Columbia Banking System Inc
NASDAQ:COLB
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Columbia Banking System Inc
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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Umpqua Holdings Corporation first quarter earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Ron Farnsworth, CFO. Please go ahead, sir.
Okay. Thank you, Hannah. Good morning, and thank you for joining us today on our first quarter 2018 earnings call. With me this morning are: Cort O'Haver, the President and CEO of Umpqua Holdings Corporation; Tory Nixon, our Chief Banking Officer; and Dave Shotwell, our Chief Risk Officer. After our prepared remarks, we will then take questions.
Yesterday afternoon, we issued an earnings release discussing our first quarter 2018 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning. Both of these materials can be found on our website at umpquabank.com in the Investor Relations section.
During today's call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the safe harbor provisions of federal securities law. For a list of factors that may cause actual results to differ materially from expectations, please refer to Page 2 of our earnings conference call presentation as well as the disclosures contained within our SEC filings.
And I will now turn the call over to Cort O’Haver.
Thanks, Ron, and welcome to everyone listening in on the call. Let me begin by providing a brief recap of our quarterly financial performance and an update on Umpqua Next Gen. Ron will discuss the financials in more detail, including results from the operational and back office efficiency review we've been conducting. After that, we'll take your questions.
Our first quarter of 2018 was very strong with earnings per share of $0.35, one of the best quarters we've ever had. The financial performance achieved this quarter was attributable to the success of key initiatives we put into place over the last 12 months. Our strong results were anchored by continued growth in loans and deposits, stronger fee income, stable credit quality and a reduction in core expenses, along with the benefits of tax reform and short-term interest rate increases.
As I go through my remarks today, I want to focus on 3 of the key initiatives we introduced last year as a part of Umpqua Next Gen strategy: Balanced growth, operational excellence and human-digital.
Starting with balanced growth. When we announced this initiative last year, our focus was on adding new multifaceted relationships across the bank. This means more consistent and diversified growth, driven by stronger, deeper and more profitable customer relationships. Today, I can confidently say this initiative is working well. Our first quarter is typically a slower seasonal loan growth quarter. We also experienced some higher payoffs and despite this, we were able to grow the loan and lease portfolio by $234 million, which represents a 5% annualized growth over the prior quarter. This growth was distributed nicely throughout the commercial, commercial real estate and consumer loan portfolios. Our commercial loan portfolio, which includes C&I as well as our leasing business, increased by 11% annualized over the prior period level. Consistent with the last few quarters, a significant portion of this growth came from our corporate banking group, which continues to perform very well. Given the talent we've been able to attract in our markets, we're adding new core banking relationships, both in corporate banking space and in the small business segment. Further, our loan production and pipelines remain robust, and we expect that loan growth will continue to remain strong this year.
Turning now to deposits. Total deposits increased by $159 million or 3% annualized over the prior quarter level. This reflects growth in noninterest-bearing demand and time deposits, partially offset by lower balances of money market accounts from some planned public runoff. A few comments on deposits. First quarter was typically a slower seasonal deposit quarter, driven by higher levels of net outflows related to tax payments. Despite the seasonality and the 31 store consolidations we've already completed this year, we were able to generate healthy deposit growth, which is a testament to our value proposition and talented associates. Ron will discuss the financial impact and timing of the remaining consolidations, but I want to take a moment and applaud our retail banking division for their terrific job they're doing. Consolidations like these are never easy, but as of today, we have haven't experienced any significant deposit attrition. In fact, total deposits at the receiving locations are flat to slightly up and I attribute this success to 2 key factors: First, the proactive outreach and investments we've made in those communities; and second, taking the time to engage and educate our customers on the many channels Umpqua offers to meet their banking needs and in some cases, coming up with some pretty cool and creative ideas to accomplish this.
The second next-gen initiative I want to highlight this morning is operational excellence. As we evolve to reflect how today's customers want to bank, it's an opportunity to advance our operations in order to deliver smart, efficient experiences that customers value. As part of this effort, we've clearly focused -- we're clearly focused on maintaining disciplined expense management so we can redeploy capital to the future of the company. Earlier this year, we engaged Boston Consulting Group to help us identify and execute on strategies to fundamentally change the way our back office operates. Through these efforts, we've identified back office efficiency opportunities totaling $24 million to $36 million. Between Phases 1 and 2, this represents approximately 8% to 12% of the $300 million. We provide some additional details on Slide 4 in the earnings call presentation. Ron will cover updated financial targets and timing, but I want to reiterate that these initiatives are additive to the efficiency savings already outlined and incorporated into Umpqua Next Gen.
Our initial diagnostic review of the back office support areas was completed during the first quarter. Individual work streams have been identified and include things like organizational simplification and design, procurement, real estate optimization and technology simplification, along with the redesign of the end-to-end customer journey. Several of these are currently underway. These initiatives not only drive stronger financial performance and improved profitability, but will help bring customers and associates closer together, allowing our teams to operate in a more nimble and customer-centric manner.
As a part of that redesign, I promoted Tory Nixon to Chief Banking Officer. In this new role, Tory will oversee all customer-facing bank divisions, focusing on creating seamless, human-digital customer experiences across all retail, home lending, commercial and wealth management areas.
