Columbia Banking System Inc
NASDAQ:COLB
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Columbia Banking System Inc
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Hello and thank you for standing by. Welcome to Columbia Banking System’s Second Quarter 2023 Earnings Conference Call. [Operator Instructions] At this time, I would like to introduce Jacque Bohlen, Investor Relations Director for Columbia to begin the conference.
Thank you, Towanda. Good afternoon, everyone. Thank you for joining us as we review our second quarter 2023 results, which we released shortly after the market closed today. The earnings release and corresponding presentation, which we will refer to during our remarks this afternoon, are available on our website at columbiabankingsystem.com.
With me this afternoon are Clint Stein, President and CEO of Columbia Banking System; Chris Merrywell and Tory Nixon, the Presidents of Umpqua Bank; Ron Farnsworth, Chief Financial Officer; and Frank Namdar, Chief Credit Officer.
After our prepared remarks, we’ll take your questions. During today’s call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the Safe Harbor provisions of federal securities law. For a list of factors that may cause actual results to differ materially from expectations, please refer to Slide 2 of our earnings presentation as well as the disclosures contained within our SEC filings. We will also reference non-GAAP financial measures alongside our discussion of GAAP results. We encourage you to review the GAAP to non-GAAP reconciliations provided in our earnings release and throughout the earnings presentation.
I will now turn the call over to Clint.
Thank you, Jacque. Good afternoon, everyone. It was another productive quarter for Columbia. Merger integration activity remains a heightened priority, but we are nearing its completion as milestones continue to be achieved on or ahead of schedule.
I am pleased to report we have already surpassed $100 million in cost synergies. We remain on track to meet our original target over the next 2 months and additional opportunities beyond $135 million have already been identified. We’re 4 months out from the systems conversion that took place in March, and our teams are benefiting from unified systems, products and services. We have the necessary tools and support to win new business and expand existing relationships as we use our scale to drive revenue synergies across both legacy customer bases. Our enhanced footprint provides new opportunities to deploy successful businesses into new markets, which supports our strategy to drive balanced growth.
However, the current environment is not without its challenges. Our balance sheet is not immune to quantitative actions affecting industry deposit balances and contributing to the modest remix of our deposit base. Our talented associates, service-driven operating model and expansion in newer markets provide us with opportunities and resources to retain our favorable placement within the industry. As I look at our footprint throughout 8 Western states, I’m excited by our prospects to grow our business in each of these markets.
I will now turn the call over to Ron.
Okay. Thank you, Clint. And for those on the call who want to follow along, I will be referring to certain page numbers from the earnings presentation. Starting on Slide 4, we are projecting achievement of $105 million in cost synergies as of June 30. Again, we are well on track to hit the $135 million in annualized target as of September 30 and are targeting a higher number by year-end as we complete the final stages of integration.
Next, on Slide 5. We present the remaining balance of discount marks as compared to the prior quarter and at closing. For the AFS portfolio, the acquired discount was reduced $20 million via accretion to interest income. In our earnings release detail, we include this $20 million along with $17 million of higher bond interest income from the portfolio restructure, we completed post close to arrive at the $37 million of total accretion for bonds. On the loan side, we had $30.5 million of rate accretion and $7.1 million for credit. The total marks declined $75 million in Q2 through a combination of accretion interest income and the loan sale.
Slide 6 covers our liquidity, including deposit flows during the quarter. For comparability, we presented the table on the left as if we were combined for all periods presented. Total deposits declined 1.8% in the second quarter. Market liquidity tightening and the impact of inflation on consumer spending continued to pressure customer deposit balances. We utilize short-term broker deposits and Federal Home Loan Bank borrowings to fund the outflows and maintain the higher on balance sheet liquidity.
The upper right table details our off-balance sheet liquidity with $10.3 billion available as of quarter ahead. Below that, we had cash and excess bond collateral not pledged for loans to arrive a total available liquidity of $18.1 billion. This represents 134% of uninsured deposits as of quarter end.
On the next page, Slide 7, we detailed out the investment portfolio. The upper left table takes you from current par to amortize costs to fair value, knowing the difference between current par and amortized cost is the combined net discount, which will be accretive to interest income over time. The decline in market value this quarter, of course, resulted from slightly higher market yields on the front end of the curve. As you can tell, I’m excited about this portfolio as it does give us significantly higher and stable earnings stream with greater optionality.
The overall book yield was 3.58% with an effective duration of 5.7 as of quarter end. And lastly, we only have $2.4 million in HTM bonds, which represents some CRA-related bonds with no unrealized loss. To better help investors given the combination accounting and moving parts on Slide 8, we provided an updated outlook for 2023 on several key financial statement items.
Our lower NIM assumptions incorporate the second quarter’s funding remix, guided ranges incorporate stability at the upper end of the range and continued remix at the lower end. Our GAAP NIM is further impacted by lower accretion estimates as higher interest rates have slowed prepayment assumptions, delaying the realization of the discount into income. On our expense outlook includes an estimate for the FDIC special assessment we expect to hit in Q3, and we continue to expect the quarterly expense run rate ex CDI in the $240 million to $250 million range in Q4. This run rate includes the realization of all cost savings by September 30 and is unchanged from last quarter’s guide.
Slides 10 through 12 provide summary financials for Q2, but I want to take you forward to Slide 13. Here, we break out Q2 GAAP earnings to help investors understand the non-operating and merger-related impacts and resulting core bank results in the faraway column.
