CORPORATE PROFILEBanner Corporation is a dynamic banking organization that has developed a significant and expanding regional franchise throughout the Pacific Northwest. Formed in 1995, Banner Corporation is the holding company for Banner Bank, a Washington-chartered commercial bank headquartered in Walla Walla, Washington, with roots that date back to 1890. In 2007, the Company acquired Islanders Bank, which operates in Washington’s San Juan Islands. Banner Bank and Islanders Bank strive to deliver a high level of individualized service as community banks while offering advantages available from being part of a larger financial institution. The Company’s leadership consists of an experienced executive management team headed by President and CEO, Mark J. Grescovich. Banner Corporation aims to be the premier Pacific Northwest banking franchise. Serving a growing and prosperous region with a full range of deposit services and business, commercial real estate, construction, residential, agricultural and consumer loans, the Company provides community banking services through a combined total of 88 branch offices and seven loan offices located in 29 counties of Washington, Oregon and Idaho. The Company’s employees take pride in extending the highest levels of service, convenience, and banking knowledge to their clients. Banner Bank and Islanders Bank are members of the Federal Home Loan Bank of Seattle and their deposits are insured by the Federal Deposit Insurance Corporation. Banner Bank and Islanders Bank are wholly-owned subsidiaries of Banner Corporation. Banner Corporation common stock is traded over the counter on The NASDAQ Stock Market® under the symbol “BANR.” This document, together with the Company’s Form 10-K, represents the annual report to shareholders of Banner Corporation.Banner Bank - 2012 Annual Report OUTSIDE COVER | w/1/4” bleed: 17.5” x 11.25” (inludes 1/4” backbone), cover trims to: 8.25” x 10.75” | Agency: Uppercut Advertising, agency contact: Laurie Jaglois office: 206-623-3308. cell: 425-922-6490 laurie@uppercutadvertising.com BANNER CORPORATION 2012 ANNUAL REPORTCorporate Headquarters: 10 South First Avenue, P.O. Box 907Walla Walla, WA 99362-0265509-527-3636 | 800-272-9933 bannerbank.com bannerbank@bannerbank.comBetter ideas. Better banking. Fellow Shareholders,
We sometimes complain when we think our lives never change from
day to day or year to year. When unwelcome changes come along,
though, we long for those ordinary days. In banking, we certainly
have not returned to some golden period of the past. But as there
continue to be uncertainties and difficulties, at Banner at least, we
seem to be returning to some familiar patterns. Rather than having
to invest major resources to overcome threats to our franchise, we
are spending our time doing what high performing financial
institutions do— providing all our clients value added financial
solutions through convenient delivery channels and capable bankers.
In what should become familiar and routine to you, I am pleased to
report that Banner Corporation’s financial results for the year ended
December 31, 2012 reflect a year of significant accomplishment. We
improved core performance, showing consistent and sustained
profitability. We achieved a moderate risk profile with steady
improvements in credit quality. We retired the Series A Preferred
Stock and welcomed the termination of regulatory actions by the
FDIC, Washington State Division of Banks and Federal Reserve Bank
of San Francisco. These accomplishments underscore the hard work
of our employees throughout the Company and their dedicated
focus on the execution of strategies and priorities to deliver
sustainable results. Our return to profitability for the last seven
quarters demonstrates that our strategic plan is effective as we
continue to strengthen the franchise and build shareholder value.
For the year 2012, Banner Corporation reported a net profit
available to common shareholders of $59.1 million or $3.16 per share
compared to a net loss of $2.4 million or a loss of $0.15 per share in
2011. Looking at earnings before tax, preferred stock dividends and
discount accretion, Banner’s net income improved to $40.1 million
or $2.14 per share compared to $5.5 million or $0.33 per share in
the prior year.
Our operating performance showed generally consistent
improvement quarter by quarter on key metrics when compared to
a year ago. Revenues from core operations increased by 8% to $211.4
million, a record for the Company, driven by significant improvement
in our net interest margin and resulting net interest income as well
as solid deposit fee revenues fueled by growth in core deposit
accounts and strong mortgage banking revenues. These results are
especially impressive as the low interest rate environment continues
to reflect a sluggish economy, making revenue growth particularly
challenging for banks.
This steady improvement demonstrates the value of our super
community bank strategy implemented in 2010. It is reducing our
funding costs by remixing our deposits away from high-priced
certificates of deposit, growing new client relationships, and
improving our core funding position. In 2012, our non-interest-
bearing deposits increased by 26% and our core deposits increased
by 14%, reflecting solid growth in the number of accounts and
customer relationships. It is noteworthy that this represents organic
growth within our existing 88-branch network. As a result of the
growth in transaction and savings accounts and planned reductions
in higher cost certificates of deposit, core deposits increased to 71%
of total deposits at 2012 year end compared to 64% a year earlier.
It gives me great pleasure to write that we can now fairly
characterize Banner’s credit risk profile as moderate. As you know,
our priority focus for several years has been to improve the risk
profile of Banner and aggressively manage our troubled assets.
Achieving this goal is the result of tremendous hard work and
creativeness by our bankers and workout teams. Through their
dedicated efforts, our non-performing assets have been reduced
by 83% over the past three years and now represent just 1.18% of
total assets compared to 6.27% at the end of 2009.
I want to make special mention of the significant reduction in real
estate owned (REO) as a notable success during 2012. Banner’s
special assets team reduced REO by 63% from $43 million at
December 31, 2011 to $16 million at December 31, 2012. REO sales
were nearly $41 million in 2012 and resulted in net gains on sale of
$4.7 million, demonstrating the team’s proficiency with regard to
both valuation and liquidation.
of 2012, the coverage of our allowance for loan and lease losses to
non-performing loans increased to 225%, despite a significant
reduction in the provision for loan and lease losses, and the ratio of
the allowance to total loans was 2.39%. Further, our capital position
and liquidity are extremely strong. Our total capital to risk-weighted
assets ratio was 16.96%, our tangible common equity ratio improved
to 11.80% and our loan-to-deposit ratio was 91%. As a result, our
balance sheet is one of the strongest in the banking industry. This
will provide considerable flexibility with regard to capital
management strategies going forward.
Throughout 2012 we continued to invest in our franchise, adding
talented commercial, retail and mortgage banking personnel to our
Company in all of our markets, and we continued to invest in further
developing and integrating all our bankers into Banner’s new credit
and sales culture. The “Banner Way” sales management process
within the retail division and the disciplined calling efforts and
responsiveness of all of our bankers are resulting in a consistent
pipeline of new business and lending opportunities. Our customer
service model places clients’ interests at the forefront, with a focus
on retaining clients and expanding relationships that will ultimately
drive revenue growth. These efforts are yielding very positive results
as evidenced by our strong account growth and record mortgage
banking revenues and cross-sell ratios. Our 13th consecutive quarter
of year-over-year increases in revenues from core operations serves
as affirmation of our course. Moreover, we have received
marketplace recognition, which we believe reflects this progress, as
J.D. Power and Associates ranked Banner Bank as “Highest
Customer Satisfaction with Retail Banking in the Northwest Region.”
Our persistent focus on improving the risk profile of Banner and
our successful execution of our strategic turnaround plan has now
resulted in seven consecutive quarters of profitability. With
confidence in the sustainability of our future profitability along with
our commitment to prudently manage capital, we chose to
repurchase all of our Series A Preferred Stock in private transactions
and a final redemption on December 24, 2012, resulting in an
average price slightly below net book value.
Among other accomplishments during the year, we expanded
specialty lending products, resulting in record SBA loan production
and sales, completed a project to upgrade the entire Company’s
communication system, enhancing performance and significantly
reducing costs, and continued investing in our workforce through
the launch of a wellness program.
In closing, I would like to congratulate my colleagues throughout
the Company and thank them for their hard work and focus on
executing the strategic plan. Our performance in 2012 demonstrates
that we are making substantial and sustainable progress in
improving core operating performance, growing the client base,
extending the franchise through market share gains and building
shareholder value.
In addition, I want to thank Mr. Edward Epstein, who is retiring from
our Board of Directors this year, for his steadfast contribution to
Banner over his ten years of service and his personal commitment
to provide me counsel through this turnaround.
Thank you for your continuing interest in and commitment to
Banner. While we are understandably pleased with our results for
2012, we are committed to remaking the Company into a high
performance Bank. For the coming year, we will focus on enriching
the experience of Banner’s clients, improving operational efficiency
and increasing shareholder returns. We have largely completed the
task of strengthening the foundation of the Company and have
turned our strategic priorities toward optimizing the franchise value
of Banner Corporation. We believe we have made good progress in
2012 and look forward to reporting further improvements in 2013.
