Thanks. Good morning, everybody. We are pleased to continue the morning with Columbia Banking System, Inc. We have Clint Stein, the Chairman, President, and CEO, and Ivan Seda, the CFO, joining us today. Thanks a lot for coming all the way in from the West Coast.
Thanks for having us.
Maybe starting off, we are now well into the third quarter. How would you characterize the operating environment today relative to where things stood at the end of July? When you think about customer activity, pipelines, sentiment, competitive behavior, what has gotten better, what has gotten tougher? I guess what surprised you the most?
There is a lot of different aspects to that question. I think from my perspective, not much has changed in terms of our pipelines are pretty much where they were in July. Customers are still moving forward with their projects and activities and investments. Competition, it started really picking up in the second quarter on the deposit side. Then some, what I characterized in the second quarter as borderline irrational things on the loan side. We still see that. There is still a big push for folks that are just trying to grow totals on their balance sheet. But so far, our bankers have done a great job of navigating that. Part of that is the markets that we are in, our positioning within that market.
I guess if I just had to sum up the third quarter, I would say it's just been a continuation of the second quarter.
You just described parts of the market as irrational and increasingly competitive. I guess where is that showing up in loans and deposits? More specifically, and how are you deciding when to compete aggressively versus when to step away?
We see it on the loan side. We see it in both pricing and structure. Oftentimes we can compete on the pricing element. We're not going to relax our underwriting standards and give on structure. Our value proposition isn't to be the low-cost provider or a max proceeds lender. We work really hard, and have for many years, to be a trusted advisor. With that, we expect to get paid for that. That comes with a premium price. From that perspective, if we're going to compete and get a little more aggressive on pricing, we really look at the entire relationship. What's the profitability of it? What are the offsetting elements of it? Do they have significant non-interest-bearing deposits with us? Do we have their treasury management, their corporate card? Do we have a wealth relationship with the owners or executives?
All of those things, and it's really kind of on a loan-by-loan, customer-by-customer basis that we'll make that determination as to if we want to compete or if we want to walk away. For new relationships, it's a higher bar because you don't already have all of those things. That's typically where we'll just step back and say, "Come see us when the market's more rational." The deposit side, it's more excess liquidity that people are chasing yield. For that, the way I look at it, and Ivan Seda might feel differently, is: what's our alternative? We're not going to pay more or risk cannibalizing the pricing of our entire deposit portfolio if we can just simply go and replace some of that funding at the Federal Home Loan Bank.
Yeah, I would agree with that. I think on the deposit side, the tide shifted in Q2 from my perspective, from an environment where I think if you go back six months, I think there was expectations that rates would continue to decline. That was what was originally within our plan at the beginning of the year. You go back to six months ago, I think it was kind of like a slack tide, is what I would call it. Then you started to see, I think in Q2, an expectation for we'll see what happens tomorrow, but rising interest rates. That's put pressure on funding costs across the entirety of the industry. We see it in our marginal funding costs, and I think what that's required is for us to be very surgical in terms of how we decide to price deposits.
We price in particular CDs, money market. The benefit that we have, I think, and what you saw from us in Q2 was a continued decrease in the cost of interest-bearing deposits. I think we've signaled that'll be hard to replicate. In Q3, I think that if anything, we'll probably be flat or potentially up a little bit because we've had to really be thoughtful around where you place deposit pricing so that our bankers are out there competing for deposits, and we're not tying both hands behind their backs. But at the same time, making sure that we're not making irrational pricing decisions that are going to be a drag on that net interest margin. So it's required a really thoughtful surgical approach to that.
Right. There's several transactions and leadership changes have occurred across California and other Western markets over the last year. How much opportunity do periods of disruption create for Columbia, and where are you seeing the greatest ability to win customers, recruit talent, or gain market share?
Yeah. Specific to California, that was one of the appealing things for us. One of many appealing things for us with the PacPremier acquisition was what it did for us in Southern California and the fact that that market is fragmented. There's not a clear dominant bank in there. We've seen opportunities from some of the acquisitions that have happened over the past, call it three to five years, attracted some great talent in that market that has really built some nice portfolios on both sides of the balance sheet. We see it really throughout our entire footprint in terms of our ability to just be in a space that's different. We're kind of in a sweet spot when you just think about our market position. The money center banks don't always want to come down to the level that our business customers are at.