The first column represents our Q2 GAAP fully combined results, with the net income of $133 million or $0.64 per diluted share. The second column includes our non-operating designation for income statement changes mostly related to fair value swings along with $29.6 million of merger costs included in non-interest expense, which are detailed as in the appendix. These net to a $36 million reduction in Q2 earnings, resulting in the third column for operating income. Our operating income for Q3 on a fully combined basis was $169.4 million or $0.81 per diluted share with our return on assets at 1.3% and return on tangible common equity at 21.1%.
The fourth column presents the net effect of the merger accounting, which net to $29 million or $0.14 per diluted share. Taking us to the last column, which showed the core bank, excluding the merger accounting benefit with solid results of $440 million in income or $0.67 per diluted share and 17.5% return on tangible equity. While this is lower than expected when our combination was announced, it reflects higher borrowing costs with Q2 deposit outflows. Even with the higher interest expense, it is great to see the benefit of this combination with a 17.5% return on tangible equity, excluding a net merger accounting benefit.
Now I’m going to reiterate this Page 13 is the key page. The bridge from GAAP reported earnings, isolated non-operating and fair value changes, then the merger-related items of discount accretion and CDI and then to adjusted operating income. The discount accretion will be a steady and reliable source of interest income over time as the majority is driven by rate, not credit, providing with a steady build of capital over time as well. We continue to clearly highlight it here to aid investors in valuing both the accretion and the core bank appropriately. Okay. With that, moving ahead for a couple of more items.
Slide 15 breaks out accretion from net interest income. Slide 16 does the same for the margin. The decline in NIM from the prior quarter and from prior expectations resulted directly from higher borrowing costs to offset the QT field deposit declined. The NIM, excluding PAA for the month of June was 3.26%, slightly under the Q2 level of 3.32%. And the excess liquidity held on balance sheet had a roughly 17 basis point impact on the month of June NIM.
Slide 17 breaks out the repricing and maturity characteristics of the loan portfolio, noting 42% is fixed, 28% is floating and 30% are adjustable. And Slide 18 provides an updated view of our combined interest rate sensitivity under both ramp and shock scenarios. We have taken proactive measures to reduce the balance sheet sensitivity to a future declining rate environment. As you can see here, the trending over the past few quarters where our rates break down where our rates down risks have been reduced significantly. In noted below, we calculate our cycle-to-date funding betas, which are calculated on a combined company basis over the periods presented for comparability. As of the second quarter, our interest-bearing deposit portfolio is priced in 31% of the Fed funds rate increases. Notable here is the cost of interest-bearing deposits, which at 1.83% for the month of June matches the quarter end spot rate of 1.3% highlighting stability.
And finally, in the back on Slide 28, we highlight our regulatory capital position, noting our risk-based capital ratios increased roughly 20 basis points in Q2. We expect to quickly approach our long-term capital targets of 12% on total risk-based capital, which will provide for enhanced flexibility to return excess capital to shareholders.
And with that, I will now turn the call over to Frank.
Thank you, Ron. Turning to Slide 21, origination volume of $1.2 billion in the quarter was offset by prepayments, payoffs and the decision to sell roughly $500 million in non-relationship loans as outlined in our earnings release. Excluding sales and reclassifications to held for sale, loans expanded by 5% on an annualized basis during the quarter.
Slide 22 details select characteristics of our loan portfolio by a major category with added detail surrounding production during the second quarter. Additional industry detail for our commercial portfolio is provided on Slide 23 and Slide 24 provides a number of data points on our office portfolio, given investor focus on this asset category. I encourage you to review it in detail as it provides credit and repricing information on this diversified, granular portfolio that is primarily supported by properties located in suburban markets.
Moving on. Slide 25 highlights our reserve coverage by loan category. Additionally, the remaining credit discount on loans provides a further 25 basis points of loss-absorbing capacity. The $16 million provision expense recorded during the quarter reflects several variables, which include stabilizing credit trends in the FinPac portfolio and reserve release associated with non-relationship commercial loans that were sold and reclassified.
Slide 26 provides an overview of our consolidated credit trends. In general, our credit performance is and has remained positive ex the anticipated trend in FinPac charge-offs. As previously communicated FinPac charge-offs remained elevated during the second quarter, still centered in the trucking sector of the portfolio. Early-stage delinquency trends continue to improve indicative that a plateau has been reached. Charge-offs will retreat at a lag. There is no indication of any spillover to the broader commercial portfolio or other sectors within FinPac. Excluding FinPac, charge-off activity at the bank remains at a very low level.
I’ll now turn the call over to Tory.
Thank you, Frank. Turning to deposits. Slide 27 highlights the quality of our granular deposit base. Market liquidity tightening, the impact of inflation on consumer spending and businesses use of cash contributed to the modest deposit contraction and remix that took place during the second quarter.
Due to the ongoing efforts and expertise of our bankers, we continue to have a very high rate of customer retention. We successfully consolidated 47 branches over a 4-week period in May and June, an extensive planning process, proximity of existing Umpqua Bank branches to locations that were closed, and the outstanding customer service provided by our teams contributed to our ability to execute consolidations without disrupting our customers or impacting accounts in any discernible way.