Although 2012 credit costs were still above our long-term goal, since
initiating our turnaround plan we have reduced problem assets
significantly while maintaining substantial reserve levels. At the end
Mark J. Grescovich
President & Chief Executive Officer
Banner Corporation & Banner Bank
CORPORATE HEADQUARTERS
10 South First Avenue
P.O. Box 907
Walla Walla, WA 99362-0265
509-527-3636
800-272-9933
Web site: www.bannerbank.com
E-mail: bannerbank@bannerbank.com
SUBSIDIARIES
Banner Bank - bannerbank.com
Islanders Bank - islandersbank.com
Community Financial Corporation
TRANSFER AGENT and REGISTRAR
Computershare Trust Company, N.A.
P.O. Box 43036
Providence, RI 02940
INDEPENDENT PUBLIC
ACCOUNTANTS and AUDITORS
Moss Adams LLP
805 SW Broadway, Suite 1200
Portland, OR 97205
SPECIAL COUNSEL
Breyer & Associates PC
8180 Greensboro Drive, Suite 785
McLean, VA 22102
ANNUAL MEETING of SHAREHOLDERS
10 a.m., Tuesday, April 23, 2013
Marcus Whitman Hotel
6 West Rose Street
Walla Walla, WA 99362
DIVIDEND PAYMENTS SENT QUARTERLY
Dividend payments are reviewed quarterly by
the Board of Directors and, if appropriate and
authorized, have historically been paid during
the months of January, April, July and October.
To avoid delay or lost mail, and to reduce costs,
we encourage you to request direct deposit of
dividend payments to your bank account.
To enroll in the Direct Deposit Plan, telephone the
Company’s Investor Services Department at
800-272-9933.
DIVIDEND REINVESTMENT and
STOCK PURCHASE PLAN
Banner Corporation offers a dividend
reinvestment program whereby shareholders
may reinvest all or a portion of their dividends
in additional shares of the Company’s common
stock. Information concerning this optional
program is available from the Investor Services
Department or from Computershare Investor
Services at 800-697-8924.
INVESTOR INFORMATION
Shareholders and others will find the Company’s
financial information, press releases and other
information on the Company’s web site at
www.bannerbank.com. There is a direct link from the
web site to the Securities and Exchange Commission
(SEC) filings via the EDGAR database, including
Forms 10-K, 10-Q and 8-K.
Shareholders may contact:
Investor Relations, Banner Corporation
P.O. Box 907
Walla Walla, WA 99362
or call 800-272-9933 to obtain a hard copy
of these reports without charge.
DIRECTORS
Robert D. Adams
Gordon E. Budke
Edward L. Epstein
Jesse G. Foster
Mark J. Grescovich
D. Michael Jones
David A. Klaue
Constance H. Kravas
Robert J. Lane
John R. Layman
Brent A. Orrico
Gary Sirmon
Michael M. Smith
EXECUTIVE OFFICERS
Mark J. Grescovich,
President and Chief Executive Officer
Lloyd W. Baker
EVP and Chief Financial Officer
Richard B. Barton
EVP, Chief Lending Officer
Douglas M. Bennett
EVP, Real Estate Lending Operations
Tyrone J. Bliss
EVP, Risk Management and Compliance Officer
Cynthia D. Purcell
EVP, Retail Banking and Administration
James T. Reed, Jr.
SVP, West Region Commercial Banking
M. Kirk Quillin
SVP, East Region Commercial Banking
Steven W. Rust
EVP and Chief Information Officer
Gary W. Wagers
EVP, Retail Products and Services
John T. Wagner
EVP, Corporate Administration
Banner Bank - 2012 Annual Report INSIDE COVER | w/1/4” bleed: 17.5” x 11.25” (inludes 1/4” backbone), cover trims to: 8.25” x 10.75” | Agency: Uppercut Advertising, agency contact: Laurie Jaglois office: 206-623-3308. cell: 425-922-6490 laurie@uppercutadvertising.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2012
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________to __________
Commission File Number 0-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
Washington
(State or other jurisdiction of incorporation
or organization)
91-1691604
(I.R.S. Employer
Identification Number)
10 South First Avenue, Walla Walla, Washington 99362
(Address of principal executive offices and zip code)
Registrant’s telephone number, including area code: (509) 527-3636
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share
(Title of Each Class)
The NASDAQ Stock Market LLC
(Name of Each Exchange on Which Registered)
Securities registered pursuant to section 12(g) of the Act:
None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act Yes __ No X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act Yes __No X
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes X No ____
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such files) Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained,
to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or
any amendment to this Form 10-K. ____
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer ____
Accelerated filer X
Non-accelerated filer ____
Smaller reporting company ____
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes ____No X
The aggregate market value of the voting and nonvoting common equity held by nonaffiliates of the registrant based on the closing sales price
of the registrant’s common stock quoted on The NASDAQ Stock Market on June 30, 2012, was:
Common Stock - $402,237,057
(The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the Registrant
that such person is an affiliate of the Registrant.)
The number of shares outstanding of the registrant’s classes of common stock as of February 28, 2013:
Common Stock, $.01 par value – 19,455,023 shares
Documents Incorporated by Reference
Portions of Proxy Statement for Annual Meeting of Shareholders to be held April 23, 2013 are incorporated by reference into Part III.
BANNER CORPORATION AND SUBSIDIARIES
Table of Contents
PART I
Item 1.
Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recent Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lending Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Asset Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deposit Activities and Other Sources of Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Personnel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management Personnel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 1A. Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 2.
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 3.
Mine Safety Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities . . . . . .
Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . .
Executive Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Comparison of Financial Condition at December 31, 2012 and 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Comparison of Results of Operations
Year ended December 31, 2012 and 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year ended December 31, 2011 and 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Market Risk and Asset/Liability Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liquidity and Capital Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Capital Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of Inflation and Changing Prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Contractual Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 7A. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 8.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . .
Item 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters . . . . . . . . . . . . . . .
Certain Relationships and Related Transactions, and Director Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Principal Accounting Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART IV
Page
4
4
5
6
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12
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13
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21
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33
35
38
38
43
60
68
71
76
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77
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79
79
Item 15.
Exhibits and Financial Statement Schedules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
80
81
2
Forward-Looking Statements
Certain matters in this Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995. These statements relate to our financial condition, liquidity, results of operations, plans, objectives, future performance or
business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use
of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,”
“outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements
include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic
performance and projections of financial items. These forward-looking statements are subject to known and unknown risks, uncertainties and
other factors that could cause actual results to differ materially from the results anticipated or implied by our forward-looking statements,
including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-
offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial
real estate markets and may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan
losses not being adequate to cover actual losses and require us to materially increase our reserves; changes in general economic conditions, either
nationally or in our market areas; changes in the levels of general interest rates and the relative differences between short and long-term interest
rates, loan and deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold
homes, land and other properties and fluctuations in real estate values in our market areas; secondary market conditions for loans and our ability
to sell loans in the secondary market; results of examinations of us by the Board of Governors of the Federal Reserve System (the Federal Reserve
Board) and of our bank subsidiaries by the Federal Deposit Insurance Corporation (the FDIC), the Washington State Department of Financial
Institutions, Division of Banks (the Washington DFI) or other regulatory authorities, including the possibility that any such regulatory authority
may, among other things, institute a formal or informal enforcement action against us or any of the Banks which could require us to increase
our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds, or maintain or increase
deposits, or impose additional requirements and restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or
regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory
capital or other rules, including as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the
implementing regulations; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating
costs and expenses; the use of estimates in determining fair value of certain of our assets and liabilities, which estimates may prove to be incorrect
and result in significant changes in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations
in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; the
failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs
and effects of litigation, including settlements and judgments; our ability to implement our business strategies; our ability to successfully integrate
any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related
revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency
rates; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the
availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our
common stock and interest or principal payments on our junior subordinated debentures; adverse changes in the securities markets; inability of
key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial
institution regulatory agencies or the Financial Accounting Standards Board including additional guidance and interpretation on accounting
issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic,
competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and other risks detailed
from time to time in our filings with the Securities and Exchange Commission, including this report on Form 10-K. Any forward-looking
statements are based upon management’s beliefs and assumptions at the time they are made. We do not undertake and specifically disclaim any
obligation to update any forward-looking statements included in this report or the reasons why actual results could differ from those contained
in such statements, whether as a result of new information, future events or otherwise. These risks could cause our actual results to differ
materially from those expressed in any forward-looking statements by, or on behalf of, us. In light of these risks, uncertainties and assumptions,
the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements.
As used throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to Banner Corporation and its consolidated subsidiaries,
unless the context otherwise requires. All references to “Banner” refer to Banner Corporation and those to “the Banks” refer to its wholly-owned
subsidiaries, Banner Bank and Islanders Bank, collectively.