As I mentioned on the last earnings call, a key strategy embedded in Umpqua Next Gen is the redeployment of capital. Part of the savings we generate from our operational excellence and store consolidation work will go towards funding investments in technology, data and analytics. At the center of this is our human-digital strategy, which uses technology, not just to provide self-service capabilities, but also to build deeper relationships with our customers. Think of our human-digital strategy as a spectrum, spanning both the human and technology aspects of banking. We're building and utilizing new digital capabilities to enable our associates to provide experiences and solutions that are both highly valuable for the customer and for Umpqua. By doing so, we can build a better overall customer experience, leading to market share growth along with deeper and more profitable banking relationships. So let me outline a few of those investments.
Engaged. The platform developed by our Pivotus subsidiary will be moving from a successful pilot to enterprise rollout. This technology is an important part of our human-digital strategy in a highly, highly differentiated way to deepen and strengthen our customer relationships. We look forward to watching it throughout the footprint later this year. In early 2018, we expanded our digital capabilities with the launch of a redesigned website, umpquabank.com as well as new online account origination. After a few months, we're already starting to see really good traction. Overall website traffic is up, and we're acquiring a significant amount of new retail customers via this channel. As part of this launch, we've also rolled out a new digital marketing campaign during the quarter. Through targeted digital marketing aimed at our core growth markets, we saw double-digit increases in both website traffic and foot traffic at the physical store located within those customers' proximity. In addition, we're making significant investments in technology and people to improve the customer experience. On the technology side, we are building new systems that support our commercial, retail and wealth associates in establishing and deepening customer relationships. These include things like mobile account origination, an integrated payable solution and marketing automation. On the people front, we've begun relationship-based training across the organization, including our commercial, retail and wealth divisions. We believe this investment in our associates will help us more fully understand and identify solutions to meet customer needs.
And now I'll turn it back over to Ron to cover the financial results.
Okay. Thank you, Cort. And for those on the call who want to follow along, I'll be referring to certain page numbers from our earnings presentation.
Turning first to Page 6 of the slide presentation, which contains our summary P&L. First quarter earnings were $78 million or $0.35 per share, down from $82 million or $0.37 per share in the fourth quarter, but up from $46 million or $0.21 per share in the same quarter a year ago. At a high level, the $0.02 decrease from Q4 to Q1 resulted from: $0.01 of higher net interest income, with continued loan growth and recent short-term interest rate increases; $0.03 from higher noninterest income; and $0.02 from lower noninterest expense, offset by $0.08 from the increased income tax rate at 24% here in Q1 versus 4% in Q4, given the revaluation of our net deferred tax liability back in Q4 resulting from federal tax reform.
Turning to net interest income and margin on Slide 7 and noted on Page 6 of the earnings release, net interest income increased 1.2% from Q4. Great to see when historically Q1 sees a small seasonal decline. The increase reflects continued solid loan growth and an increase in rate environment. Also, within net interest income, our interest income on investments was up slightly, representing lower premium amortization. And our interest expense on deposits increased $2.4 million or 7 basis points based in part on the growth this quarter and modest repricing based on recent fed funds rate increase.
Our deposit beta based on the fed rate increases over the past year has increased slightly to 19%, driven primarily by higher cost public funds and broker deposits. For the first quarter, our net interest margin increased 8 basis points, while the margin ex credit discount was also up 8 basis points at 3.88%, slightly above our prior guidance range, given deposit betas are still relatively low.
On Slide 8, the provision for loan and lease losses was $13.7 million, up slightly from Q4 based primarily on a continued strong loan growth. As shown later in the deck on Page 14, net charge-offs were 26 basis points annualized and our NPA ratio decreased to 33 basis points of assets. Overall, credit quality remains very strong.
Moving now to noninterest income on Slide 9. The increase in total noninterest income from Q4 to Q1 was driven primarily by the accounting change this quarter with fair value adjustments on our trust preferred debt, known as own credit marks, are now flowing through accumulated other comprehensive income. Also, within noninterest income, home lending was seasonally lower as expected. Additionally, as guided to, we did not sell any portfolio loans, resulting in the drop and gain on sale of loans being just for SBA activity.
In other noninterest income, we had swap revenue of $5 million, up $2.7 million from Q4, along with the positive fair value adjustment on the swap derivative of $1.1 million with higher rates. Also, included in the other category was some small miscellaneous gains for $2 million.
On the home lending front, as shown on Slide 10, and also in more detail on the last page of our earnings release, for sale mortgage originations declined from both the prior and year-ago quarter. Our gain on sale margin decreased to 3.32% this quarter. In absolute declining rates, we expect a normal seasonal bell curve for 2018 in both mortgage originations and gain on sale margins with total volume off 5% to 10% year-over-year.
