 
(17
)
 
4,044

Mortgage-backed or related securities
1,320,826

 
10,952

 
(8,201
)
 
1,323,577

Asset-backed securities
17,889

 
5

 
(81
)
 
17,813

 
$
1,599,347

 
$
14,383

 
$
(9,926
)
 
$
1,603,804

Held-to-Maturity:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
389

 
$
3

 
$

 
$
392

Municipal bonds
163,614

 
2,527

 
(1,248
)
 
164,893

Corporate bonds
3,701

 

 
(13
)
 
3,688

Mortgage-backed or related securities
51,289

 
151

 
(301
)
 
51,139

 
$
218,993

 
$
2,681

 
$
(1,562
)
 
$
220,112


16




 
December 31, 2018
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair
Value
Trading:
 
 
 
 
 
 
 
Corporate bonds
$
27,203

 
 
 
 
 
$
25,896

 
$
27,203

 
 
 
 
 
$
25,896

Available-for-Sale:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
151,012

 
$
149

 
$
(2,049
)
 
$
149,112

Municipal bonds
116,548

 
1,806

 
(532
)
 
117,822

Corporate bonds
3,556

 

 
(61
)
 
3,495

Mortgage-backed or related securities
1,355,258

 
5,210

 
(16,607
)
 
1,343,861

Asset-backed securities
22,047

 
6

 
(120
)
 
21,933

 
$
1,648,421

 
$
7,171

 
$
(19,369
)
 
$
1,636,223

Held-to-Maturity:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
1,006

 
$
14

 
$
(1
)
 
$
1,019

Municipal bonds
176,663

 
1,727

 
(2,578
)
 
175,812

Corporate bonds
3,736

 

 
(13
)
 
3,723

Mortgage-backed or related securities
52,815

 
66

 
(898
)
 
51,983

 
$
234,220

 
$
1,807

 
$
(3,490
)
 
$
232,537



17


At March 31, 2019 and December 31, 2018, 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):
 
March 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
$
713

 
$
(4
)
 
$
120,227

 
$
(1,436
)
 
$
120,940

 
$
(1,440
)
Municipal bonds
753

 
(3
)
 
23,686

 
(184
)
 
24,439

 
(187
)
Corporate bonds
2,344

 
(14
)
 
297

 
(3
)
 
2,641

 
(17
)
Mortgage-backed or related securities
42,354

 
(203
)
 
608,455

 
(7,998
)
 
650,809

 
(8,201
)
Asset-backed securities
6,861

 
(32
)
 
9,956

 
(49
)
 
16,817

 
(81
)
 
$
53,025

 
$
(256
)
 
$
762,621

 
$
(9,670
)
 
$
815,646

 
$
(9,926
)
Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$
915

 
$
(1
)
 
$
42,524

 
$
(1,247
)
 
$
43,439

 
$
(1,248
)
Corporate bonds

 

 
488

 
(13
)
 
488

 
(13
)
Mortgage-backed or related securities
1,037

 
(7
)
 
32,991

 
(294
)
 
34,028

 
(301
)
 
$
1,952

 
$
(8
)
 
$
76,003

 
$
(1,554
)
 
$
77,955

 
$
(1,562
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
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
$
75,885

 
$
(1,240
)
 
$
50,508

 
$
(809
)
 
$
126,393

 
$
(2,049
)
Municipal bonds
6,422

 
(54
)
 
27,231

 
(478
)
 
33,653

 
(532
)
Corporate bonds
3,199

 
(56
)
 
295

 
(5
)
 
3,494

 
(61
)
Mortgage-backed or related securities
316,074

 
(2,939
)
 
571,989

 
(13,668
)
 
888,063

 
(16,607
)
Asset-backed securities
10,582

 
(24
)
 
9,913

 
(96
)
 
20,495

 
(120
)
 
$
412,162

 
$
(4,313
)
 
$
659,936

 
$
(15,056
)
 
$
1,072,098

 
$
(19,369
)
Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
145

 
$
(1
)
 
$

 
$

 
$
145

 
$
(1
)
Municipal bonds
29,898

 
(274
)
 
44,637

 
(2,304
)
 
74,535

 
(2,578
)
Corporate bonds

 

 
487

 
(13
)
 