As Clint highlighted, we are taking strategic actions to further support our focus on relationship banking. The sale of non-relationship loans aligned with our intent to deploy liquidity into business-generating activities that provide more balanced growth opportunities, continued expansion of products and services, like deposit gathering capabilities to support our commercial banking teams and wealth management options within existing and newer markets provides avenues for growth and enhanced company profitability. We continue to add talent across our footprint and our team’s success drives our enthusiasm for future prospects.
I will now turn the call back over to Clint.
Thanks, Tory. Our regulatory capital position is outlined on Slide 28. We remain above both well-capitalized and internal threshold targets. We increased our regular dividend during the second quarter to $0.36 per share, highlighting the foundational strength of our combined organization. And as Ron discussed, we expect capital to continue to accrete quickly in the coming quarters providing us with ample flexibility for future shareholder return.
This concludes our prepared comments. The team is now available to answer your questions. Towanda, please open the call for Q&A.
[Operator Instructions] Our first question comes from the line of Jeff Rulis with D.A. Davidson. Your line is open.
Thanks and good afternoon. Clint, maybe I could just tackle that last comment that you had on capital. It looks like your CET1 target now north of 9% or north of the target, I should say. I guess just fully fleshing that on, I mean, you raised the dividend, but kind of want to see or check in on the attractiveness of the buyback or further from here potentially on the dividend, either an increase or special from here?
Sure. So if you think about the various ratios, the one that is the – I guess, the constraint at the current time is total risk-based capital. Our long-term target for that and it has been for quite a while is 12%. And so we still got a little bit of room to grow into that target and just in general, if you take the regulatory requirements to be well capitalized at 150 basis points. So whatever ratio you are using, that’s going to align pretty closely with how we think about our optimum long-term targets. So we are not there on total risk-based capital yet. But when we do get there and as we have talked over the past couple of quarters and in our prepared remarks, capital will accrete pretty quickly. And all those things you mentioned will be things that we will discuss with our Board and certainly remain distinct possibilities in terms of regular dividend, special dividends and the potential for buybacks, but not in the next quarter or so, I don’t think.
Okay, got it. And then checking in on the, I guess, expectations for deposits in the second half, both deposit flows I guess that’s the first question on balances. The second question would just be your betas either the total beta at 19% or interest-bearing at 31%. I think Ron mentioned maybe some indication of some stability there. I just wanted to check in on your terminal deposit beta expectations. So one part, deposit flows, second part is sort of the terminal beta? Thanks.
Hey, Jeff. Good afternoon. This is Ron. Let me take the last part of that and I’ll turn it back to Tory for the first part. So on the betas, yes we are at the 31% cumulative. Our model is closer to 50%, 53% per the footnotes on that page. But as we’ve said pretty consistently over the last couple of quarters, we expect to be below that by the time we get to the end of this raise in the cycle or at least a couple of quarter lag on the back end of that. So I’d expect continued modest increase in that beta, but staying a little shy of the 50%. Tory?
Yes. I mean if you look at the kind of the flow deposits, we did a lot of analysis over the course of the quarter. I mean I kind of go back to Slide 27, if you look at the granularity of the deposit base, I mean our average consumer deposit is $19,000. Our average commercial deposit is $107,000. And most of the analysis really just shows the flow of cash is normal business usage and some quantitative tightening inflation up, but just kind of normal business activity and normal business usage. So pipelines for us on deposits look really, really strong and as we went through conversion and the teams were out – they have kind of turned their attention outbound and really working hard to generate a lot of activity. So I feel really good about the energy and the activities that are happening in the company on – certainly on the fee income and on the deposit side.
Tory, the inflation and market-related pressure impacting deposit levels, has that abated at all? I guess if we look at early in the second quarter to where we look at early now third quarter, I guess I am looking for 3-month look back, are we in a better spot? Obviously, we have tax season that’s not impacting us seasonally in the second half. But just want to – I know it’s a tough question to answer, but just in firmer footing in terms of that the inflation and market pressure items?
Yes. I think the best way for me to answer that is if I look at the – even the change in the average account balance quarter-over-quarter, it’s from $20,000 on the consumer side to $19,000 in $118 to $117 million. So you just – it’s just a natural flow of cash being used for business activities. Typically for us, the second half of the year, especially because of the ag portfolio, you start to see a run up in deposit balances. So my expectation is if I’m looking at the pipelines and thinking about kind of historical trends, we’ve got some nice momentum for deposit activity in the second half of the year.
Okay, thank you. I’m sorry, one last, just a housekeeping. The outlook slide on the expenses for the $240 million to $250 million run rate. I can’t carve out – you guys kind of talking about opportunistically, you might have more cost synergies than you announced on the deal. Is that inclusive of those additional opportunities? Or are we looking at something lower than $240 million to $250 million and is that timing outside of this calendar year?
Hey, Jeff, this is Ron again. That number does not include the additional above the $135 million. We will talk more about that in the October call once we hit the $135 million outlook for the balance of Q4, we could see going into Q1.
Jeff, this is Clint again. The one thing I would add to that is part of the reason we said early on that we had a higher internal target was the uncertainty around inflation. But also while the merger was pending, we expanded our footprint, and we’re in some new markets, and we’re going to invest in those markets. And so part of that is maybe a reallocation of that expense into expanding in certain parts of our footprint.
Okay, appreciate it. Thank you.