With the increase in longer term rates this quarter, we saw a net fair value gain on the MSR asset of $5 million, up slightly from Q4. Following up on our discussion last quarter, you'll recall we've been reviewing the overall home lending segment, including potential options to reduce sensitivity on the MSR fair value fluctuations as rates change. Through that review, we've confirmed our market-leading position of higher-than-peer revenue and lower-than-peer direct costs to deliver. We've also explored potential hedging and portfolio sale options for the MSR. Given the noise, cost and risk of hedging, we've concluded our best course is to not hedge the fair value of the MSR asset. We view this asset as a counter macroeconomic hedge to mortgage production levels as rates change, and we'll continue to focus on deepening our relationships with customers. We may look at selective sale of non-relationship customer MSR over time.
Turning now to Slide 11. Noninterest expense was $186 million, down from $193 million in Q4 and under our guidance range for Q1 of $192 million to $197 million. The bridge we provide on the right side details the major moving parts: including seasonal payroll tax increase of $3.4 million; higher consulting and professional fees of $2.7 million; FDIC assessments increased $2.4 million, related to a credit we had back in Q4, offset by declines in home lending direct expense of $3.3 million as expected with seasonally lower volume; a decline in expense from Q4 of approximately $4.5 million related to items recorded back in Q4 resulting from the benefit of tax reform, including a profit-sharing contribution and the contribution to the Umpqua Bank Charitable Foundation; a decline of $6.8 million in other expense categories, which I will talk about here in a minute; and a small decline in exit disposal costs, knowing this came in under our estimate, and we expect to record a small gain on about half of the property exits, but cannot recognize them until the properties are disposed of, which will be in Q2.
I'll say as for the lower expense here in Q1 compared to our guidance range of $192 million to $197 million, the shortfall related primarily to $2.5 million of lower exit disposal costs on the 31 stores consolidated this year; $2 million of lower home lending expense; and $4 million of lower expense across categories, including some project and technology spend which we moved into the next 2 quarters to help support commercial and consumer fee initiatives.
Before I get into expense estimates for the remainder of the year, I want to mention we've made great progress with the overall operational excellence and back office operations efficiency review we've been conducting with the Boston Consulting Group as noted on Slide 4. Recall, we have approximately $300 million of annual back office and operations costs. We completed the diagnostic work, identified individual work streams that are now in the process of implementation. Under Phase 1, we've identified an opportunity range of 6% to 8% of savings, off a $300 million expense base and expect to achieve 2/3 of this on a run-rate basis by Q4 this year and 100% by mid-2019 as expense reductions. I expect the cost to achieve this level of savings, namely severance and additional professional fees, will range from $5 million to $6 million of additional cost for both Q2 and Q3 with savings starting to be realized during Q4. Under Phase 2, we have preliminary visibility into additional levers of 2% to 4% of savings for projects in 2019, taking the total to 8% to 12% of run rate savings on the $300 million base by late 2019. We will continue to update you on progress over the coming quarters.
So with that, moving parts for expense over the balance of the year include: one, a few million a quarter of digital technology and marketing investments we're making to help support fee income and deposit growth initiatives; two, annual compensation merit increase starting in Q2 of approximately $2 million per quarter; three, home lending expenses at approximately 250 basis points of volume for the full year with seasonally higher volume in Q2 and Q3. From a timing perspective, home lending expenses are generally 30 to 40 basis points higher in the beginning of the year and then decline over the remainder of the period, meaning the direct expense was 270 basis points of volume here in Q1. Four, the severance and professional fees related to various efficiency initiatives underway of $5 million to $6 million for the next 2 quarters. And these expense increases will be offset by: the decline of a seasonal payroll tax increase bump in Q1 each year of approximately $1 million per quarter over the balance of the year; savings from the 31 stores shift consolidated of approximately $12 million annualized starting later in Q2; and savings from the operational excellence review expected in Q4 this year of $3 million to $4 million. With these moving parts, we expect our overall GAAP expense to be in the range of $188 million to $193 million for the second quarter declining over the year to be in the range of $175 million to $180 million by the fourth quarter of 2018. Recall the prior Q4 expense guidance range was $178 million to $183 million and this reduction to a new range of $175 million to $180 million reflects the savings expected from our efficiency initiatives just noted. Further, we expect the ROATCE benefit for the Phase 1 efficiency gains to be approximately 0.5% accretive to our 2020 goals discussed in January, increasing our flat rate ROATCE target to 15% and the rising rate ROATCE target to 17.5% for 2020.
Turning now to the balance sheet, beginning on Slide 12. Loans increased slightly faster than deposits in Q1 as expected, resulting in a small decline to interest-bearing cash. Within total loans, recall we announced a rundown of the indirect auto portfolio last winter. Here in Q1, this portfolio declined $45 million down to $450 million in total, noted in the consumer loan category on the next page.
Cort talked about the success of the 31 store consolidations earlier. At this time, we are not expecting additional consolidations this year. We have identified the remaining 70 stores for consolidation discussed last quarter and plan to split them evenly between early 2019 and early 2020.
Also, I discussed the accounting change this quarter for fair value measurements on our trust preferred debt, related to own credit marks. With that, we had a reclass of $9 million out of retained earnings and into accumulated other comprehensive income for the cumulative P&L impact to date. We will have $103 million of fair value discount to accrete on the liability over the coming 15-or-so years to maturity, which will now flow through OCI, not the income statement. And the accounting is odd, but at maturity many years from now, it will flip from OCI to the income statement to get it back in the retained earnings. Also, our tangible book value per share is $9.97, which when you also account for the dividends to shareholders increased 12% over the prior year level.