The smaller banks, they don't have the balance sheet or the products, or both, to serve those customers. There's only four of us west of the Rockies that are between that $50 billion and $100 billion mark. Two of them have very different business models from us. That's appealing to customers. It's appealing to talent. When I think about our expansion markets of Colorado, Utah, Arizona, the folks that have joined us in those markets are phenomenal. Our legacy markets in the Northwest, likewise, we've attracted talent from; you could pretty much name any top 10 bank, and we've hired great performers that do really well in our system. Super excited about what we're seeing on the talent front. We don't take it for granted. I've said before that our people used to always get recruited by smaller banks.
Now we see some of our junior bankers and others that are getting recruited by the large banks as well. Part of that's our market position; part of it's the kind of people that we have. We haven't lost any of what I consider our top talent to anybody either upstream or downstream. That's been helpful. It's also opened up doors in terms of bringing new customers into the bank.
With that backdrop, does that help accelerate that full relationship banking model? Are you seeing sort of a better uptick in some of those new expansion markets that you've talked about, or when you're bringing in a new experienced banker?
Oh, absolutely. Especially the ones that are coming from the bigger banks because they're used to having a lot of different products and services and bringing the full assortment of those to the customer and really kind of wrapping their arms around that relationship, and they're not shy about asking for it. That's where we've seen them be really successful, and we're not lacking for any products. Technology, we're never going to be on the cutting edge, but all of our tech platforms are contemporary. The bankers know they can go in and compete, and they do with anybody. That's helped in terms of kind of upskilling even some of our folks that have been with us for a long time, and now they see new people come in, a different way of doing it.
It causes everybody to just kind of step up their game.
Great. Over the last year, you've made a conscious decision to shrink lower- return assets while improving profitability. Where would you say Columbia is today in that balance sheet optimization process, and how much of the benefit is still ahead of you?
I'll start, and then I'll step back, and Ivan can give you some details on the numbers. I think what we're proving now, and we'll continue to do that over the next year, is that we can have a smaller balance sheet, be more profitable, and have less risk on that balance sheet. That's why we've been remixing it and why we're committed to continuing to do so. Do you want to talk about kind of what that looks like in the coming year?
Yeah. Maybe what I'll do is I'll start kind of looking backward for a minute and then talk about kind of what that looks like going forward because I think it's insightful to kind of think about the journey we've been on. For those in the room that maybe are not as familiar with our story, I think the question is largely in relation to a component about 15% of our loan portfolio that we deem to be transactional in nature. These are credit relationships that are on our balance sheet from legacy, either Umpqua or PPBI lending, where there's really no other relationship that we have. Like I said, that represents about $7 billion of total loans, about 15%, and that's been declining at a pace of about $1 billion, just over $1 billion per year in terms of volume.
If you look back about a year ago, what that's allowed us to do is a handful of things. In the last year, we've added 20 basis points to net interest margin. We've continued to see that step by step continue to increase over time. We've taken the component of our funding that's reliant upon wholesale down by over 20% at the same period of time. We've added about 10 basis points from Q2 to Q2 in terms of the return profile on an ROAA basis. We've actually, despite putting up a very substantial share buyback program here in the last year, we've actually seen our total capital levels increase a little bit from summer of last year to summer of this year. I think that optimization has been a really positive factor in terms of the return profile of the bank. You're absolutely right.
What it's done is slightly de-leverage the bank. We've taken loans down slightly, and we've signaled for this quarter that we'll likely be flat to slightly down. As you look forward, I think the pace of continued runoff of that portfolio has been measured, which, selfishly from my perspective in terms of managing that balance sheet, I like. We've fielded questions over the last year around, "Hey, why don't you sell a component of it now, reposition your balance sheet?" For us, that doesn't make financial sense for our shareholders. Instead, what we're able to do is see that continue to measure down. Over the next year, we've got a significant portion of that $7 billion portfolio that'll either reprice or mature.