Thank you. [Operator Instructions] Our next question comes from the line of Matthew Clark with Piper Sandler. Your line is open.
Good afternoon, everyone.
Hi, Matt.
Maybe just on the loan sales, I think they were mentioned in your prepared remarks and in the slide deck, any sense for additional sales from here? And just trying to get a sense for whether or not there is deliberate loan sales still to come and flattish loan balances are kind of a reasonable forecast consistent with this quarter?
Hi. This is – It’s Tory again. I don’t really anticipate future loan sales at this point. I mean what we exited from we’re just really transactional participations in larger syndications that just wasn’t the right deployment of capital and liquidity from our perspective. So I think it was a good move for the company and right thing to do and really kind of it’s over and kind of it’s moving forward.
Okay. And then can you address a media report that came out just a couple of weeks ago on multifamily suggesting that Umpqua was getting out of that business? Just want to confirm whether or not that’s true or not?
Yes, it’s Tory again. Definitely not the case and not accurate. We exited the multifamily division, which was a part of the commercial bank that had existed at kind of legacy Umpqua Bank for quite some time, about $3.9 billion to $4 billion in assets, small garden-style apartments, average deal about $2 million, and it was just – we just made the decision that, again, is very transactional, was it in line with the commentary around really strong full relationship banking. And so exited that business. And – but we have many other parts of the company that we will continue to do multifamily lending for our customers in the commercial real estate division in community commercial banking. So we will continue to do lots of multifamily lending. We’re just not doing it through the multifamily division.
Okay, thank you.
Welcome.
Thank you. [Operator Instructions] Our next question comes from the line of Chris McGratty with KBW. Your line is open.
Great, thanks. Ron, maybe a margin question. Looking at your Slide 8, you gave the range of – on a core basis, 3.10% to 3.30% for Q3. And obviously, you talked about the – what would take to get to the high and low end of that. To get to your full year guide of 3.20% to 3.40%, that would imply kind of an exit, if you assume the low end of around 3%. I guess I wanted to take your temperature on your thoughts about that entering 2024. If the Fed stays at high rates, like how do you view the core margin of this company trending once the Fed is done?
Hey, Chris, this is Ron. So again, the Q3 guide, we included in that there is going to be based off of deposit flows in the third quarter, and we sort of talked a bit about it, but we can see how that plays out. I’m not saying that the guide at 3% on an exit velocity basis. This is a blended – this is an annual number, but it also recognizes the fact that the first 2 months of the year was holding standalone. We closed the combination for the month of March and then that’s still given through the year. So one would assume that there are stable deposit flows will be pretty consistent in Q4 as we expect to be in Q3. Again, that’s going to be the determining factor.
Okay. So the 3.10% to 3.30% range for Q3, that could also be the range for Q4 based on – I just want to make sure I got that button up. Is that right?
Very much so. Very much so. And sensitivity within that range will be based off deposit flows. Simple as that.
Understood. Okay. Got it. Thanks. And then on the expenses, I just want to come back to – I know you’ve talked about investing some of the additional savings. Is that kind of what you’re trying to message to us that you may have more to talk about next quarter, but don’t go in putting cost – additional cost saves in the numbers. Is that kind of what you’re trying to message?
Sort of, yes. Chris, this is Clint. Yes, what we stated all along was that we were committed, regardless of what was going on with inflation, tight labor market and everything else to delivering a minimum of $135 million of cost savings to the bottom line. And – but we also were working on other internal opportunities so that we have flexibility to address those issues. And also during that time period, separately Umpqua and Columbia, both expanded into the Phoenix market. Umpqua expanded into the Colorado market and Columbia into the Utah market. And it’s – our commitment is to bank – bring our full scope of services and solutions to those markets. And so part of that just, frankly, is some retail locations and we can essentially kind of just put a rough number out on what each retail location costs us. And so those are ways that by taking that extra amount – and we will tell you as we go kind of – you might read about, let’s say, we established a branch location in Utah. We will put out a press release, you’ll read about it. And then we will talk about, okay, here’s how we offset the cost. So I think that’s how you can expect temerity to go, but it will be outside of the scope of that $135 million that we’ve been talking about.
Okay. That’s helpful. And then if I could just get to a couple of modeling quick ones. On the tax rate, a little help there would be great. And then the special assessment, most of your banks haven’t talked about dropping in the third quarter, at least that I’ve talked to. Is that – I guess that would be in – is that just kind of a one-time or a step-up in the assessment, right?
Chris, this is Ron here. Tax rate target 25%, everyone might be just a little bit above or a little low what we target 25% internally. And on the special assessment of the consensus, that would be expensed once the rule is finalized, we expect that here in the third quarter. And you see all the expense for that in Q3 to be paid out over the course of 2 years.
Okay. Great, thanks.
Thank you.
Thank you. [Operator Instructions] Our next question comes from the line of Steven Alexopoulos with JPMorgan. Your line is open.
Hello, this is Janet Lee on for Steven Alexopoulos. My first question is on NIM. So 3.20% to 3.40% for 2023, that’s a fairly wide range. Can you talk through what level of non-interest-bearing deposit mix is assumed for that low and high end of that guidance? And what’s your bias based on where you stand today in terms of the NIM?
Yes. This is Ron again. And following up just on the comments from earlier. So if we see consistent flows on the deposit side like we saw in Q2 in the third quarter, we’d be on the lower end of that range. If it’s stabilized, we’d be in the middle and if we get better than the upper, same for Q4 from that standpoint. So that’s simply the driver there.