And lastly, on Slide 15, I want to highlight capital. Noting that all of our regulatory ratios remain in excess of well-capitalized levels, with our Tier 1 common at 11% and total risk-based capital at 14%. Our total payout ratio was 57% this quarter. Our excess capital is approximately $230 million and as discussed earlier, we expect this to decline moderately over the coming 3 years.
To conclude, our focus is on executing our Umpqua Next Gen and operational excellent strategies, improving financial results and generating solid returns for shareholders over time, including a healthy dividend.
And with that, we will now take your questions.
[Operator Instructions] And we'll go first to Jeff Rulis with D.A. Davidson.
Ron, just to follow up on the expense run rate. So if we're at $175 million to $180 million at year-end and then you've got a remaining $6 million to $12 million savings carryover from Phase 1, is that -- is the Phase 2 $6 million to $12 million in addition to sort of what's moving into '19?
Yes. So for the Phase 1, I expect we'll hit 2/3 of that in Q4, which is why we dropped that Q4 range by $3 million, approximately. If you look at that range. Then the balance of that, the other 1/3 of that will come in by mid-2019. The Phase 2 is additive to Phase 1, so an additional $6 million to $12 million we expect to have in-house by the end of the year of 2019.
Okay. So it's -- got it. That is helpful. And then maybe just an overall comment on that core margin is a nice jump, and if -- I mean, you talked about some of the components there, but I guess the biggest sense is the flow-through from further rate hikes. Any comments on kind of margin impact going forward, being that there's some wildcards on the deposit beta?
Yes. I mean, that's the primary wildcard, right? So on the asset side, it's moved up as we expected in connection with the rate increases here over the last couple of quarters, but the liability cost side has lagged now. It's unknown when that's going to kick. Everybody has theories on it. I'll just reiterate that our 3-year goals were targeted off of betas of approximately 60%. So yes, we are outperforming the flat rate and even the mildly increasing rate at this phase, here in Q1 of '18. I'd like to think that's going to continue. I think in the near term, it will. But as we look into '19 and '20, I've got to default back to my expectation that betas will return to some form of historical norm based on that level of increase.
Got you. And then one final one, maybe for Cort. Just you talked about kind of the customer responses of the branch consolidations and the deposit retention. How about just the employee, kind of morale? Any commentary on how that's been received? And it's been a pretty big change in focus since the past regime, I guess, if you will.
Yes. I mean, I think -- it's always tough, right? I mean, I'll be honest with you, Jeff. I mean, when you're consolidating operations and there certainly was a loss of associates in some of those stores, but the people that have remained obviously from the performance of the stores would indicate that they're heads up and they're doing the right thing. And we have turnover relative to natural attrition, and that is always a part of it. So when we did mention or message to the stores that we would be doing this, I think we were 90 days or -- actually, it might have been 4 months prior to the actual closure, it gave some time for the natural attrition to work its way through, which also helps with the staffing. So I think the morale is good. We are working on making sure that the culture of the company stays strong throughout this process and it's a very good question that you asked.
And we'll go next to Steven Alexopoulos with JPMorgan.
I wanted to start, what was behind the decision to push the remaining branch closures to 2019 and 2020?
Actually, it wasn't -- when we laid this out last fall, we had intentionally targeted 1/3, 1/3, 1/3 over the course of the 3 years. So at this point, we're not making a call to accelerate any of the 2019 items. We'll be watching that. I mean, as we go over the next couple of quarters, as these initiatives kick in, there's potentially -- we could pull some forward, but at this time, we're not announcing that.
And Ron, specific to next gen, what are the cost saves that are in the run rate currently?
Specific to next gen, cost saves related to the operational back office efficiency review, there's virtually none in the run rate currently here for Q1. That's why I gave the updated guidance range for Q4 and then the guidance into 2019.
Okay. So if we look at the almost $7 million reduction in the core expenses this quarter, none of that was related to next gen? Is that what you're saying?
Correct. In terms of the back office operational review, savings hasn't kicked in yet.
Okay. So I want to put this together, just from a very high level. So if we look at the total cost savings that are left from all of the initiatives that you're currently doing, how much -- nothing's in the run rate, you're saying. How much will hit this year? How much will hit in 2019? How much will hit in 2020? How much gets reinvested? And what falls to the bottom line?
Great point. So I'll start with the technology in digital investments we already included in the 3-year goals of the return intangible targets for 2020 that we talked about in October and January. Harken back to Page 4, Slide 4 of the earnings presentation, we're targeting $3 million to $4 million of saves hitting in Q4, which is roughly 2/3 of the $18 million to $24 million annualized. For 2019, you'll have the majority, if not all of the $18 million to $24 million from Phase 1. And then we expect a chunk, 1/4, a quarter and a half of the Phase 2 amount in late 2019. You go to 2020 and then you'd expect to see the entire amount. Now again, I'm going to reiterate that we've got very good visibility into the Phase 1 initiatives. Phase 2, we've identified. We have not yet determined the cost to achieve. That will occur over the coming quarters, but we'll be rolling that out in more detail as we get that detailed information to you guys on these quarterly calls.