3
Item 1 – Business
PART 1
General
Banner Corporation (the Company) is a bank holding company incorporated in the State of Washington. We are primarily engaged in the business
of planning, directing and coordinating the business activities of our wholly-owned subsidiaries, Banner Bank and Islanders Bank. Banner Bank
is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and, as of December 31,
2012, its 85 branch offices and seven loan production offices located in Washington, Oregon and Idaho. Islanders Bank is also a Washington-
chartered commercial bank that conducts business from three locations in San Juan County, Washington. Banner Corporation is subject to
regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board). Banner Bank and Islanders Bank (the Banks)
are subject to regulation by the Washington State Department of Financial Institutions, Division of Banks (the DFI) and the Federal Deposit
Insurance Corporation (the FDIC). As of December 31, 2012, we had total consolidated assets of $4.3 billion, net loans of $3.2 billion, total
deposits of $3.6 billion and total stockholders’ equity of $507 million.
Banner Bank is a regional bank which offers a wide variety of commercial banking services and financial products to individuals, businesses
and public sector entities in its primary market areas. Islanders Bank is a community bank which offers similar banking services to individuals,
businesses and public entities located primarily in the San Juan Islands. Our primary business is that of traditional banking institutions, accepting
deposits and originating loans in locations surrounding our offices in portions of Washington, Oregon and Idaho. Banner Bank is also an active
participant in the secondary market, engaging in mortgage banking operations largely through the origination and sale of one- to four-family
residential loans. Lending activities include commercial business and commercial real estate loans, agriculture business loans, construction and
land development loans, one- to four-family residential loans and consumer loans. A portion of Banner Bank’s construction and mortgage lending
activities are conducted through its subsidiary, Community Financial Corporation (CFC), which is located in the Lake Oswego area of Portland,
Oregon. Our common stock is traded on the NASDAQ Global Select Market under the ticker symbol “BANR.”
Since becoming a public company in 1995, we have invested significantly in expanding our branch and distribution systems with a primary
emphasis on strengthening our market presence in our five primary markets in the Northwest. Those markets include the four largest metropolitan
areas in the Northwest: the Puget Sound region of Washington and the greater Boise, Idaho, Portland, Oregon, and Spokane, Washington markets,
as well as our historical base in the vibrant agricultural communities in the Columbia Basin region of Washington and Oregon. Our aggressive
franchise expansion during this period included the acquisition and consolidation of eight commercial banks, as well as the opening of 28 new
branches and relocating ten others. Over the past ten years, we also invested heavily in advertising campaigns designed to significantly increase
the brand awareness for Banner Bank. These investments, which have been significant elements in our strategies to grow loans, deposits and
customer relationships, have increased our presence within desirable marketplaces and allow us to better serve existing and future customers. This
emphasis on growth and development resulted in an elevated level of operating expenses during much of this period; however, we believe that
the expanded branch network and heightened brand awareness have created a franchise that we believe is well positioned to allow us to successfully
execute on our super community bank model. That strategy is focused on delivering customers, including middle market and small businesses,
business owners, their families and employees, a compelling value proposition by providing the financial sophistication and breadth of products
of a regional bank while retaining the appeal and superior service level of a community bank.
Despite weak economic conditions and ongoing strains in the financial and housing markets, Banner Corporation's successful execution of its
strategic turnaround plan and operating initiatives ,which resulted in our return to profitability in 2011, continued in 2012 and delivered noteworthy
results as evidenced by our solid profitability for the year ended December 31, 2012. We achieved substantial progress on our goal to position
the Company with a moderate risk profile and to maintain that profile and earnings momentum going forward. Highlights for the year included
further improvement in our asset quality, additional customer account growth, significantly increased non-interest-bearing deposit balances and
strong revenues from mortgage banking operations. As a result, substantially reduced credit costs, significant improvement in our net interest
margin and strong non-interest revenues all contributed to meaningfully increased profitability in 2012. Also notable during the year was the
repurchase and retirement of all of our Series A Preferred Stock. We realized gains of $2.5 million on these repurchase transactions. For the
year ended December 31, 2012, we had net income of $64.9 million which, after providing for the preferred stock dividend, related discount
accretion and gains on repurchases of preferred stock, resulted in a net income available to common shareholders of $59.1 million, or $3.16 per
diluted share, compared to a net income of $5.5 million which, after providing for the preferred stock dividend and related discount accretion,
resulted in a net loss to common shareholders of $2.4 million, or ($0.15) per diluted share for the year ended December 31, 2011.
Our return to consistent profitability was punctuated in 2012 by management's decision to reverse the valuation allowance against our deferred
tax assets. For the year ended December 31, 2012, the elimination of the deferred tax asset valuation allowance, combined with the Company's
pre-tax income, resulted in a net tax benefit of $24.8 million which significantly added to our net income for the year. The decision to reverse
the valuation allowance reflects our confidence in the sustainability of our future profitability. Further, as a result of our return to profitability,
including the recovery of our deferred tax asset, our improved asset quality and operating trends, strong capital position and our expectation for
sustainable profitability for the foreseeable future, we also significantly reduced the credit portion of the discount rate utilized to estimate the
fair value of the junior subordinated debentures issued by the Company. As a result, the estimated fair value of our junior subordinated debentures
increased by $23.1 million during the year, accounting for most of the $16.5 million net charge before taxes for fair value adjustments for the
year ended December 31, 2012. Changes in these two significant accounting estimates, while substantial, represent non-cash valuation adjustments
that have no effect on our liquidity or our ability to fund our operations.
4
Although economic conditions have improved from the depths of the recession resulting in a material decrease in credit costs in recent periods,
the pace of recovery has been modest and uneven and ongoing stress in the economy, reflected in high unemployment, tepid consumer spending,
modest loan demand and very low interest rates, will likely continue to create a challenging operating environment going forward. Nonetheless,
over the past two years we have significantly improved our risk profile by aggressively managing and reducing our problem assets, which has
resulted in lower credit costs and stronger revenues, and which we believe will lead to further improved operating results in future periods.
Our provision for loan losses was $13.0 million for the year ended December 31, 2012, compared to $35.0 million in 2011 and $70 million in
2010. The decrease from a year earlier reflects significant progress in reducing the levels of delinquencies, non-performing loans and net charge-
offs, particularly for loans for the construction of one- to four-family homes and for acquisition and development of land for residential properties.
From 2008 through 2011, higher than historical provision for loan losses was the most significant factor adversely affecting our operating results;
however, the substantial decrease in non-performing assets resulted in much lower provisioning in 2012 and the expectation of more normal
levels going forward. (See Note 6, Loans Receivable and the Allowance for Loan Losses, as well as “Asset Quality” below in this Form 10-K.)
Aside from the level of loan loss provision, our operating results depend primarily on our net interest income, which is the difference between
interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities,
composed primarily of customer deposits and borrowings. Net interest income is primarily a function of our interest rate spread, which is the
difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average
balances of interest-earning assets and interest-bearing liabilities. Our net interest income before provision for loan losses increased to $167.6
million for the year ended December 31, 2012, compared to $164.6 million for the same prior year, primarily as a result of expansion of our net
interest spread and net interest margin due to a lower cost of funds and a reduction in the adverse impact of non-performing assets. The continuing
trend to lower funding costs primarily reflects a further decline in interest expense on deposits driven by significant changes in our deposit mix
and pricing. This decrease in deposit costs coupled with the reduction in the adverse impact of non-performing assets represent important
improvements in our core operating fundamentals. The increase in net interest income occurred despite a modest decline in average earning
assets compared to a year ago, as we continued to focus on reducing our non-performing loans and make changes in our mix of assets and
liabilities designed to reduce our risk profile and produce more sustainable earnings.
Our net income also is affected by the level of our other operating income, including deposit fees and service charges, loan origination and
servicing fees, and gains and losses on the sale of loans and securities, as well as our non-interest operating expenses and income tax provisions.
In addition, our net income is affected by the net change in the value of certain financial instruments carried at fair value and in certain periods
by other-than-temporary impairment (OTTI) charges or recoveries. (See Note 22 of the Notes to the Consolidated Financial Statements.) For
the year ended December 31, 2012, we recorded a net loss of $16.5 million in fair value adjustments and $409,000 of OTTI charges. In comparison,
we recorded a net fair value loss of $624,000 for the year ended December 31, 2011, which was more than offset by a $3.0 million OTTI recovery.
The current year fair value loss was primarily related to the increased valuation of our junior subordinated debentures, which was partially offset
by similar adjustments to the fair value estimates for certain investment securities also carried at fair value.