Right. Is there – so relative to 39% of non-interest-bearing deposit mix today, do you think that pace of non-interest-bearing deposit outflows could less it from here? Or will that stay fairly consistent of what you side the second quarter, if you look through the second half of 2023?
Again, I just center back on what we talked about. If we see we see consistent deposit flows, including the mix shift reduction in non-interest-bearing increase in money market in your time, you’d be on the lower end of that range. Third and fourth quarter if it stabilizes, which it has through early – middle of July, but again, it’s only the middle of July, they are still 2 net months ago in the quarter, and that would change. So I hope that’s pretty straightforward, right?
Okay. And for the – if you look at the second half of the year, is there a level of cash you want to maintain on your balance sheet over the near-term versus $3 billion, $4 billion. Are you – would you contemplate any borrowing paydowns versus what you have as of the second quarter over the near-term?
Yes. In a normalized world, my expectations will be cash flow – interest-bearing cash flow would be about half of where they are now. So you get a sense of what we consider the excess on balance sheet. We think it’s prudent in this environment just given the uncertainties within the QT field deposit outflows. And I’d also point out that, that cash is sitting at the Federal Reserve, earning the 5%, 5.25%. So the net effect of that is that additional $1.5 billion is pretty small, talking maybe at $0.06 a penny on a quarterly basis. So we just think it’s prudent to hold that at this point just based off the environment till the outlook clears before we make some moves.
Okay. That’s helpful. And in terms of your reserve levels, assuming no major changes in economic forecast, is the second level reserve ratio a good level you would like to maintain? I understand that reserve releases had some have to do with the loan sales, but in terms of the allowance for loan leases as a percentage of loans.
Yes. I mean based on CECL, right, with the economic forecast, that’s where we feel the reserve should be. I think it all else remains equal, which is a big if, right, up or down. It’ll stay about that level, if not drift down to closer to 1% over time. And when I say 1% over time, when I think about just long-term history of charge-offs and the duration of the loan book, it’s generally going to be about 25 bps over the course of 4 years, would give you at around 100 bps. So we’re a bit above that at this point based in part on the economic forecast based in part on the deal marks, etcetera. So near-term, I’d expect it to stay around the current levels, unless there is a significant change in economic forward.
Okay, thanks. So my last question, how should we think about the loan growth for the rest of 2023?
Hi, Janet, this is Tory Nixon. I think I touched on just briefly earlier, the loan pipeline continues to grow, and we are looking at a lot of really good, strong opportunities in the company throughout our eight Western states. It’s full relationship banking. We’re not making loans for people who don’t put deposits with us, and we don’t provide fee income opportunities for us. So we’re looking at full relationship banking, which is we feel is the best way for us to carry the bank forward. We – I feel we have opportunity to grow the loan book, and it’s going to be mid to low single digits for loan growth. But I think good prudent loan growth that supports relationship growth and relationship banking is what we will continue to do throughout the footprint.
Okay, thank you.
Thank you. [Operator Instructions] Our next question comes from the line of Jared Shaw with Wells Fargo. Your line is open.
Good afternoon, everybody. I guess, maybe looking at the mortgage revenue, how should we be thinking about revenue there with the normalized impact from hedging and the planned MSR sale?
Yes. This is Ron, and I’d say levels will be consistent. Again, assuming rates stay relatively consistent with where they are now. That’s obviously been the big story within mortgage lending over the last 1.5 years. We are targeting that sale of $4.5 billion of MSR just to reduce – continue to reduce future volatility. So that also played into the fact that you didn’t have the MSR fair value gain this quarter because we had locked in that price a bit earlier in the quarter before you saw some of the bond market. So still very much core product and Clint, you want to add to the...
Yes. Thanks, Ron. Jared, I think we’ve settled into a nice place with the pivot from more of a brokerage model into more of a bank model, plenty of coverage out there. I’ll tie it to Tory’s comments around relationships. We’re seeing our customers come in, requesting purchases. It’s granular across the footprint, focusing more on held for sale and less on portfolio, but it’s still products and it’s still out there. We still have some construction lending that’s in the pipeline. That’s going to wind down over the next couple of quarters as well. But I think the team there should be applauded for making the shift, making the transition, and I really like the offering that we have in the current environment.
Great. Thanks.
Thank you. [Operator Instructions] Our next question comes from the line of Brody Preston with UBS. Your line is open.
Hey, good afternoon, everyone. Thanks for taking my questions. I was hoping maybe just a follow-up on the MSR sale. I know you get the capital relief from the reduction in the MSRs. But I just wanted to ask, did you happen to disclose what the gain from the sale of the MSR that you expect to book is just given those are pretty valuable right now?
This is Ron. I’d say we carry that at fair value. So it’s not going to be a gain or loss on sale. We basically priced that $4.5 billion at the locked in sale price, roughly 132 basis points in the overall – the balance of the portfolio – with the overall portfolio at 137 at the quarter end. So there is some liquidity discount that we’ve noticed here when it comes to the market itself with overall where the levels of that asset is, but no additional gain or loss on that component of the MSR when it’s sold.