Okay. And then Ron, on the tax spend, how much are you planning to spend on technology this year?
Well, that's kind of a loaded question, because technology also includes operations. So when I think about maybe new initiatives that were included in the 3-year targets, our 3-year goals and return intangible that we talked about, there's roughly $10 million to $15 million of additional technology and/or marketing investments for 2018 through 2020 on an annual basis. So that's as close as I can get to for I think what you're going for, which is just the new initiatives, not the base.
I'm looking for a full year tax spend this year.
Full year tax spend this year, from a technology direct cost, it's roughly $115 million. I'd say in terms of additional digital marketing investments, more on the product marketing side, probably another $15 million on that, so roughly $130 million out of the total spend. But that includes a lot of technology that I think is something different than what you're talking about, right? Just the core operation.
Yes. No, I got you. Yes. Yes. And then, Ron, just quick. I know the NIM came out a little bit better than you were looking for. How are you thinking about the NIM here, near term?
I'm thinking -- I feel pretty good about it here, near term. As I talked about it earlier, the wildcard's going to be when betas kick in, and there's no near term visibility to that occurring. So that could be a discussion -- that's a discussion, obviously, we'll have on a quarterly basis going forward, but I think here in the near term, our NIM should be relatively range band about this level.
We'll go next to Michael Young with SunTrust.
Ron, maybe if I can just start with a quick follow-up on the NIM question. How much premium amortization decline was there this quarter? How much of a benefit to the margin was that? And what's the -- maybe just on a nominal basis or absolute basis, what's the level of premium amortization running through right now?
Yes. So for the bottom portfolio, that's obviously a benefit of rising rates, which is factored into our sensitivity models. So that was roughly $0.75 million drop in premium amortization this quarter. It ended up right around $5.5 million, give or take for the quarter.
Okay. And maybe on a bigger picture question. I think we're just trying to capture -- obviously, the back office piece is good, but that plus next gen all together prepackaged, with where we're at now and declining expenses to the end of the year and then how much of that is left to come in 2019? So in other words, we should be down year-over-year even with normal expense inflation. In 2019, we should be at a lower kind of rate than where we are this year, and then does that continue going forward? And then -- just trying to put a high level understanding on that.
Yes. I mean, I'm not giving a 2019 total expense guidance level at this point. That's something we'll talk about later this year. But a big tailwind on that is -- what we talked about here in terms of the operational back office savings we were targeting through this. And again, as we lay out on Slide 4 there, that Phase 1 component of roughly $18 million to $24 million will be in 2019 results for the year, with a good chunk or probably half of the Phase 2 amount in 2019, and that will carry into 2020. But a lot of other moving parts, including the investments I talked about earlier; our substance for home lending, which pretty much align with MBA forecast of 5% to 10% drop, so a lot of moving parts there. All of it though bakes into the return on tangible common equity goals we really talked about, because that's what we're driving towards.
Right. And my last question, just on that. The denominator's obviously a key portion of being able to achieve those. Where do you kind of feel is your gating factor on capital right now? And is dividend really the priority or if, now at higher profitability levels with the tax act than where we initially planned going into next gen, do you think there's an opportunity to kind of lower that equity base and achieve those ROATCE targets sooner?
As we talked about with the excess capital forecast, I expect that excess capital to decline naturally over the coming now 2.5 years, just with the growth initiatives. And we fully expect to maintain a healthy dividend payout ratio, which I think over my 20-year career, we just view as a better form of capital return to shareholders than buybacks, which are pretty one-time and up and down.
We'll go next to Aaron Deer with Sandler O'Neill.
Following up on the expense discussion. I just want to be clear. The guidance that you gave, in sort of in terms of dollar range, say in the fourth quarter, does that include or not include the anticipated exit and disposal cost that you've talked about?
That does not -- we don't expect any in Q4 this year, I think, especially with the Q1 amount being at $2.5 million. I expect the exit cost in Q2 will be relatively small, if not a small credit, just with some gains flowing through. So that excludes exit costs in Q4. That'll probably be more future Q1 of 2019 with the next round of consolidations. And granted, as we move through the year if we decide to move some of those forward, then that would change the exit number, but just move it from one quarter to the next.
Okay. And then with the -- I guess, the planned runoff of the public deposits, those were a higher cost to fund, so I imagine that, that also helped on the funding cost this quarter. But as you look to replace that funding with other, kind of core deposits, where are you kind of seeing the incremental cost of deposits to fund the growth going forward?
On a blended basis, it's pretty close to our interest bearing deposit cost, but I'll point out it was up 7 bps this quarter, right, just between the cost of interest bearing deposits. The real traction that I'm excited to see is the growth in the core consumer checking products, obviously DDAs, no beta. But then we've got a lot of growth still in the wealth and commercial space, which generally tends to come in, in the 50 to 100 bps range. So overall, I expect we'll see a modest increase in our cost for insuring deposits over the course of this year, but betas will stay pretty small. In terms of the first quarter impact for the public runoff, it was very minimal. And it's at 47 bps.