487

 
(13
)
Mortgage-backed or related securities
10,761

 
(220
)
 
30,035

 
(678
)
 
40,796

 
(898
)
 
$
40,804

 
$
(495
)
 
$
75,159

 
$
(2,995
)
 
$
115,963

 
$
(3,490
)

At March 31, 2019, there were 233 securities—available-for-sale with unrealized losses, compared to 271 at December 31, 2018.  At March 31, 2019, there were 49 securities—held-to-maturity with unrealized losses, compared to 90 at December 31, 2018.  Management does not believe that any individual unrealized loss as of March 31, 2019 or December 31, 2018 represented other-than-temporary impairment (OTTI).  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-month periods ended March 31, 2019 or 2018. The Company did not recognize any OTTI charges or recoveries on securities—trading during the three-month periods ended March 31, 2019 or 2018. There were no securities—trading in a nonaccrual status at March 31, 2019 or December 31, 2018.  Net unrealized holding losses of $58,000 were recognized during the three months ended March 31, 2019 compared to $3.4 million of net unrealized holdings gains recognized during the three months ended March 31, 2018.

There was one sale of securities—available-for-sale during the three months ended March 31, 2019, with a net gain of $1,000.  There were no sales of securities—available-for-sale during the three months ended March 31, 2018, although partial calls of securities resulted in a net gain

18


of $4,000 for the three months ended March 31, 2018. There were no securities—available-for-sale in a nonaccrual status at March 31, 2019 or December 31, 2018.

There were no sales of securities—held-to-maturity during the three-month periods ended March 31, 2019 and 2018. There were no securities—held-to-maturity in a nonaccrual status at March 31, 2019 or December 31, 2018.

The amortized cost and estimated fair value of securities at March 31, 2019, 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, 2019
 
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
$

 
$

 
$
6,520

 
$
6,514

 
$
2,869

 
$
2,865

Maturing after one year through five years

 

 
86,092

 
86,474

 
61,698

 
61,839

Maturing after five years through ten years

 

 
382,934

 
386,318

 
57,947

 
58,934

Maturing after ten years through twenty years
27,203

 
25,838

 
198,705

 
201,247

 
62,540

 
63,667

Maturing after twenty years

 

 
925,096

 
923,251

 
33,939

 
32,807

 
$
27,203

 
$
25,838

 
$
1,599,347

 
$
1,603,804

 
$
218,993

 
$
220,112


The following table presents, as of March 31, 2019, investment securities which were pledged to secure borrowings, public deposits or other obligations as permitted or required by law (in thousands):
 
March 31, 2019
 
Carrying Value
 
Amortized Cost
 
Fair
Value
Purpose or beneficiary:
 
 
 
 
 
State and local governments public deposits
$
149,193

 
$
149,306

 
$
150,815

Interest rate swap counterparties
10,835

 
10,931

 
10,895

Repurchase agreements
150,783

 
150,027

 
150,783

Other
2,739

 
2,739

 
2,678

Total pledged securities
$
313,550

 
$
313,003

 
$
315,171



19


Note 5: LOANS RECEIVABLE AND THE ALLOWANCE FOR LOAN LOSSES

Loans receivable at March 31, 2019 and December 31, 2018 are summarized as follows (dollars in thousands):
 
March 31, 2019
 
December 31, 2018
 
Amount
 
Percent of Total
 
Amount
 
Percent of Total
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
1,442,724

 
16.6
%
 
$
1,430,097

 
16.4
%
Investment properties
2,124,049

 
24.4

 
2,131,059

 
24.5

Multifamily real estate
387,142

 
4.5

 
368,836

 
4.2

Commercial construction
181,888

 
2.1

 
172,410

 
2.0

Multifamily construction
183,203

 
2.1

 
184,630

 
2.1

One- to four-family construction
514,468

 
5.9

 
534,678

 
6.2

Land and land development:
 

 
 
 
 

 
 
Residential
187,660

 
2.2

 
188,508

 
2.2

Commercial
28,928

 
0.3

 
27,278

 
0.3

Commercial business
1,524,298

 
17.5

 
1,483,614

 
17.1

Agricultural business, including secured by farmland
373,322

 
4.3

 
404,873

 
4.7

One- to four-family residential
967,581

 
11.1

 
973,616

 
11.2

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
564,872

 
6.5

 
568,979

 
6.6

Consumer—other
212,522

 
2.5

 
216,017

 
2.5

Total loans
8,692,657

 
100.0
%
 
8,684,595

 
100.0
%
Less allowance for loan losses
(97,308
)
 