Okay. Thank you for that clarification. And then I just want to follow-up also on the loans that you sold this quarter. Could you just walk me through maybe the accounting of how that works? I mean, what happened to the marks that were on those loans that you sold if there was a mark? And then was there – was the negative $7 million change in the fair value of certain HFI loans. Was that tied to that loan sale at all?
Yes, Brody, this is Ron again. No, the $7 million was related to a separate portfolio that’s carried at fair value and the fact that rates increase led to the fair value loss, it will flip and become a fair value gain when rates decrease. In terms of the loans that were sold that were marked, we had a roughly $800,000 loss on sale recognized in Q2, there will be about a $900,000 gain on sale recognized in Q3, just given we didn’t get all $0.5 billion of that settled, we had $135 million of it sitting in held for sale, we weren’t able to recognize it. So it will be close to a push, but that just means that the sale price was right on top of our market price in terms of the rate and credit discounts. So, no significant gain or loss on that.
Got it, thank you for that. And then I did just want to follow-up on the NIM guidance, and I hear you on the different scenarios on the mix shift dynamics. But Ron, I think we tried to talk about in the past sort of what you’re assuming for an interest-bearing or a total deposit beta moving forward? It’s obviously not the 50-plus that I’m glad last cycle. So just within that kind of 3.10% to 3.30% NIM guide for the third quarter. I guess, what are you assuming for deposit costs or interest-bearing deposit costs?
We’re assuming the beta to move as it has over the last two quarters. So a small single-digit increase in the overall cumulative beta recognized Q3, Q4, but still stay far shy of 53% by time we get to the end of the year.
Okay. Alright. Great. Thank you very much for that. And then I did just want to follow-up on the mortgage as well the gain on sale margins? It seems like there is some differing dynamics amongst the banks this quarter reporting mortgage results. Is – I guess, is the difference between what we’re seeing maybe with you and some others that have maybe different channels? Is that just a preference between retail origination channels and correspondent origination channels right now?
If you’re referring to gain on sale margin being higher than someone else’s gain on sale margin, yes, that could very much play into it. For example, if it’s wholesale, it’s going to be a lower margin despite the fall because you’re paying a commission to get the loan and to resell it. So our gain on sale margin is relatively consistent around 2.7%, I think, again, that will be subject to volatility in the rate market over the near-term, but we expect a relatively consistent number in that range over the balance of the year.
Got it. Okay. And then just real quick on the expenses that the FDIC special assessment, I think – and maybe I was just quickly doing the math, but it feels – it looks like you’re saying about $30 million is what to expect. So it would kind of be fair to maybe tuck that in as a one-time expense around that area for the third quarter?
We are estimating just a bit underneath that. So, if you take the midpoint of the annual range from last April and you look at our updated guidance now, you are probably talking high $20 million range. So, somewhere in that range, we will see if it gets finalized, and we do expect to expense all of that in the third quarter. So, there won’t be any expense tail on it just be cash paid over time.
Got it. Okay. And then last one for me. Where do you view the normalized level of liquidity for the balance sheet going forward? Our cash balance is still a bit elevated. And I guess if you – if the deposit flows do start to stabilize at all, would you look to kind of maybe use those excess cash balances to pay down some borrowings?
Yes. We talked about this just a couple of minutes ago, right. So ballpark, I think roughly inspiring cash in an ideal world, maybe about half of the level as it is now. We brought on $2 billion back on March 13th, just given the environment just to be conservative in the outlook with the pressure. So, given there is still QT deposit pressure out there, we feel it’s prudent to hold on to that higher level in sparing cash. So, as we see that change, then that target level of on balance sheet cash will change, but it hasn’t happened as of this point. And I would say too, that of that $3 billion in cash are sitting on at the Fed, so that’s – you can see that in to be $1.5 billion or so higher than the ideal world, and that is being carried in the borrowings. When you look at the net cost of that given we got the cash park at the Fed, it’s roughly $0.60 on a quarterly basis. So, a number – a good number, but not material, we think it’s just prudent to hold on to exit liquidity for the time being.
Got it. I guess and one last one real quick. Just within the $6.25 billion that you have in borrowings. How – I guess like what portion of that could kind of quickly get paid down? Like how much of it is short-term that could, in theory get paid down through year-end if you decided to do so?
We kept all of that in that, call it, two-month to four-month tenure. So, the idea that acting like a swap given what that cash flows in the bond portfolio, if you do ever see rates stand in the future. But two months to four months, so a pretty quick turn.
Great. Thank you, guys very much.
Thank you.
Thank you. Please standby for our next question. Our next question comes from the line of David Feaster with Raymond James. Your line is open.
Hi. Good afternoon everybody.
Good afternoon.
Maybe just switching back to the loan side, I appreciate your commentary. Obviously, we are focused on four relationships. We have exited some of the more transactional businesses, I am just curious, it looks like the growth that you did have, excluding the loan sales was pretty broad-based. But where are you still seeing good risk-adjusted returns right now an opportunity to gain those four relationships? Are there any segments or markets where you are seeing more opportunity at this point?
Yes. Hey David, this is Tory again. Certainly, there is a ton of opportunity in the C&I space for us throughout our footprint. So – and we have got really high-quality bankers throughout their eight Western states. And they have great pipelines, great prospects, a lot from within the bank existing customers and then new customers of the company. So, there is a ton of C&I opportunities, a lot of disruption depending on where you go in the footprint in – it’s a great opportunity for us. So, I see – that’s a big focus for us and will continue to be. What comes with a C&I lending opportunity is going to be non-interest bearing deposits, other deposits, good core fee income kind of everything we are looking for.