When these largely ARM products hit their repricing date, they kind of jump back to either market-rate loans and are no longer a financial drag to us, or they reprice elsewhere. Either way, we can leverage that kind of freed- up capital to reinvest. I think it's been a positive effect in terms of optimizing the earning asset side of our balance sheet, and we expect that to continue. At some point, that pace will slow down, likely kind of in Q2 of next year. We'll see the pace of kind of the repricing behaviors begin to slow down in that portfolio, and there'll be a longer tail to it over several years. But at that point, it'll be a smaller portion of our balance sheet and likely will become less of a headwind from a growth perspective.
Like I said, in the meantime, we'll continue that optimization journey we've been on and expect that will continue to have favorable financial effects for us.
I think associated with that, investors have become increasingly focused on the path to a sustainable 4%+ net interest margin. As you think about the next several quarters, what are the biggest drivers of that net interest margin expansion, and what could cause that timeline to change?
Yeah. So this is a quarter where we've signaled we'll achieve that number and likely surpass it. We feel good about that. The first part of that really is what we just talked about, the continued remixing of our loan portfolio. We just talked about it, but essentially that book is sitting at about 4.14% coupon today. As those loans reprice, that's a powerful factor for us. We're seeing, like I mentioned earlier, some of that reprice and stay on the balance sheet, some of that prepay and go off our balance sheet, go elsewhere. At the same time, we're replacing that with core relationship-based lending, which, in addition to having a higher coupon, higher total return profile, also allows us to bring in deposits, bring in the ancillary fee income, which has been growing really nicely from that perspective.
The other side of it is just the funding side. We're not a bank that is going to put up a 10% growth in core deposits. It really is, from my perspective, core commercial banking up and down every single market that we're in, from small business to medium-sized businesses to increasingly larger commercial enterprises. When that's humming, I think that's kind of a 2%, 3%, 4% total deposit growth rate, which some folks might not get excited about. I do because I can see how that compounds over time, and we can see the effects. It's hard to measure in any particular quarter, especially because as you think about the various businesses that we serve, there's seasonality factors for many of the businesses, ebbs and flows in certain business lines that we support.
It's hard to measure progress in any given month or any given quarter. When you look back and you see the progress that you've made in terms of the ability to continue to optimize your funding stack, that's where, from my seat, it gets really exciting to see that continue to grow over time. Those are the two factors that really I think we look to. I think the business model at its core, as we achieve the target balance sheet mix that we want, should be operating kind of in that 4%+ range. That's kind of what our projections are telling us, and that's what we're seeing in the business as well.
Great. On the loan growth side, clearly you're being impacted by the runoff of the loans that you talked about. When you look at where you're actually seeing production, what are some of the dynamics for new loan production and new loan pipelines? Where are you seeing the most attractive opportunities for growth today across the franchise?
Well, certainly we're seeing it in some of our specialty verticals. Things like our tribal banking group, our franchise finance, some of those areas continue to be very strong. Broadly, it's across all of our markets and all of our different verticals. I was in Boise market last week and talking with the team there, and they've got so many deals in the works. It was shocking to me the number of things that they have going and the variety of them. So it's not any one thing. I'll go back to, I think it's our position in the market where we're just able to do things quicker, differently, or better depending on if it's an upstream or downstream competitor.
The other side of it is, and this is something that we work really hard to achieve, and we don't take it for granted, is we have customers that refer their vendors and their business partners to us. That also is additive. I'll just give you an example. In Oregon, we have a customer that just completed a new manufacturing facility, and they're obviously very pleased with our team and the service that we've given them. They referred the contractor that built their facility to them. It's a nice couple hundred million dollar revenue company that was with a top 10 bank and was just not satisfied. So it's not any one thing. I'll go back to, we always talk about what are the activities that we're doing.
I've said this for many, many years, even clear back to when I was Ivan Seda as the CFO. We have periods of time where the types of businesses that we bank, they sell, they go through generational transitions, and things of that nature. So the totals can ebb and flow. I always say, what are our activities? Are bankers doing the right things? We've been running the Columbia model ever since the Umpqua acquisition. It wasn't necessarily readily apparent, I don't think, in the first year or year and a half. But if you look back now, it's been three and a half years, a little over three and a half years. If you look back at where we've had growth in the balance sheet, it's been in those core commercial- type products.