 

 
(96,485
)
 
 

Net loans
$
8,595,349

 
 

 
$
8,588,110

 
 


Loan amounts are net of unearned loan fees in excess of unamortized costs of $724,000 as of March 31, 2019 and $1.4 million as of December 31, 2018. Net loans include net discounts on acquired loans of $24.2 million and $25.7 million as of March 31, 2019 and December 31, 2018, respectively.

Purchased credit-impaired loans and purchased non-credit-impaired loans. Purchased loans, including loans acquired in business combinations, are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased credit-impaired (PCI) or purchased non-credit-impaired. PCI loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments. The outstanding contractual unpaid principal balance of PCI loans, excluding acquisition accounting adjustments, was $20.7 million at March 31, 2019 and $22.0 million at December 31, 2018. The carrying balance of PCI loans was $13.3 million at March 31, 2019 and $14.4 million at December 31, 2018.
The following table presents the changes in the accretable yield for PCI loans for the three months ended March 31, 2019 and 2018 (in thousands):
 
Three Months Ended
March 31,
 
2019
 
2018
Balance, beginning of period
$
5,216

 
$
6,520

Accretion to interest income
(493
)
 
(1,097
)
Disposals

 
58

Reclassifications from non-accretable difference
55

 
807

Balance, end of period
$
4,778

 
$
6,288


As of March 31, 2019 and December 31, 2018, the non-accretable difference between the contractually required payments and cash flows expected to be collected was $6.5 million and $7.1 million, respectively.

Impaired Loans and the Allowance for Loan Losses.  A loan is considered impaired when, based on current information and circumstances, the Company determines it is probable that it will 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 include, but are not limited to, the financial condition of the borrower, the value of the underlying collateral and the current status of the economy. Impaired loans are comprised of loans on nonaccrual,

20


troubled debt restructurings (TDRs) that are performing under their restructured terms, and loans that are 90 days or more past due, but are still on accrual. PCI loans are considered performing within the scope of the purchased credit-impaired accounting guidance and are not included in the impaired loan tables.

The following tables provide information on impaired loans, excluding PCI loans, with and without allowance reserves at March 31, 2019 and December 31, 2018. Recorded investment includes the unpaid principal balance or the carrying amount of loans less charge-offs and net deferred loan fees (in thousands):
 
March 31, 2019
 
Unpaid Principal Balance
 
Recorded Investment
 
Related Allowance
 
 
Without Allowance (1)
 
With Allowance (2)
 
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
3,771

 
$
3,345

 
$
200

 
$
21

Investment properties
8,624

 
2,388

 
5,574

 
219

Multifamily construction
1,901

 
1,427

 

 

One- to four-family construction
919

 
919

 

 

Land and land development:
 
 
 
 
 
 
 
Residential
1,026

 
690

 

 

Commercial business
4,948

 
3,615

 
393

 
12

Agricultural business/farmland
5,619

 
2,507

 
2,561

 
66

One- to four-family residential
6,335

 
3,961

 
2,333

 
59

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
2,130

 
1,948

 
132

 
5

Consumer—other
345

 
275

 
61

 
3

 
$
35,618

 
$
21,075

 
$
11,254

 
$
385

 
 
 
 
 
 
 
 
 
December 31, 2018
 
Unpaid Principal Balance
 
Recorded Investment
 
Related Allowance
 
 
Without Allowance (1)
 
With Allowance (2)
 
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
3,193

 
$
2,768

 
$
200

 
$
19

Investment properties
7,287

 
1,320

 
5,606

 
226

Multifamily real estate
1,901

 
1,427

 

 

One- to four-family construction
919

 
919

 

 

Land and land development:
 
 
 
 
 
 
 
Residential
1,134

 
798

 

 

Commercial
44

 
44

 

 

Commercial business
4,014

 
2,937

 
391

 
16

Agricultural business/farmland
4,863

 
1,751

 
2,561

 
96

One- to four-family residential
6,724

 
4,314

 
2,358

 
51

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
1,622

 
1,438

 
133

 
6

Consumer—other
112

 
49

 
62

 
2

 
$
31,813

 
$
17,765

 
$
11,311

 
$
416


(1) 
Includes loans without an allowance reserve that have been individually evaluated for impairment and that evaluation concluded that no reserve was needed, and $10.6 million and $9.0 million, respectively, of homogenous and small balance loans as of March 31, 2019 and December 31, 2018, that are collectively evaluated for impairment for which a general reserve has been established.
(2) 
Loans with a specific allowance reserve have been 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.