Just one last question then. On the mortgage activity, you mentioned in terms of production expectations and sales, you follow the bell curve. What about in terms of the gain on sale margin? Is that -- obviously, that came in this quarter. Do you expect it to stay down, kind of at this lower end of the historic range?
No. That's -- like we talked about in January, that's part of the bell curve. So we expect roughly 3 1/4 to 3 range, which is in Q1, up closer to 3.5 Q2, Q3 and then back down to this level in Q4. So that's the bell curve I'm referencing.
We'll go next to Tyler Stafford with Stephens.
I wanted to start on loan growth and FinPac, specifically. What are the average yields of that portfolio now? And can you just remind us of the pricing dynamics of that portfolio, how much is floating and what index that may or may not be based off of?
Tyler, it's Tory Nixon. The yield on a FinPac portfolio is around 12%. The mix kind of generated is really moving towards 1/3 and 1/3 and 1/3, meaning 1/3 of our kind of classic small ticket, which has the highest yield; 1/3 in our vendor finance business; and then 1/3 in our larger ticket leasing that is primarily connected to our corporate banking initiative, and that obviously would produce the lowest yield of the 3.
And how much -- I'm sorry. How much is the total of that portfolio floating?
I don't have that number in front of me. Sorry.
Okay. And just from a growth perspective, what do you think about kind of the outlook of the growth of that FinPac portfolio? Would you think it would track historic levels over the last couple of years?
Yes. I think that the FinPac portfolio will continue kind of grow in -- as it has in the last several quarters, for sure. As I said just a couple of minutes ago, the mix is a little bit different. We're moving more towards having less in the small ticket side and more on the kind of direct business through banking relationships.
Okay. Got it. And then, I think in the prepared remarks, you mentioned higher payoffs this quarter. Can you quantify that for us and just for a frame of reference, what was the payoff levels in the fourth quarter?
Tyler, it's Tory again. You know that the total payoff was, I think, around $70 million more for us in the commercial space and that was primarily due to maturing construction loans to our commercial real estate group, so -- and that was by design. Essentially at maturity, we'll take another look at the project, and depending on credit metrics and price, decide if it's something we want to bid on to keep or to let it go. So we're doing this very consciously as we really kind of continue to move the commercial real estate business into some more term lending.
Okay. Got it. And then just lastly, Ron, just to be clear on the Phase 2 back office cost savings, whatever you get out of that would be upside to the 50 basis point ROATCE improvement from Phase 1. Is that correct?
That is correct.
We'll go next to Matthew Clark with Piper Jaffray.
Wanted to clarify the noninterest expense run rate in the upcoming quarter. I think you mentioned it's on a GAAP basis, maybe including $5 million to $6 million of severance in 2Q, 3Q. Should we strip out, if you think about kind of the unusual aspect of that being $2.5 million to $3 million in each of those 2 quarters? Is that fair, to come up with kind of core operating number?
Yes. It's Ron. Actually, $5 million to $6 million for both Q2 and Q3, so -- well, $10 million to $12 million in total over the 2 quarters combined, but that is included in the $188 million to $193 million guidance range for Q2.
Got it. And then the fourth quarter run rate, you mentioned it's clean of severance and disposal cost, right?
Correct.
Okay. Okay. And then on the margin outlook, in terms of what's embedded in your guidance with the 2 different rate scenarios, you mentioned it incorporates a 60% deposit beta. What are you assuming for a loan beta in that outlook? And how does that compare to historicals?
Well, I guess when I refer to betas, it's really on the deposit side. On the loan side we, of course, assume front end rates are moving up over the course of that horizon. So as it impacts prime and LIBOR rates, that's roughly 100% in terms of those. Now we assume consistent spread expectations. You could have some play with that, but I think there's plenty of upside there.
Okay. And then just -- can you remind us how big that indirect auto portfolio is at the end of the first quarter?
Yes. $450 million, down $45 million during the quarter.
Okay. And in the other fees, I think you mentioned swap revenue was up $2.7 million from the fourth and I think there was $2 million of miscellaneous gains. Is that right? And what were those?
Correct. That was in other noninterest income, about $2 million of miscellaneous gains. Part of that was a gain on some -- on a TARP redemption we did this quarter, and another part of that was lease residual gain that was unexpected, nor expected to recur, but pretty small.
We'll go next with Jackie Bohlen with KBW.
Touching on the money market accounts again and just kind of the remixing that took place in the quarter. Do you have the timing of when that happened, Ron?
That was in the month of February for the most part. Some public money market out, replaced with some wealth in commercial money market and/or CDs, so we're starting to see some transition as rates are moving up back into CDs.
Okay. So the money market that's transitioned into the CDs and some of that movement, so the -- I know you mentioned it earlier in the call, but just trying to fine-tune it a little bit. So that's not having a large impact on the margin going forward then, the changes that happened in the quarter?
Correct. I think the bigger impact on the margin going forward will be, do betas pick up and get closer to historical norms.