Reflecting the large adverse fair value adjustment, our other operating income for the year ended December 31, 2012 decreased to $26.9 million,
compared to $34.0 million for the year ended December 31, 2011. As a result, our total revenues (net interest income before the provision for
loan losses plus other operating income) for 2012 decreased $4.0 million, to $194.6 million, compared to $198.6 million for 2011. However,
as a result of exceptionally strong mortgage banking revenues and growth in core deposits, our revenues, excluding fair value and OTTI
adjustments, which we believe are more indicative of our core operations, increased by $15.2 million, or 8%, to $211.4 million for the year
ended December 31, 2012, compared to $196.2 million for the year ended December 31, 2011.
Our other operating expenses decreased to $141.5 million for the year ended December 31, 2012, compared to $158.1 million for the year ended
December 31, 2011, largely as a result of decreased costs related to real estate owned, FDIC deposit insurance costs and professional services,
which were partially offset by increased compensation expenses. While significantly lower in 2012 than in 2011, both years' expenses reflect
significant costs associated with problem loan collection activities including professional services and valuation charges related to real estate
owned, which should decline in future periods as a result of the continuing reduction in non-performing assets.
Other operating income, revenues and other earnings information excluding fair value adjustments and OTTI losses are financial measures not
made in conformity with U.S. generally acceptable accounting principles (GAAP). Management has presented these and other non-GAAP
financial measures in this discussion and analysis because it believes that they provide useful and comparative information to assess trends in
our core operations. Where applicable, we have also presented comparable earnings information using GAAP financial measures.
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more detailed information about our
financial performance, critical accounting policies and reconciliations of these non-GAAP financial measures.
Recent Developments and Significant Events
Regulatory Actions: On March 19, 2012, the Memorandum of Understanding (MOU) by and between Banner Bank and the FDIC and Washington
DFI (originally effective March 29, 2010) was terminated. On April 10, 2012, the MOU by and between the Company and the Federal Reserve
Bank of San Francisco (originally effective March 23, 2010) was also terminated.
5
Income Tax Reporting and Accounting:
Amended Federal Income Tax Returns: On October 25, 2011, the Company filed amended federal income tax returns for tax years 2005, 2006,
2008 and 2009. The amended tax returns, which are under review by the Internal Revenue Service (IRS), significantly affect the timing for
recognition of credit losses within previously filed income tax returns and, if approved, would result in the refund of up to $13.6 million of
previously paid taxes from the utilization of net operating loss carryback claims into prior tax years. The outcome of the anticipated IRS review
is inherently uncertain and since there can be no assurance of approval of some or all of the tax carryback claims, no asset has been recognized
to reflect the possible results of these amendments as of December 31, 2012. Accordingly, the Company does not anticipate recognizing any
tax benefit until the results of the IRS review have been determined. We expect this review to be completed and the issue resolved during 2013.
Deferred Tax Asset Valuation Allowance: The Company and the Banks file consolidated U.S. federal income tax returns, as well as state income
tax returns in Oregon and Idaho. Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset
or liability is determined based on the enacted tax rates which are expected to be in effect when the differences between the financial statement
carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on
deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Under GAAP, a valuation allowance
is required to be recognized if it is “more likely than not” that all or a portion of our deferred tax assets will not be realized. While realization
of the deferred tax asset is ultimately dependent on sustained profitability, the guidance reflected in the accounting standard is significantly
influenced by consideration of recent historical operating results. During 2010, the Company evaluated its net deferred tax asset and determined
it was prudent to establish a valuation allowance against the entire asset. As a result, we recorded an $18.0 million income tax expense for the
year ended December 31, 2010. No tax benefit or expense was recognized during 2011. During the year ended December 31, 2012, management
analyzed the Company's performance and trends, focusing on trends in asset quality, loan loss provisioning, capital position, net interest margin,
core operating income and net income and the likelihood of continued profitability. Based on this analysis, management determined that a full
valuation allowance was no longer appropriate and reversed all of the valuation allowance during the year ended December 31, 2012. See Note
13 of the Notes to the Consolidated Financial Statements for more information.
Stockholder Equity Transactions:
Preferred Stock: On March 29, 2012, the Company's $124 million of Series A Preferred Stock with a liquidation value of $1,000 per share,
originally issued to the U.S. Treasury (Treasury) as part of its Capital Purchase Program, was sold by the Treasury as part of its efforts to manage
and recover its investments under the Troubled Asset Relief Program (TARP). While the sale of these preferred shares to new owners did not
result in any proceeds to the Company and did not change the Company's capital position or accounting for these securities, it did eliminate
restrictions put in place by the Treasury on TARP recipients. The Treasury retained its related warrants to purchase up to $18.6 million in Banner
common stock. Subsequently, during 2012, the Company repurchased or redeemed its Series A Preferred Stock, realizing gains aggregating
$2.5 million, which partially offset the accelerated amortization of a portion of the initial discount recorded at the issuance of the Series A
Preferred Stock. In addition, dividends paid in 2012 on the Series A Preferred Stock were reduced by the retirement of the repurchased shares.
Lending Activities
General: All of our lending activities are conducted through Banner Bank, its subsidiary, Community Financial Corporation, and Islanders
Bank. We offer a wide range of loan products to meet the demands of our customers and our loan portfolio is very diversified by product type,
borrower and geographic location within our market area. We originate loans for our own loan portfolio and for sale in the secondary
market. Management’s strategy has been to maintain a well diversified portfolio with a significant percentage of assets in the loan portfolio
having more frequent interest rate repricing terms or shorter maturities than traditional long-term fixed-rate mortgage loans. As part of this
effort, we have developed a variety of floating or adjustable interest rate products that correlate more closely with our cost of funds, particularly
loans for commercial business and real estate, agricultural business, and construction and development purposes. However, in response to
customer demand, we continue to originate fixed-rate loans, including fixed interest rate mortgage loans with terms of up to 30 years. The
relative amount of fixed-rate loans and adjustable-rate loans that can be originated at any time is largely determined by the demand for each in
a competitive environment.
Historically, our lending activities have been primarily directed toward the origination of real estate and commercial loans. Prior to 2008, real
estate lending activities were significantly focused on residential construction and land development and first mortgages on owner-occupied,
one- to four-family residential properties; however, over the subsequent four years our origination of construction and land development loans
declined materially and the proportion of the portfolio invested in these types of loans has declined substantially. During 2011 and particularly
in 2012, we experienced more demand for one- to four-family construction loans and outstanding balances have increased modestly. Our
residential mortgage loan originations also decreased during the earlier years of this cycle, although less significantly than the decline in
construction and land development lending as exceptionally low interest rates supported demand for loans to refinance existing debt as well as
loans to finance home purchases. Refinancing activity was particularly significant during 2012, which resulted in a meaningful increase in
residential mortgage originations compared to the same period a year earlier. Despite the recent increase in these loan originations, our outstanding
balances for residential mortgages have continued to decline, as most of the new originations have been sold in the secondary market while
existing residential loans have been repaying at an accelerated pace. Our real estate lending activities also include the origination of multifamily
and commercial real estate loans. While reduced from periods prior to the economic slowdown, our level of activity and investment in these
types of loans has been relatively stable in recent periods. Our commercial business lending is directed toward meeting the credit and related
deposit needs of various small to medium-sized business and agribusiness borrowers operating in our primary market areas. Reflecting the weak
economy, in recent periods demand for these types of commercial business loans has been modest and, aside from seasonal variations, total
outstanding balances have not significantly increased or decreased. Our consumer lending activity is primarily directed at meeting demand from
6
our existing deposit customers and, while we have increased our emphasis on consumer lending in recent years, demand for consumer loans
also has been modest during this period of economic weakness as we believe many consumers have been focused on reducing their personal
debt. At December 31, 2012, our net loan portfolio totaled $3.158 billion compared to $3.213 billion at December 31, 2011.
For additional information concerning our loan portfolio, see Item 7, “Management’s Discussion and Analysis of Financial Condition—
Comparison of Financial Condition at December 31, 2012 and 2011—Loans and Lending” including Tables 7 and 8, which sets forth the
composition and geographic concentration of our loan portfolio, and Tables 9 and 10, which contain information regarding the loans maturing
in our portfolio.
One- to Four-Family Residential Real Estate Lending: At both Banner Bank and Islanders Bank, we originate loans secured by first mortgages
on one- to four-family residences in the Northwest communities where we have offices. While we offer a wide range of products, we have not
engaged in any sub-prime lending programs, which we define as loans to borrowers with poor credit histories or undocumented repayment
capabilities and with excessive reliance on the collateral as the source of repayment. However, in recent years we have experienced a modest
increase in delinquencies on our residential loans in response to the weakened housing market conditions. At December 31, 2012, $582 million,
or 18% of our loan portfolio, consisted of permanent loans on one- to four-family residences.