Okay. That makes sense. And then maybe just following up kind of on Clint’s comments a bit earlier about the branch locations and supporting the hires that you have made, I guess what’s your appetite for additional hiring? I mean there has been a lot of disruption and dislocation around you. Is that – are you seeing opportunities for – would it be more focused on the C&I front? Are there any new segments that you would be interested in expanding into? I am just curious how you think about that. And is it more market expansion, or would it be kind of infill as we look at some of the expansion? Is it infill or truly market expansion at this point?
Hey David, this is Clint. The answer is yes to all of those. We are always on the lookout for quality bankers that can help us grow our franchise long-term. And that’s in the newer markets. I mean that’s how even with the pending merger of the size and magnitude that we had we were able to attract top talent in new markets and expand into Arizona, Utah and Colorado. And so with the disruption, yes, there are some opportunities. I am going to pass it over to Tory and Chris and let them talk about maybe some of the more specific things that they are focused on.
Yes. Thanks Clint. And David, this is Chris. Quickly on your last question, I would say there is a little bit of growth, as I mentioned, in that mortgage part of the portfolio of construction. So, that goes along with the commercial side. As far as locations and segments, I think we have talked over the years about the best time to hire somebody is when they are available and they are ready versus putting postings out there and trying to go into a market and build on that. And I think you find the best quality bankers. So, reiterating what Clint said, the answer is yes. Now, with some – in that, we are looking at the newer markets of – and we should have things out there soon around Utah, Arizona, and follow-up with Colorado for some locations to support our bankers, as Tory mentioned earlier. And then from there, we do see some infill opportunities, and we are getting our hands around some of the opportunities in Southern California market and things of that nature. It will look a little different. It will be branches to support our commercial efforts, our small business efforts. And you won’t see as many or the density that you would pick up in the Northwest. But yes from there, we are pretty excited about those opportunities. And I will kick it over to you, Tory.
I don’t think I have much to add. We got a great company with a great opportunity and people want to work here. And it’s the fun story to tell and looking forward to us to continue to grow the organization.
Yes. I think with our model and what we put together, you are really seeing opportunities where people are intrigued to join up our size with our capabilities and then ultimately, with our philosophy of how we go to market as a community bank of scale.
That’s helpful. And I am just curious, I guess what kind of branches are you looking to roll out? I mean is it more prototypical branches? Are we looking at smaller footprints? And then where does that kind of NeighborHub playing in this? That was the concept that you guys had been dabbling with? I am just curious kind of what is the branches that you are looking to expand look like?
They will certainly be smaller. That’s anything that we have done where we have had the opportunity to move a lease, things of that nature. We downsized considerably. Typically, it’s more of an open concept, walk in and see a teller to go along with that NeighborHub concept. We have some things we call financial hubs that are very similar, but they house other types of bankers in there with it. NeighborHub specifically, there are certainly opportunities. It requires a neighborhood that is a fairly dense walkable things of that nature, and we are always on the lookout for it. The last one we opened was in Boise, and it’s right in the downtown core, and it’s fantastic if you are over there, check it out.
That’s helpful. And then maybe just touching on credit more broadly, I mean obviously, we talked about FinPac. But outside of that, I mean credits held up pretty well. I mean, NPAs are steady classified assets were down. I am just curious as you look at your portfolio, is there anything that you are seeing that’s causing you any concern, or as you look into your crystal ball, I guess how do you think about credit going forward? And what are you watching perhaps more closely and maybe tighten standards the most?
Hey David, this is Frank. Yes, our portfolio certainly has held up very well. And I personally am not surprised by it. I think what we continue to watch is, yes, you see some of the lower-margin small businesses and consumers. You are seeing delinquencies start to tick up there. But we have got our eyes on that. But quite honestly, I mean there are no – there are no big cracks developing. I am certainly watching the CMBS space as it relates to office as those CMBS pools begin to mature and valuations are completed, and we are seeing lower valuations. We don’t have the direct exposure there, but certainly on maturing obligations, we are cognizant of the potential impact that could have on valuations and resizing deals within our portfolio. We don’t see that as an issue right now based upon the leverage-averse nature of our portfolio, but that’s something we are watching very closely.
Alright. That’s helpful. Thanks everybody.
[Operator Instructions] Our next question comes from the line of Andrew Terrell with Stephens. Your line is open.
Hi. Good afternoon.
Good afternoon.
Maybe just sticking on the last point on credit and then in office specifically, loan to values are really low at 57%. The book is obviously incredibly granular and more suburban-focused. But I was curious, have you had any borrowers in the portfolio where you have go to the process of reappraising the loan in the past quarter, or just more broadly, as you look at appraisals or valuations that are coming up in the market, have you noticed any kind of trend or a level that valuations are declining for office properties or any kind of trends you can speak to there would be helpful.
Yes. Andrew, it’s – they are moving very slowly. We just had one. We just refinanced actually one in our portfolio with no issue. So, it’s kind of surprising how really relatively slowly cap rates and valuations are moving. But other than that, no, we haven’t seen anything materially concerning or stressful in terms of rewriting some of these deals as they mature.