The totals are starting to show up, and you see it translate into the increases that we've had in fee income growth and things of that nature. I can't just pinpoint it to any particular area, any particular geography. I know when you look at us from the outside, and you look at peer banks, some of them that have put up larger growth numbers have gone all in on one sector, one vertical. Then if it's disclosable, you can see that. For us, it's just a continuation of doing the thing, serving the market, whatever that market is. If it's a no- stoplight town in Eastern Oregon, or if it's downtown L.A., they have very different opportunities, and we want to make sure that we're capturing whatever that market provides for an opportunity.
I guess California feels like it's one of the most attractive long-term opportunities for Columbia. As you look at that market today, do you feel you have the positioning you need there to gain market share while maintaining that discipline you've talked about?
I feel like we have the infrastructure now. That was the thing that we lacked. Our team, prior to PacPremier, punched way above its weight in the Southern California market. We think about California in its entirety. We have roughly the same number of offices there as we do in Oregon and as we do in Washington. So about 330 offices between those three states. We look at what we have in terms of deposits and loans. Southern California is our biggest market now, and we've just scratched the surface. So I still remain very optimistic, especially now that we just had the one-year anniversary of closing the PacPremier deal. Those bankers that joined us through that continue to impress me with how they've embraced having a bigger balance sheet, more products, more services. Their cross-business line referral numbers are outstanding.
Again, it's such a deep market that we've just scratched the surface.
One theme that keeps coming up is your ability to attract experienced bankers. What are those people seeing at Columbia today that makes them want to join from wherever they are coming from?
I think it is a combination of our culture. They know, or maybe in previous employers, have worked with some of our folks that have joined us and are very successful. We have a flat work structure, access to executive management. I have an open- door policy. I am sure we hired a new employee yesterday. It was Monday. That person can call, email, come into my office if I am there, ask me anything they want. I think that is refreshing is that we all show up, we roll up our sleeves, and we are working managers and colleagues. That seems to resonate. Then our ability to execute. High performers, what they care about is if they have achieved that trusted advisor status with their customers. They care about being able to execute and deliver on that.
In our model, we have got a track record of people being able to do that.
We spoke about loan growth and margin, but fee income businesses have become an increasingly larger contributor. How are treasury management, cards, wealth management, and other fee businesses changing the economics of a customer relationship?
Yeah, I'm happy to start. You're spot on, right? I think Clint talked about it earlier, but one of the things that we've seen in the data is that we continue to deepen customer relationships, in particular as you see some of these non-core transactional borrowers continue to migrate off of our balance sheet. We continue to deepen in those areas, right? Treasury management services, card services, merchant, swap syndications, wealth management. Right now, one of the things that we focus a lot on is continued growth in some of those metrics. The one that I like to focus on is non-interest revenue as a percentage of total average assets. Because it's been pointed out to us before that, boy, of the total revenue pie, fee income is a relatively small portion.
I always say, "Well, yeah, but that's because our net interest margin is so strong," right? If I wanted to grow that size of the pie, the best thing I could do is drop down to a 370 margin, but I don't think that's a good outcome for us. The way that I like to measure it is a function of kind of the business model, and as we continue to transition the balance sheet from where it's been to where I think we've articulated it's going, which is more C&I- centric, more commercial- centric, that measure will continue to increase. We've also seen that. You go back to Q2 of last year, we had about 45 basis points of average assets in terms of fee-based revenues. Right now, we're up to about 55 basis points, so it continues to deepen and grow.
It's very, very difficult when you look at a pricing model and whether it's at. I don't care whose model you use, it doesn't really matter if it's on a reg cap basis, if you allocate 10% or 12%. If you don't get any other services, if it is purely a lending relationship with no deposits and no ancillary fee services, it's very difficult to get to a 10%, 12%, 15% return on relationship. You really do need to have that full relationship in order to kind of make the math work from that perspective, and so that's what we look to. We don't always get every single piece of the business, nor do we necessarily expect to. But over time, that's the goal, right?