We offer fixed- and adjustable-rate mortgages (ARMs) at rates and terms competitive with market conditions, primarily with the intent of selling
these loans into the secondary market. Fixed-rate loans generally are offered on a fully amortizing basis for terms ranging from 10 to 30 years
at interest rates and fees that reflect current secondary market pricing. Most ARM products offered adjust annually after an initial period ranging
from one to five years, subject to a limitation on the annual change of 1.0% to 2.0% and a lifetime limitation of 5.0% to 6.0%. For a small
portion of the portfolio, where the initial period exceeds one year, the first rate change may exceed the annual limitation on subsequent rate
changes. Our ARM products most frequently adjust based upon the average yield on Treasury securities adjusted to a constant maturity of one
year or certain London Interbank Offered Rate (LIBOR) indices plus a margin or spread above the index. ARM loans held in our portfolio may
allow for interest-only payments for an initial period up to five years but do not provide for negative amortization of principal and carry no
prepayment restrictions. The retention of ARM loans in our loan portfolio can help reduce our exposure to changes in interest rates. However,
borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the
level of interest rates and the difference between the initial interest rates and fees charged for each type of loan. In recent years, borrower demand
for ARM loans has been limited and we have chosen not to aggressively pursue ARM loans by offering minimally profitable, deeply discounted
teaser rates or option-payment ARM products. As a result, ARM loans have represented only a small portion of our loans originated during this
period and of our portfolio.
Our residential loans are generally underwritten and documented in accordance with the guidelines established by the Federal Home Loan
Mortgage Corporation (Freddie Mac or FHLMC) and the Federal National Mortgage Association (Fannie Mae or FNMA). Government insured
loans are underwritten and documented in accordance with the guidelines established by the Department of Housing and Urban Development
(HUD) and the Veterans Administration (VA). In the loan approval process, we assess the borrower’s ability to repay the loan, the adequacy of
the proposed security, the employment stability of the borrower and the creditworthiness of the borrower. For ARM loans, our standard practice
provides for underwriting based upon fully indexed interest rates and payments. Generally, we will lend up to 95% of the lesser of the appraised
value or purchase price of the property on conventional loans, although higher loan-to-value ratios are available on certain government insured
programs. We require private mortgage insurance on conventional residential loans with a loan-to-value ratio at origination exceeding 80%. For
the past four years, particularly in 2009 and 2010, a number of exceptions to these general underwriting guidelines were granted in connection
with the sale or refinance of properties, particularly new construction, for which we were already providing financing. These exceptions most
commonly relate to loan-to-value and mortgage insurance requirements and not to credit underwriting or loan documentation standards. Such
exceptions, while less frequent in recent periods, will likely continue in the near term to facilitate troubled loan resolution and may result in
loans having performance characteristics different from the rest of our one-to-four-family loan portfolio.
Through our mortgage banking activities, we sell residential loans on either a servicing-retained or servicing-released basis. During the past
three years, we have sold a significant portion of our conventional residential mortgage originations and nearly all of our government insured
loans in the secondary market.
Construction and Land Lending: Historically, we have invested a significant portion of our loan portfolio in residential construction and land
loans to professional home builders and developers; however, as housing markets weakened the amount of this investment was substantially
reduced in recent years. In years prior to 2008, residential construction and land development lending was an area of major emphasis at Banner
Bank and the primary focus of its subsidiary, CFC. To a lesser extent, we also originate construction loans for commercial and multifamily real
estate. More recently, in response to improvement in certain sub-markets, our construction and development lending increased in 2011 and 2012
and made a meaningful contribution to increased revenues and profitability in those years. Although well diversified with respect to sub-markets,
price ranges and borrowers, our construction and land loans are significantly concentrated in the greater Puget Sound region of Washington State
and the Portland, Oregon market area. At December 31, 2012, construction and land loans totaled $305 million, or 9% of total loans of the
Company, consisting of $161 million of one- to four-family construction loans, $77 million of residential land or land development loans, $53
million of commercial and multifamily real estate construction loans and $14 million of commercial land or land development loans.
Construction and land lending affords us the opportunity to achieve higher interest rates and fees with shorter terms to maturity than are usually
available on other types of lending. Construction and land lending, however, involves a higher degree of risk than other lending opportunities
because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost of the project. If the
estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit
completion of the project. If the estimate of value upon completion proves to be inaccurate, we may be confronted at, or prior to, the maturity
7
of the loan with a project the value of which is insufficient to assure full repayment. Disagreements between borrowers and builders and the
failure of builders to pay subcontractors may also jeopardize projects. Loans to builders to construct homes for which no purchaser has been
identified carry additional risk because the payoff for the loan is dependent on the builder’s ability to sell the property before the construction
loan is due. We attempt to address these risks by adhering to strict underwriting policies, disbursement procedures and monitoring practices.
Construction loans made by us include those with a sales contract or permanent loan in place for the finished homes and those for which purchasers
for the finished homes may be identified either during or following the construction period. We actively monitor the number of unsold homes
in our construction loan portfolio and local housing markets to attempt to maintain an appropriate balance between home sales and new loan
originations. The maximum number of speculative loans (loans that are not pre-sold) approved for each builder is based on a combination of
factors, including the financial capacity of the builder, the market demand for the finished product and the ratio of sold to unsold inventory the
builder maintains. We have attempted to diversify the risk associated with speculative construction lending by doing business with a large
number of small and mid-sized builders spread over a relatively large geographic region with numerous sub-markets within our three-state
service area.
Loans for the construction of one- to four-family residences are generally made for a term of twelve to eighteen months. Our loan policies
include maximum loan-to-value ratios of up to 80% for speculative loans. Individual speculative loan requests are supported by an independent
appraisal of the property, a set of plans, a cost breakdown and a completed specifications form. Underwriting is focused on the borrowers’
financial strength, credit history and demonstrated ability to produce a quality product and effectively market and manage their operations. All
speculative construction loans must be approved by senior loan officers.
Historically, we have also made land loans to developers, builders and individuals to finance the acquisition and/or development of improved
lots or unimproved land, although over the past five years we generally have not originated this type of loan. In making land loans, we follow
underwriting policies and disbursement and monitoring procedures similar to those for construction loans. The initial term on land loans is
typically one to three years with interest only payments, payable monthly, and provisions for principal reduction as lots are sold and released
from the lien of the mortgage.
We regularly monitor the construction and land loan portfolios and the economic conditions and housing inventory in each of our markets and
increase or decrease this type of lending as we observe market conditions change. Housing markets in most areas of the Pacific Northwest
significantly deteriorated beginning in 2008 and our origination of new construction loans declined sharply as a result; however, our level of
construction lending has increased in the past two years as certain sub-markets have improved. We believe that the underwriting policies and
internal monitoring systems we have in place have helped to mitigate some of the risks inherent in construction and land lending; however, weak
housing market conditions nonetheless resulted in material delinquencies and charge-offs in our construction and land loan portfolios in recent
years. While construction and land loans, including residential, commercial and multifamily, have been meaningfully reduced, they still represent
9% of our portfolio. Reducing the amount of non-performing construction and land development loans and related real estate acquired through
foreclosure was the most critical issue that we needed to resolve to return to acceptable levels of profitability and we have made substantial
progress during the past three years in this regard, as reflected in the decline in non-performing construction and land loans to 12% of non-
performing loans at December 31, 2012 from 52% of non-performing loans at December 31, 2010. The most significant risk in this portfolio
relates to the land development loans in a few areas where demand for building lots remains weak. (See “Asset Quality” below and Item 7,
“Management's Discussion and Analysis of Financial Condition and Results of Operations-Asset Quality.”)
Commercial and Multifamily Real Estate Lending: We originate loans secured by multifamily and commercial real estate including, as noted
above, loans for construction of multifamily and commercial real estate projects. Commercial real estate loans are made for both owner-occupied
and investor properties. At December 31, 2012, our loan portfolio included $138 million in multifamily and $1.073 billion in commercial real
estate loans, including $489 million in owner-occupied commercial real estate loans and $584 million in non-owner-occupied commercial real
estate loans, which in aggregate comprised 37% of our total loans. Multifamily and commercial real estate lending affords us an opportunity to
receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by multifamily
and commercial properties are generally greater in amount, more difficult to evaluate and monitor and, therefore, potentially riskier than one-
to four-family residential mortgage loans. Because payments on loans secured by multifamily and commercial properties are often dependent
on the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate
market or the economy. In addition, many of our commercial and multifamily real estate loans are not fully amortizing and contain large balloon
payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make
the payment, which may increase the risk of default or non-payment. In originating multifamily and commercial real estate loans, we consider
the location, marketability and overall attractiveness of the properties. Our underwriting guidelines for multifamily and commercial real estate
loans require an appraisal from a qualified independent appraiser and an economic analysis of each property with regard to the annual revenue
and expenses, debt service coverage and fair value to determine the maximum loan amount. In the approval process we assess the borrowers’
willingness and ability to manage the property and repay the loan and the adequacy of the collateral in relation to the loan amount.