21



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 and 2018 (in thousands):
 
Three Months Ended
March 31, 2019
 
Three Months Ended
March 31, 2018
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
3,451

 
$
2

 
$
5,383

 
$
3

Investment properties
7,227

 
76

 
9,972

 
83

Commercial construction
1,427

 

 

 

One- to four-family construction
919

 

 
605

 
4

Land and land development:
 
 
 
 
 
 
 
Residential
726

 

 
798

 

Commercial business
3,803

 
5

 
4,007

 
7

Agricultural business/farmland
5,117

 
27

 
9,109

 
33

One- to four-family residential
6,446

 
65

 
8,892

 
101

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

 
5

 
1,390

 
2

Consumer—other
319

 
1

 
149

 
1

 
$
31,498

 
$
181

 
$
40,305

 
$
234


Troubled Debt Restructurings. Some of the Company’s loans are reported as TDRs.  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.  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.  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 a result of these concessions, restructured loans are impaired as the Company will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement.  Loans identified as TDRs are accounted for in accordance with the Company's impaired loan accounting policies.

The following table presents TDRs by accrual and nonaccrual status at March 31, 2019 and December 31, 2018 (in thousands):
 
March 31, 2019
 
December 31, 2018
 
Accrual
Status
 
Nonaccrual
Status
 
Total
TDRs
 
Accrual
Status
 
Nonaccrual
Status
 
Total
TDRs
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
200

 
$
76

 
$
276

 
$
200

 
$
78

 
$
278

Investment properties
5,574

 
1,090

 
6,664

 
5,606

 

 
5,606

Commercial business
392

 

 
392

 
391

 

 
391

Agricultural business, including secured by farmland
2,561

 

 
2,561

 
2,561

 

 
2,561

One- to four-family residential
4,116

 
239

 
4,355

 
4,469

 
239

 
4,708

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Consumer secured by one- to four-family
132

 

 
132

 
133

 

 
133

Consumer—other
61

 

 
61

 
62

 

 
62

 
$
13,036

 
$
1,405

 
$
14,441

 
$
13,422

 
$
317

 
$
13,739



As of March 31, 2019 and December 31, 2018, the Company had commitments to advance additional funds related to TDRs up to $49,000 and none, respectively.


22


One new TDR occurred during the three months ended March 31, 2019 and none during the three months ended March 31, 2018 (dollars in thousands):
 
Three Months Ended March 31, 2019
 
Three Months Ended March 31, 2018
 
Number of
Contracts
 
Pre-modification Outstanding
Recorded Investment
 
Post-modification Outstanding
Recorded Investment
 
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

 


 
$

 
$

Total
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, 2019 and 2018. A default on a TDR results in either a transfer to nonaccrual status or a partial charge-off, or both.

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 and leases 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.  There were no material changes in the risk-rating or loan grading system in the three months ended March 31, 2019.

Risk Rating 1: Exceptional
A credit supported by exceptional financial strength, stability, and liquidity.  The risk rating of 1 is reserved for the Company’s top quality loans, generally reserved for investment grade credits underwritten to the standards of institutional credit providers.

Risk Rating 2: Excellent
A credit supported by excellent financial strength, stability and liquidity.  The risk rating of 2 is reserved for very strong and highly stable customers with ready access to alternative financing sources.

Risk Rating 3: Strong
A credit supported by good overall financial strength and stability.  Collateral margins are strong; cash flow is stable although susceptible to cyclical market changes.

Risk Rating 4: Acceptable
A credit supported by the borrower’s adequate financial strength and stability.  Assets and cash flow are reasonably sound and provide for orderly debt reduction.  Access to alternative financing sources will be more difficult to obtain.

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