Is to continue to get your foot in the door with some of these commercial relationships, bring in those deposits, show that you can execute to the comments Clint made earlier. As you do that, more often than not, we see kind of these wins come to the table. That's been fun, and that's exciting to see. I'm just the finance guy, so I'm rooting from the sidelines sometimes, but I always like to help participate in the celebration when they do kind of bring those full relationships in because it certainly makes my job easier, as those are the relationships that drive a strong return profile.
Wealth management is an area we've heard a lot of banks talking about emphasizing and growing and trying to tap the existing customer base. What's driven your success there, and how much opportunity remains within the existing commercial customer base to expand?
Yeah. Our model is actually pretty simple. I'd say we're a Main Street commercial bank, so we lead with commercial products. We've always had a private bank wealth management division because we want to bank the owners and executives of those companies that we have the commercial relationship with. Our retail network is largely there to support the needs of those businesses, those owners and executives, and then hopefully the employees of those companies will choose to bank with us. So it's not a cast a wide net consumer type model that we run. For the 33 years that the company's been in existence, that's always been our approach. I think we can get better. I'm never satisfied. I look at the progress that we're making. But I think that we could do more across our existing customer base.
I think where you're seeing the growth in that area is a result of the growth in the company in some of these other markets, the talent that we've been able to attract, and we talked about it on the commercial side. It holds true on the wealth side. Then just in some of those markets, like Southern California, there's just an enormous amount of wealth. As we've leaned into that market, we're seeing the results, and that's where you're seeing some of that growth come from.
Maybe shifting over to credit. Credit remains remarkably stable despite a period of elevated rates. Where are you spending the most time today, and where have your concerns changed over the past few quarters?
Yeah. Credit remains really, really good and strong. Frank, our Chief Credit Officer, is still very relaxed. Where he has spent, and his team where they've spent, the bulk of their time this year is just really analyzing our agricultural portfolio. I think ag gets a lot of publicity because it's cyclical. Ours is very diversified. It's anything from cattle to row crops to nuts to nursery stock to grass seed. I mean, it really runs whatever can be grown in our footprint makes up the portfolio. Even at that, they're navigating things pretty well, and some are doing exceptionally well. I was speaking with a cattle rancher a few weeks ago, and he was excited and in disbelief at how much he just sold his steers for. Where we do have an issue, I think our non-performing agricultural loans are about 3.8%.
1.8% is the one pop deal that we previously disclosed earlier this year. All in all, it still remains very strong. We do some things to minimize the risk in that book. We participate in Farmer Mac programs and USDA programs that help to de-risk that as well.
Maybe looking at AI, which is a theme we're talking about clearly this year. You've discussed AI-enabled relationship management tools, customer analytics, operating efficiency initiatives, and productivity improvements. Where are you seeing the most tangible benefits today, and which applications have the most potential to create shareholder value over the next few years?
Ivan and I are sitting up here, and we're going to, not do the answer near the justice that Drew Anderson, our Chief Administrative Officer, who's with us and absolutely lives this stuff each and every day. We're going to put him on the spot and ask him to come up. You'll get a much more robust, detailed answer.
Great. Thanks, Drew.
Thanks, Jared. AI at Columbia Banking System is really kind of broken out into a couple of categories. One that we've really found a lot of success in is in our call center. We've put about three different AI applications in front of our call center agents and our customers. What we've seen over the last year is we've actually flipped. When a client sends a message, now it's 7:1 agent response versus human response. The reason we're seeing that change is the agent's getting a lot better. Certain things like what's your routing number? Where's your closest branch? What's your hours of the branching operations? The agent just takes care of that. Then the super complicated, "Hey, I have fraud on my account. What do I do?" That's where the human steps in.
We've seen a tremendous productivity increase in our call center. The point I would point you to, Jared, is we added 30% more customers with the PacPremier acquisition, but our call center staff stayed flat. That's a lot of this AI work. The other thing we're seeing a lot of success in is our fraud capabilities. We have some really nice fraud tools. We layer on our own internal , self-developed internally, on top of those, and now we're catching more fraud that would have bypassed those models. Between our call center between our fraud, those are the early wins. I think what we're going to see here in the next couple of quarters is some work on the commercial lending process and speeding that up.