Multifamily and commercial real estate loans originated by us are both fixed- and adjustable-rate loans generally with intermediate terms of five
to ten years. Most of our multifamily and commercial real estate loans are linked to various Federal Home Loan Bank (FHLB) advance rates,
certain prime rates or other market rate indices. Rates on these adjustable-rate loans generally adjust with a frequency of one to five years after
an initial fixed-rate period ranging from one to ten years. Our commercial real estate portfolio consists of loans on a variety of property types
with no large concentrations by property type, location or borrower. At December 31, 2012, the average size of our commercial real estate loans
was $659,000 and the largest commercial real estate loan in our portfolio was approximately $15 million.
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Commercial Business Lending: We are active in small- to medium-sized business lending and are engaged to a lesser extent in agricultural
lending primarily by providing crop production loans. Our commercial bankers are focused on local markets and devote a great deal of effort
to developing customer relationships and the ability to serve these types of borrowers with a full array of products and services delivered in a
thorough and responsive manner. While also strengthening our commitment to small business lending, in recent years we have added experienced
officers and staff focused on corporate lending opportunities for borrowers with credit needs generally in a $3 million to $15 million range. In
addition to providing earning assets, this type of lending has helped us increase our deposit base. Expanding commercial lending and related
commercial banking services is currently an area of significant focus, including recent reorganization and additions to staffing in the areas of
business development, credit administration, Small Business Administration (SBA) lending, and loan and deposit operations.
Commercial business loans may entail greater risk than other types of loans. Commercial business loans may be unsecured or secured by special
purpose or rapidly depreciating assets, such as equipment, inventory and receivables, which may not provide an adequate source of repayment
on defaulted loans. In addition, commercial business loans are dependent on the borrower’s continuing financial strength and management
ability, as well as market conditions for various products, services and commodities. For these reasons, commercial business loans generally
provide higher yields or related revenue opportunities than many other types of loans but also require more administrative and management
attention. Loan terms, including the fixed or adjustable interest rate, the loan maturity and the collateral considerations, vary significantly and
are negotiated on an individual loan basis.
We underwrite our commercial business loans on the basis of the borrower’s cash flow and ability to service the debt from earnings rather than
on the basis of the underlying collateral value. We seek to structure these loans so that they have more than one source of repayment. The
borrower is required to provide us with sufficient information to allow us to make a prudent lending determination. In most instances, this
information consists of at least three years of financial statements, tax returns, a statement of projected cash flows, current financial information
on any guarantor and information about the collateral. Loans to closely held businesses typically require personal guarantees by the
principals. Our commercial business loan portfolio is geographically dispersed across the market areas serviced by our branch network and
there are no significant concentrations by industry or products.
Our commercial business loans may be structured as term loans or as lines of credit. Commercial business term loans are generally made to
finance the purchase of fixed assets and have maturities of five years or less. Commercial business lines of credit are typically made for the
purpose of providing working capital and are usually approved with a term of one year. Adjustable- or floating-rate loans are primarily tied to
various prime rate or LIBOR indices. At December 31, 2012, commercial business loans totaled $618 million, or 19% of our total loans.
Agricultural Lending: Agriculture is a major industry in many parts of our service areas. While agricultural loans are not a large part of our
portfolio, we intend to continue to make agricultural loans to borrowers with a strong capital base, sufficient management depth, proven ability
to operate through agricultural cycles, reliable cash flows and adequate financial reporting. Payments on agricultural loans depend, to a large
degree, on the results of operations of the related farm entity. The repayment is also subject to other economic and weather conditions as well
as market prices for agricultural products, which can be highly volatile. At December 31, 2012, agricultural business loans, including collateral
secured loans to purchase farm land and equipment, totaled $230 million, or 7% of our loan portfolio.
Agricultural operating loans generally are made as a percentage of the borrower’s anticipated income to support budgeted operating
expenses. These loans are secured by a blanket lien on all crops, livestock, equipment, accounts and products and proceeds thereof. In the case
of crops, consideration is given to projected yields and prices from each commodity. The interest rate is normally floating based on the prime
rate or a LIBOR index plus a negotiated margin. Because these loans are made to finance a farm or ranch’s annual operations, they are usually
written on a one-year review and renewable basis. The renewal is dependent upon the prior year’s performance and the forthcoming year’s
projections as well as the overall financial strength of the borrower. We carefully monitor these loans and related variance reports on income
and expenses compared to budget estimates. To meet the seasonal operating needs of a farm, borrowers may qualify for single payment notes,
revolving lines of credit and/or non-revolving lines of credit.
In underwriting agricultural operating loans, we consider the cash flow of the borrower based upon the expected operating results as well as the
value of collateral used to secure the loans. Collateral generally consists of cash crops produced by the farm, such as milk, grains, fruit, grass
seed, peas, sugar beets, mint, onions, potatoes, corn and alfalfa or livestock. In addition to considering cash flow and obtaining a blanket security
interest in the farm’s cash crop, we may also collateralize an operating loan with the farm’s operating equipment, breeding stock, real estate and
federal agricultural program payments to the borrower.
We also originate loans to finance the purchase of farm equipment. Loans to purchase farm equipment are made for terms of up to seven
years. On occasion, we also originate agricultural real estate loans secured primarily by first liens on farmland and improvements thereon located
in our market areas, although generally only to service the needs of our existing customers. Loans are written in amounts ranging from 50% to
75% of the tax assessed or appraised value of the property for terms of five to 20 years. These loans generally have interest rates that adjust at
least every five years based upon a Treasury index or FHLB advance rate plus a negotiated margin. Fixed-rate loans are granted on terms usually
not to exceed five years. In originating agricultural real estate loans, we consider the debt service coverage of the borrower’s cash flow, the
appraised value of the underlying property, the experience and knowledge of the borrower, and the borrower’s past performance with us and/or
the market area. These loans normally are not made to start-up businesses and are reserved for existing customers with substantial equity and
a proven history.
Among the more common risks to agricultural lending can be weather conditions and disease. These risks may be mitigated through multi-peril
crop insurance. Commodity prices also present a risk, which may be reduced by the use of set price contracts. Normally, required beginning
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and projected operating margins provide for reasonable reserves to offset unexpected yield and price deficiencies. In addition to these risks, we
also consider management succession, life insurance and business continuation plans when evaluating agricultural loans.
Consumer and Other Lending: We originate a variety of consumer loans, including home equity lines of credit, automobile, boat and recreational
vehicle loans and loans secured by deposit accounts. While consumer lending has traditionally been a small part of our business, with loans
made primarily to accommodate our existing customer base, it has received consistent emphasis in recent years. Part of this emphasis has been
the reintroduction of a Banner Bank-funded credit card program which we began marketing in 2005. Similar to other consumer loan programs,
we focus this credit card program on our existing customer base to add to the depth of our customer relationships. In addition to earning balances,
credit card accounts produce non-interest revenues through interchange fees and other activity-based revenues. Our underwriting of consumer
loans is focused on the borrower’s credit history and ability to repay the debt as evidenced by documented sources of income. At December 31,
2012, we had $291 million, or 9% of our loans receivable, in consumer related loans, including $170 million, or 5% of our loans receivable, in
consumer loans secured by one- to four-family residences.
Similar to commercial business loans, our other consumer loans often entail greater risk than residential mortgage loans. Home equity lines of
credit generally entail greater risk than do one- to four-family residential mortgage loans where we are in the first lien position. For those home
equity lines secured by a second mortgage, it is unlikely that we will be successful in recovering all or a portion of our loan proceeds in the event
of default unless we are prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified
by the value of the property. In the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles,
any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as
a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection
efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are
more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and
state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. These loans
may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loans such as us, and a borrower may be
able to assert against the assignee claims and defenses that it has against the seller of the underlying collateral.
Loan Solicitation and Processing: We originate real estate loans in our market areas by direct solicitation of real estate brokers, builders,
depositors, walk-in customers and visitors to our Internet website. Loan applications are taken by our mortgage loan officers or through our
Internet website and are processed in branch or regional locations. Most underwriting and loan administration functions for our real estate loans
are performed by loan personnel at central locations. We do not make loans originated by independent third-party loan brokers or any similar
wholesale loan origination channels.