Okay. And the CDs that you added, what's the duration on those?
I'm sorry. The -- oh, CDs. Sorry. Yes. Generally, the CDs have 12-month tenders. That seems to be the most popular maturity bucket.
Okay. And then, sorry, I think most of everything else must have already been asked. The loan-to-deposit ratio where you're at right now, I know it's been fairly consistent. Is that -- are we at more of an upper level of your comfort zone?
Yes. I'd say mid-90s is where I want to keep it on the high end. Anything moving north of that, we'll be looking to adjust the left side of the balance sheet forward. But again, goals for the year laid out would have deposit growth exceeding loan growth, and we knew this would occur here in the first quarter. Seasonally, we're slower through this April-May time frame, especially with taxes, so we expect that to rebound in Q3.
Okay. So essentially, you'll just advantageously take advantage where you can to kind of remix the deposit book into more core accounts, and not some of the additional public funds you might have. Is that fair?
Correct.
We'll go next to David Long with Raymond James.
Cort, you were talking about the addition of talent and how that helped with your loan growth in the quarter. And just curious if you could talk about any recent hires of some veteran lenders. Maybe is it C&I commercial real estate and any geographies where you may be having more success than others?
David, let me kick that over to Tory, because he's doing the hiring on that side of the aisle for the last couple of years, so let me kick it to Tory.
Okay. Dave, Tory Nixon. Over the past 4 or 5 quarters, really, we made this major push to kind of reallocate some resource into people in the middle-market space, and it's been kind of spread throughout our footprint. So all the way from Seattle, not any really in Portland, but in San Francisco, Sacramento, Los Angeles, Orange County, San Diego, primarily been where we've added the folks. And they've come from larger middle-market banks throughout the -- our geography, and we've had success kind of really throughout that footprint. I think predominantly, the success has been in the Bay Area, San Francisco, San Jose, Los Angeles, Orange County and San Diego, so more of a California increase than in the Pacific Northwest.
David, Cort. What Tory's been able to do in hiring people and the growth we're showing, we are an attractive alternative for a lot of lenders, to get out of maybe larger institutions to come here. And that's a testament to Tory's hard work in hiring the right people.
Got it. And with your guidance that you gave with the operating expenses for the rest of the year, what hiring assumptions do you have built into that?
This is Ron. On that front, we're not -- there's not a noticeable amount of x millions of dollars of new teams coming onboard. I think at this point, with where we're at, it's going to be continuous selective changes, but not material on the expense line within those ranges.
We're optimistic on that if we need to be. If there's a group or a lender that can bring near term revenue to the bank, we always look at those as -- on a pretty opportunistic basis.
We'll go next to David Chiaverini with Wedbush Securities.
A follow-up on the loan growth commentary. In your prepared remarks, you said how loan growth should remain strong this year. So mid- to high single-digit, that still stands?
Yes. David, this is Tory Nixon again. Yes. I mean, I think that still stands. I mean, the pipeline is strong. It's consistent where it was at the end of Q4, and it's $350 million or so higher than this time last year. So I think we'll continue to see some good loan growth throughout the rest of the year.
Great. And then it was also mentioned that the deposit attrition so far, there's been no significant deposit attrition thus far from the 31 branches that were consolidated. Now previously, it was stated that the attrition expectation was 20% to 30%. Is there still an expectation that there could still be some attrition from those branches? And if so, what level are you guys thinking now?
It's Cort. So we -- once again, hats off to the people in the stores that we consolidated. We had forecasted, obviously, to make sure we were being conservative in our expectations, that we would do some decline and we didn't. I mean, I don't know if I can actually honestly answer that because we've outperformed what we thought, and we still have a forecast that we're beating substantially that would show some declines. So I'd like to think that the efforts the store personnel are putting in place will continue to hold through in the second, third and fourth quarter. And so I can't specifically answer your question, because we're outperforming my expectation, which is great. They've done just a great job. Plus, some of the things we're doing with digital in our digital marketing where -- we've just kicked that off in the last 6 to 8 weeks, will help to augment any runoff collectively in the bank that we might have seen relative to those consolidations, and that was not something we had budgeted for. That was an add-on that we had not budgeted. That will be more accretive to any deposit growth we see going forward. We have enough things going, and based on our performance with these consolidations, I feel pretty good about it.
And how much in deposits do these 31 branches comprise?
Roughly $1 billion.
And out of curiosity, you mentioned that you had some cool and creative ideas to keep customers banking with Umpqua. What are some of those ideas?
Well, one of things that we did and I mentioned it, was just to reach out to the larger depositors in these stores we were consolidating. So we did an active calling campaign, where we actually called these customers, told them what was going on, and obviously we have to notice customers, when we were consolidating or closing store operations. We had an active campaign to do that. And we -- I don't know if it's exactly 100% of the customers, but it was a fairly robust campaign to do that. I think our digital marketing is being used in some of these markets to try to -- whether it's to track new customers or probably touching the customers we've got. I can tell you what we're going to do with our engage application that's going to hit our stores in the third -- by the third quarter or in the third quarter, will also be a really cool additive feature to provide a unique experience. So it's a digital mobile application where you basically have a banker on your phone, who is a real person, who can provide you just about any service we can do in a store today with the exception of giving you cash, which is a pretty cool feature. And as far as I know and certainly in the United States, there's no one doing that. So we think it's a really cool feature that we'll roll out in some of the markets where we're consolidating.