Like Clint said, we try to be very quick in our markets, and we feel like there's a tremendous opportunity to leverage AI in the process. Not to decide the credit yes or no, but just speed up the analytics, the reporting, the decision-making.
Great. Thanks. I guess maybe in the last few minutes here, talk a little bit about capital and M&A. You're continuing to generate excess capital while keeping that loan growth intentionally flat, as we discussed. How are you thinking about the dynamics of buybacks and capital targets? As you mentioned, it's been a year since the close of PPBI. How are you thinking about M&A going forward from here as well?
Yeah. I'll tackle the M&A question, and then Ivan can speak to what we're doing on the capital front. I can't help myself. I have to say one thing on capital. Last year when we announced the $700 million buyback program, the first question we got was, "Well, do you plan to use it all?" It's like, well, yeah, that's why we announced it. As that's winding down, Ivan can update you on where we're at. From an M&A perspective, there was something last week or the week before in S&P on M&A, and it was a little bit out of context. At a forum a few weeks ago, I was asked a hypothetical question about M&A. If you ever did M&A again, what would be the smallest thing you'd look at? Then what on the top end?
I said, "Jeez, I can't imagine anything under $3 billion that would really move the needle or do anything." Then, just looking at our marketplace and where we're interested, I don't really see anything that's a fit for us over $10 billion if we're ever to do M&A again. But I think it kind of got printed as that's our range. That's what we're seeking out. The phone still rings. I think we're still viewed as a great strategic partner option. There's nothing that's been announced in our marketplace that we didn't know was coming, that we didn't have an opportunity to say, "Not a good fit for us." It's not a priority. I think that some of the things we're working on internally are making us better and will continue to allow us to take market share organically. That work's not done.
That's where our focus is. If we ever do re-enter the M&A space, it will be something that has to absolutely be additive to our core deposit base. We're not going to do anything that weakens that core deposit base. Then we'd have to look from there as to, okay, what's the additional strategic rationale? We've worked hard these last five years integrating and transforming our company. Our bankers are having fun, we're having fun, and we can still get better. We don't need to do anything from an M&A front.
On the capital front, it's a great question. It was 11 months ago that we announced a $700 million share authorization and signaled that is our intent, right? Is to leverage that authorization to kind of return capital to shareholders. Over the course of a year with that in place, in addition to a very healthy dividend level, we'll have the opportunity to return over $1 billion of total capital to shareholders. And what we've essentially seen is that our capital levels from a risk-based capital perspective have barely moved, right? If you go back to the last three, four quarters, they've been right at that kind of 13.5% level, which frankly speaks to the power of the earnings profile of the company, right? That you're able to do that.
We repurchased $100 million shares in Q4 of last year after announcing the program, $200 million volume in Q1 and Q2 and would expect a similar level here in Q3 as we wrap up this year. Then we'll come back to the market here with an update as part of our October earnings call with regard to the continuation of a program and the size and scale of that. The other thing that we've been looking at and actively taking action on is the mix of our capital. We've talked about an opportunity to look at not just kind of the share repurchase program, but also our Tier 2 capital base, which is historically, and as you can see in our financials, been trust-preferred securities. And those are expensive, they're inefficient, and they'll begin to lose their capital treatment here starting later this year.
We're working through a program to essentially replace that with a sub-debt offering that we disclosed yesterday morning. We're excited about that. That'll be kind of a more stable, more efficient, and more cost-effective way of providing that Tier 2 capital base. And so that's something that we've been working through this quarter and are excited to get that done. And you won't see a significant movement in our total capital levels with regard to that. But we're excited to have that be something that we're able to execute on here in the third quarter as well. And that sub-debt offering, just to be clear, is intended to essentially upstream capital to COLB level and redeem some of the trust-preferred securities. And so we'll be doing that here over the next handful of weeks and months.
Great. With that, thank you very much for joining.
Thank you.
Thanks.