Our commercial bankers solicit commercial and agricultural business loans through call programs focused on local businesses and farmers. While
commercial bankers are delegated reasonable commitment authority based upon their qualifications, credit decisions on significant commercial
and agricultural loans are made by senior loan officers or in certain instances by the Board of Directors of Banner Bank and Islanders Bank.
We originate consumer loans through various marketing efforts directed primarily toward our existing deposit and loan customers. Consumer
loan applications are primarily underwritten and documented by centralized administrative personnel.
Loan Originations, Sales and Purchases
While we originate a variety of loans, our ability to originate each type of loan is dependent upon the relative customer demand and competition
in each market we serve. For the years ended December 31, 2012, 2011 and 2010, we originated loans, net of repayments, of $460 million, $270
million, and $114 million, respectively. The increase in net originations for 2012 reflects a significant increase in production of one- to four-
family residential loans, as well as increased new commercial business and agricultural business loans and commercial real estate loans, and a
reduction in charge-offs on problem loans. The lower level of originations, net of repayments and charge-offs, during 2010 was significantly
impacted by reduced demand from creditworthy borrowers due to weak economic conditions, a substantial amount of loan repayments, and
significant charge-offs.
We sell many of our newly originated one- to four-family residential mortgage loans to secondary market purchasers as part of our interest rate
risk management strategy. Originations of one- to four-family residential loans for sale increased to $504 million for the year ended December
31, 2012 from $279 million during 2011. Proceeds from sales of loans for the years ended December 31, 2012, 2011 and 2010, totaled $505
million, $282 million, and $351 million, respectively. Sales of loans generally are beneficial to us because these sales may generate income at
the time of sale, provide funds for additional lending and other investments, increase liquidity or reduce interest rate risk. We sell loans on both
a servicing-retained and a servicing-released basis. All loans are sold without recourse. The decision to hold or sell loans is based on asset
liability management goals, strategies and policies and on market conditions. See “Loan Servicing.” At December 31, 2012, we had $12 million
in loans held for sale.
We periodically purchase whole loans and loan participation interests primarily during periods of reduced loan demand in our primary market
area and at times to support our Community Reinvestment Act lending activities. Any such purchases are made generally consistent with our
underwriting standards; however, the loans may be located outside of our normal lending area. During the years ended December 31, 2012,
2011 and 2010, we purchased $18 million, $5 million and $341,000, respectively, of loans and loan participation interests.
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Loan Servicing
We receive fees from a variety of institutional owners in return for performing the traditional services of collecting individual payments and
managing portfolios of sold loans. At December 31, 2012, we were servicing $1.031 billion of loans for others. Loan servicing includes
processing payments, accounting for loan funds and collecting and paying real estate taxes, hazard insurance and other loan-related items such
as private mortgage insurance. In addition to earning fee income, we retain certain amounts in escrow for the benefit of the lender for which
we incur no interest expense but are able to invest the funds into earning assets. At December 31, 2012, we held $5.0 million in escrow for our
portfolio of loans serviced for others. The loan servicing portfolio at December 31, 2012 was composed of $687 million of Freddie Mac residential
mortgage loans, $212 million of Fannie Mae residential mortgage loans and $132 million of both residential and non-residential mortgage loans
serviced for a variety of private investors. The portfolio included loans secured by property located primarily in the states of Washington, Oregon
and Idaho. For the year ended December 31, 2012, we recognized a $872,000 gain from loan servicing in our results of operations, which was
net of $2.6 million of servicing rights amortization and a $400,000 impairment charge for a valuation adjustment to mortgage servicing rights.
Mortgage Servicing Rights: We record mortgage servicing rights (MSRs) with respect to loans we originate and sell in the secondary market
on a servicing-retained basis. The value of MSRs is capitalized and amortized in proportion to, and over the period of, the estimated future net
servicing income. For the years ended December 31, 2012, 2011 and 2010, we capitalized $3.7 million, $1.9 million, and $1.7 million,
respectively, of MSRs relating to loans sold with servicing retained. No MSRs were purchased in those periods. Amortization of MSRs for the
years ended December 31, 2012, 2011 and 2010, was $2.6 million, $1.8 million, and $2.0 million, respectively. Management periodically
evaluates the estimates and assumptions used to determine the carrying values of MSRs and the amortization of MSRs. These carrying values
are adjusted when the valuation indicates the carrying value is impaired. During 2012, we recorded a $400,000 impairment charge to reduce
the carrying value of our MSRs. MSRs generally are adversely affected by higher levels of current or anticipated prepayments resulting from
decreasing interest rates. At December 31, 2012, our MSRs were carried at a value of $6.2 million, net of amortization.
Asset Quality
Classified Assets: State and federal regulations require that the Banks review and classify their problem assets on a regular basis. In addition,
in connection with examinations of insured institutions, state and federal examiners have authority to identify problem assets and, if appropriate,
require them to be classified. Historically, we have not had any meaningful differences of opinion with the examiners with respect to asset
classification. Banner Bank’s Credit Policy Division reviews detailed information with respect to the composition and performance of the loan
portfolios, including information on risk concentrations, delinquencies and classified assets for both Banner Bank and Islanders Bank. The
Credit Policy Division approves all recommendations for new classified loans or, in the case of smaller-balance homogeneous loans including
residential real estate and consumer loans, it has approved policies governing such classifications, or changes in classifications, and develops
and monitors action plans to resolve the problems associated with the assets. The Credit Policy Division also approves recommendations for
establishing the appropriate level of the allowance for loan losses. Significant problem loans are transferred to Banner Bank’s Special Assets
Department for resolution or collection activities. The Banks’ and Banner Corporation’s Boards of Directors are given a detailed report on
classified assets and asset quality at least quarterly. For additional information regarding asset quality and non-performing loans, see Item 7,
“Management’s Discussion and Analysis of Financial Condition—Comparison of Financial Condition at December 31, 2012 and 2011—Asset
Quality,” and Tables 15, 16 and 17 contained therein.
Allowance for Loan Losses: In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among
other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in
the case of a secured loan, the quality of the security for the loan. As a result, we maintain an allowance for loan losses consistent with GAAP
guidelines. We increase our allowance for loan losses by charging provisions for possible loan losses against our income. The allowance for
losses on loans is maintained at a level which, in management’s judgment, is sufficient to provide for probable losses based on evaluating known
and inherent risks in the loan portfolio and upon continuing analysis of the factors underlying the quality of the loan portfolio. At December 31,
2012, we had an allowance for loan losses of $77 million, which represented 2.39% of loans and 225% of non-performing loans compared to
2.52% and 110%, respectively, at December 31, 2011. For additional information concerning our allowance for loan losses, see Item 7,
“Management’s Discussion and Analysis of Financial Condition—Comparison of Results of Operations for the Years Ended December 31, 2012
and 2011—Provision and Allowance for Loan Losses,” and Tables 21 and 22 contained therein.
Real Estate Owned: Real estate owned (REO) is property acquired by foreclosure or receiving a deed in lieu of foreclosure, and is recorded at
the lower of the estimated fair value of the property, less expected selling costs, or the carrying amount of the defaulted loan. Development and
improvement costs relating to the property are capitalized to the extent they add value to the property. The carrying value of the property is
periodically evaluated by management and, if necessary, allowances are established to reduce the carrying value to net realizable value. Gains
or losses at the time the property is sold are credited or charged to operations in the period in which they are realized. The amounts we will
ultimately recover from REO may differ substantially from the carrying value of the assets because of market factors beyond our control or
because of changes in our strategies for recovering the investment. If the book value of the REO is determined to be in excess of the fair market
value, a valuation allowance is recognized against earnings. At December 31, 2012, we had REO of $16 million, compared to $43 million at
December 31, 2011. Valuation allowances recognized during 2012 were $5.2 million and for both 2011 and 2010 valuation charges were $15.1
million. For additional information on REO, see Item 7, “Management’s Discussion and Analysis of Financial Condition—Comparison of
Financial Condition at December 31, 2012 and 2011—Asset Quality” and Table 18 contained therein and Note 7 of the Notes to the Consolidated
Financial Statements.