We'll go next to Michael Young with SunTrust.
Just wanted to ask on kind of the next round of branch rationalization. Are these branches relatively larger in terms of their deposit balances? Is there any reason why you would think the attrition rate on those would be higher than maybe this first round?
No. This is Cort. No. I mean, we -- when we identified these 100 stores and we have identified them. We looked at impact to markets and once we're looking at consolidations, we didn't -- we want to make sure weren't impacting geographical locations too soon. I mean, we had all kinds of things we did when we kind of triaged these. So I don't anticipate that anything in Phase 2 or Phase 3 would be any different than Phase 1. It was -- we staged them more on a basis of impact to customers and associates, so we didn't overly impact any one particular area. That's how we did it. So there may be some that are as -- whatever measurements were used to determine what stores were closed, that are just as susceptible to closure in Phase 3 as we did in Phase 1.
Okay. So we're not rationalizing kind of the bottom 1/3 and then the next 1/3 and then the next 1/3.
No. Absolutely not.
Okay. And then maybe separately, along those lines. I guess, is there a rationale or reason to do them all in the first quarter? I mean, you've kind of hinted that you guys might -- could spread these out over a little more period of time. Is there some workflow or notification time line where it's easier to do them all at once?
Well, yes, there's the notification time line that we have to give to the customers and the communities. But the rationalization truly was is that -- I mean, let's be honest, the banking sector is collectively experiencing more difficult time attracting deposits, right? I mean, you guys probably cover everybody, and you probably -- this is probably a main topic of conversation for any CFO and CEO. And we knew that consolidating basically 1/3 of our stores in a difficult deposit time would be -- I mean, we could close 100, and we could really come off a cliff. So we opted to stage it, and then we will look at the performance and the attrition rates as we close these 30. And if we -- and Ron mentioned this, if we feel like that we're beating our forecast and right now, we are, and we could pull something into 2018, we'll do that. But we don't want to overcorrect here, just for the sake of a couple of quarters and a couple of pennies. I mean, we could really tip the scale a little bit. So we're going to be very calculated about how we do this. And we do have an impact to communities and customers, too. I mean, there is an impact. There's no way to minimize. In fact, in some communities, we are leaving some communities, and we want to make sure we minimize that. We message it correctly and we work with our partners in these communities, including our regulators. I mean, there's a whole process you have to go through.
And we'll go to Jared Shaw with Wells Fargo Securities.
This is actually Timur Braziler filling in for Jared. One follow-up question on the hires and the success that you're seeing there. Looking at some of the hiring activity that's taken place over those 4, 5 quarters in California, where are they kind of relative to capacity or relative to initial expectations? Are we reaching a point where there -- where that -- where the hiring is kind of stabilizing? Or is there still a solid opportunity to kind of see ramping growth out of those markets?
This is Tory again. I think the ramp-up period for them has been different, depending on the person and the market. I do not feel in any way, shape or form that we've reached kind of a full capacity with the people that we've brought in. There's still, I think, a lot of opportunity. In some respects, I think we're just starting to hit our stride. And I think as -- so we will -- I think we'll continue to see improvement in efficiency, in growth from those people. Additionally, as Cort mentioned, I think we will be opportunistic and look for -- continue to look for people and/or teams that we feel are -- will be accretive to the company. And if it fits the right geography, and it's the right team, fits the culture of the bank, then we'll make every effort to continue to bring them in.
This is Cort. Tory has done a great job of hiring in Southern California. That market is so big. I mean, it's a huge market. And we continue to be a great alternative, not only for lenders to come to a bank that's entrepreneurial and has a good solid credit culture, but also for customers, right, who are looking for a bank who's got capacity, who maybe doesn't feel like they're getting the kind of treatment they should get at a larger bank. And so we are a great alternative. We offer a great alternative solution to big banks. And if you're a growing company, and you're growing out of your small bank, we're right in the sweet spot. So there's a lot of growth opportunity.
That was good color. And then just last one for Ron, and I apologize if I misunderstood it, but did you say that accretion is now going to be running through OCI and no longer the P&L?
This is on the trust preferred fair value, so yes, the accretions at discount, which historically has gone in that line -- specific line, with the noninterest income is now going to OCI. But again, I said the accounting was odd, right, because now with 13, 15 years from now, when these things mature and we pay them off at par, we will have taken $100 million or so through OCI. That's got to flip back out to the P&L to get it back in retained earnings, so that's the story.
And that concludes today's question-and-answer session. At this time, I'd like to turn the conference back over to today's presenters for any additional or closing remarks.
Great. Well, I want to thank you for your interest in Umpqua Holdings and your attendance on the call today. This will conclude the call. Goodbye.
Again, that does conclude today's presentation. Thank you for your participation. You may now disconnect.