Okay. I appreciate the color. And then on FinPac specifically, I think last quarter we talked about being a potential plateau in loss rates after they had accelerated. And we clearly saw a step up again this quarter. I guess can you give any color? I know it was trucking related, but were there a couple of larger deals within the portfolio that you charged off in this quarter? And can you maybe just help give us some color on why the plateau has occurred here or the FinPac loss rates should level off or potentially decline?
Sure. We have guided this every quarter. But when you look at – if you look at year-end ‘22 12/22 quarter, and compare the 31-day delinquencies, 31-day to 60-day delinquencies from that period to 6/30, they are now down 25%. When you look at 91-day and over delinquencies, they are now over 30% reduced. And that sort of trend has been happening quarter-over-quarter since 12/22. So and when you look at the – especially the later-term delinquencies, they are now reducing the earlier term delinquencies are reducing in that space and so that – this portfolio is extremely predictive in that regard. And so that’s why I feel fairly comfortable in saying that that plateau has very likely been reached, and we should see a decline from this point forward. And the loss numbers that $25 million in losses in its impact portfolio, 60% of it has been related to the trucking portfolio as with the delinquencies. So, if you take 60% off that $25 million, you are left with $10 million, and that’s kind of the sweet spot of where FinPac operates. So, things are looking as expected within that portfolio to me.
Great. That’s very helpful. I appreciate it.
Sure.
And then maybe a quick one for Ron, just going back to kind of discussion around the securities portfolio and then the borrowing position as well. I understand kind of having the flexibility within the marked bond portfolio or the bonds in a gain position specifically. But I guess with a little over $6 billion of borrowings at our 5.25% costs and potentially moving higher next week, given those are shorter term. I guess looking at like the spot yields on particularly the $2.2 billion of securities in a gain position at 6.30%, a yield of 4.30% on those the gain – the bonds in a gain position. I guess why not start to unwind or sell some of those bonds and pick up, I don’t know, 100-plus basis points on the margin and it would obviously be accretive to NII as well. I guess I appreciate some of the flexibility you have got, but given the kind of underwater nature right now, why not unwind some of that trade?
Well, this is Ron here. So obviously, though we took the discount through capital to get there, if I sell the bonds at these levels, and I am not going to recapture that. So, I am very much looking at that more as a capital return over time from that standpoint. And the borrowings, we have got the flexibility to maintain those for the time being, including the increase it need be over time. So, too early to talk about selling off bonds at the discounted prices. I much other have when I have a discount come back and accrete to income over time.
Okay. Understood. I appreciate it.
Thank you.
Thank you. Please standby for our next question. We have a follow-up question from the line of Jared Shaw with Wells Fargo. Your line is open.
Hey. Thanks for the follow-up. Maybe just a question on the health of the markets, we are hearing a lot about some of the strain in Portland and some of the other cities. How is that – how are your customers being impacted by that? Are you seeing more business moving in the suburbs, or are you actually seeing businesses and people leaving the area and moving somewhere else?
I think there is a little bit of all of that that’s occurring. So, I think in the core downtown section of, say, Portland, businesses have moved to the suburbs. Umpqua Bank is a great example of that. We have seen some of that also in Seattle. But I will say this probably isn’t a good measure, but the MLB All-Star events were in Seattle last week, and the city showed pretty well. And it’s a cruise season for the Alaska cruises that leave from Seattle. And so there is quite a bit of tourism that’s going on. So, there is a little more vibrancy, but I don’t think it’s businesses that are housed in those core downtown office towers. Likewise, last night, we had dinner in a section of Downtown Portland, and it was pretty vibrant. But it was more in the Pearl District area and that tends to – that hasn’t really had the same impact that for section that you saw on the news with 79th of riots or whatever it was. So, I would say I am more optimistic on the core downtowns, but I think that they still have a challenging path ahead of them. The suburbs remain pretty vibrant and throughout our footprint. So during the quarter Chris, Tory, Frank and myself, I think we visited customers in six states of our eight states and a host of different industries and different sizes. And they are all very optimistic and their businesses are doing well. And I think that’s where you would have seen some of the optimism in Tory’s response to the outlook for loans and then by default deposits because of the relationship focus that we have. It’s a product of being out and seeing what still pretty vibrant markets. So, I don’t know if we end up with a soft landing. I don’t know if anybody does. When it is, it’s the recession that’s never come, but we are seeing a lot of positive things from our customers. And I think that’s also why you see the credit metrics. And absent that one little sector of kind of mom-and-pop trucking operations in FinPac, the credit portfolio continues to perform very, very well. I don’t know, Tory, Chris, if you want to add anything?
No. I mean I think you are spot on. I think the granularity of our markets, we have customers in big urban markets and suburbs of those markets. And we have a lot of customers in rural parts of the West. And there is so much variety that it’s great for the bank. It’s great for our balance sheet, and it’s great for our earnings stream. And to Clint’s point, going out and visiting all of these customers, the one very consistent takeaway is how well everybody is doing and it’s great to see. And it’s – from what you read sometimes in media versus what you get with boots on the ground, talking to people is very different.
Okay. Thank you.
Thank you. Ladies and gentlemen, I am showing no further questions in the queue. I would now like to turn the call back to Jacque Bohlen for closing remarks.
Thank you, Towanda. Thank you for joining this afternoon’s call. Please contact me if you would like clarification on any of the items discussed today are provided in our earnings material. This will conclude our call. Bye.
Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.