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Investment Activities
Under Washington state law, banks are permitted to invest in various types of marketable securities. Authorized securities include but are not
limited to Treasury obligations, securities of various federal agencies (including government-sponsored enterprises), mortgage-backed and asset-
backed securities, certain certificates of deposit of insured banks and savings institutions, bankers’ acceptances, repurchase agreements, federal
funds, commercial paper, corporate debt and equity securities and obligations of states and their political subdivisions. Our investment policies
are designed to provide and maintain adequate liquidity and to generate favorable rates of return without incurring undue interest rate or credit
risk. Our policies generally limit investments to U.S. Government and agency (including government-sponsored entities) securities, municipal
bonds, certificates of deposit, corporate debt obligations and mortgage-backed securities. Investment in mortgage-backed securities may include
those issued or guaranteed by Freddie Mac, Fannie Mae, Government National Mortgage Association (Ginnie Mae or GNMA) and privately-
issued mortgage-backed securities that have an AA credit rating or higher at the time of purchase, as well as collateralized mortgage obligations
(CMOs). A high credit rating indicates only that the rating agency believes there is a low risk of loss or default. To the best of our knowledge,
we do not have any investments in mortgage-backed securities, collateralized debt obligations or structured investment vehicles that have a
material exposure to sub-prime mortgages. However, we do have investments in single-issuer trust preferred securities and collateralized debt
obligations secured by pooled trust preferred securities that have been materially adversely impacted by concerns related to the banking and
insurance industries as well as payment deferrals and defaults by certain issuers. Further, all of our investment securities, including those that
have high credit ratings, are subject to market risk in so far as a change in market rates of interest or other conditions may cause a change in an
investment’s earnings performance and/or market value.
At December 31, 2012, our consolidated investment portfolio totaled $631 million and consisted principally of U.S. Government agency
obligations, mortgage-backed securities, municipal bonds, corporate debt obligations, and asset-backed securities secured by student loans issued
or guaranteed by the Student Loan Marketing Association. From time to time, investment levels may be increased or decreased depending upon
yields available on investment alternatives and management’s projections as to the demand for funds to be used in loan originations, deposits
and other activities. During the year ended December 31, 2012, holdings of mortgage-backed securities increased $176 million to $306 million,
while Treasury and agency obligations decreased $243 million to $99 million, corporate securities including equities increased $6 million to
$49 million, municipal bonds increased $28 million to $135 million, and new investments in asset-backed securities were $43 million.
For detailed information on our investment securities, see Item 7, “Management’s Discussion and Analysis of Financial Condition—Comparison
of Financial Condition at December 31, 2012 and 2011—Investments,” and Tables 1 to 6 contained therein.
Off-Balance-Sheet Derivatives: Derivatives include “off-balance-sheet” financial products, the value of which is dependent on the value of
underlying financial assets, such as stock, bonds, foreign currency, or a reference rate or index. Such derivatives include “forwards,” “futures,”
“options” or “swaps.” As a result of the 2007 acquisition of F&M Bank, we became a party to approximately $23 million ($16 million as of
December 31, 2012) in notional amounts of interest rate swaps. These swaps serve as hedges to an equal amount of fixed-rate loans which
include market value prepayment penalties that mirror the provision of the specifically matched interest rate swaps. In addition, in 2011 we
began actively marketing interest rate swaps to certain loan customers in connection with longer-term floating rate loans, allowing them to
effectively fix their loan interest rates. These customer swaps are matched with third party swaps with qualified broker/dealers or banks to offset
the risk. As of December 31, 2012, we had $95 million in notional amounts of these customer interest rate swaps outstanding, with an equal
amount of offsetting third party swaps also in place. The fair value adjustments for these swaps and the related loans are reflected in other assets
or other liabilities as appropriate, and in the carrying value of the hedged loans. Also, as a part of mortgage banking activities, we issue “rate
lock” commitments to borrowers and obtain offsetting “best efforts” delivery commitments from purchasers of loans. While not providing any
trading or net settlement mechanisms, these off-balance-sheet commitments do have many of the prescribed characteristics of derivatives and
as a result are accounted for as such. Accordingly, on December 31, 2012, we recorded an asset of $74,000 and a liability of $74,000, representing
the estimated market value of those commitments. Further, in 2012 we began using forward contracts for the sale of mortgage-backed securities
and mandatory delivery commitments for the sale of loans to partially hedge "rate lock" commitments and closed loans to borrowers in our
mortgage banking activities. On December 31, 2012, we recorded an asset of $436,000 and a liability of $121,000, representing the estimated
market value of those commitments. These forward contracts and mandatory delivery commitments, as well as the related "rate lock" commitments
and loans, are accounted for in the Consolidated Financial Statements at fair value with changes in fair value recognized in earnings. On
December 31, 2012, we had no other investment related off-balance-sheet derivatives.
Deposit Activities and Other Sources of Funds
General: Deposits, FHLB advances (or other borrowings) and loan repayments are our major sources of funds for lending and other investment
purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are
influenced by general economic, interest rate and money market conditions and may vary significantly. Borrowings may be used on a short-
term basis to compensate for reductions in the availability of funds from other sources. Borrowings may also be used on a longer-term basis for
general business purposes, including funding loans and investments.
We compete with other financial institutions and financial intermediaries in attracting deposits. There is strong competition for transaction
balances and savings deposits from commercial banks, credit unions and non-bank corporations, such as securities brokerage companies, mutual
funds and other diversified companies, some of which have nationwide networks of offices. Much of the focus of our branch expansion,
relocations and renovation and advertising and marketing campaigns has been directed toward attracting additional deposit customer relationships
and balances. In addition, our electronic banking activities including debit card and automated teller machine (ATM) programs, on-line Internet
banking services and, most recently, customer remote deposit and mobile banking capabilities are all directed at providing products and services
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that enhance customer relationships and result in growing deposit balances. Growing core deposits (transaction and savings accounts) is a
fundamental element of our business strategy.
Deposit Accounts: We generally attract deposits from within our primary market areas by offering a broad selection of deposit instruments,
including demand checking accounts, interest-bearing checking accounts, money market deposit accounts, regular savings accounts, certificates
of deposit, cash management services and retirement savings plans. Deposit account terms vary according to the minimum balance required,
the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of deposit accounts, we
consider current market interest rates, profitability to us, matching deposit and loan products and customer preferences and concerns. At
December 31, 2012, we had $3.558 billion of deposits, including $2.529 billion of transaction and savings accounts and $1.029 billion in time
deposits. For additional information concerning our deposit accounts, see Item 7, “Management’s Discussion and Analysis of Financial Condition
—Comparison of Financial Condition at December 31, 2012 and 2011—Deposit Accounts.” See also Table 11 contained therein, which sets
forth the balances of deposits in the various types of accounts, and Table 12, which sets forth the amount of our certificates of deposit greater
than $100,000 by time remaining until maturity as of December 31, 2012. In addition, see Note 9 of the Notes to the Consolidated Financial
Statements.
Borrowings: While deposits are the primary source of funds for our lending and investment activities and for general business purposes, we
also use borrowings to supplement our supply of lendable funds, to meet deposit withdrawal requirements and to more efficiently leverage our
capital position. The FHLB-Seattle serves as our primary borrowing source, although in recent years we have significantly reduced our use of
FHLB advances. The FHLB-Seattle provides credit for member financial institutions such as Banner Bank and Islanders Bank. As members,
the Banks are required to own capital stock in the FHLB-Seattle and are authorized to apply for advances on the security of that stock and certain
of their mortgage loans and securities provided certain credit worthiness standards have been met. Limitations on the amount of advances are
based on the financial condition of the member institution, the adequacy of collateral pledged to secure the credit, and FHLB stock ownership
requirements. At December 31, 2012, we had $10 million of borrowings from the FHLB-Seattle. At that date, Banner Bank had been authorized
by the FHLB-Seattle to borrow up to $889 million under a blanket floating lien security agreement, while Islanders Bank was approved to borrow
up to $26 million under a similar agreement. The Federal Reserve Bank also serves as an important source of borrowing capacity. The Federal
Reserve Bank provides credit based upon acceptable loan collateral, which includes certain loan types not eligible for pledging to the FHLB-
Seattle. At December 31, 2012, based upon our available unencumbered collateral, Banner Bank was eligible to borrow $595 million from the
Federal Reserve Bank, although at that date we had no funds borrowed under this arrangement. Although eligible to participate, Islanders Bank
has not applied for approval to borrow from the Federal Reserve Bank. For additional information concerning our borrowings, see Item 7,
“Management’s Discussion and Analysis of Financial Condition—Comparison of Financial Condition at December 31, 2012 and 2011—
Borrowings,” Table 14 contained therein, and Notes 10 and 11 of the Notes to the Consolidated Financial Statements.
We issue retail repurchase agreements, generally due within 90 days, as an additional source of funds, primarily in connection with cash
management services provided to our larger deposit customers. At December 31, 2012, we had issued retail repurchase agreements totaling $77
million, which were secured by a pledge of certain U.S. Government and agency notes and mortgage-backed securities with a market value of
$109 million. We also may borrow funds through the use of secured wholesale repurchase agreements with securities brokers; however, during
the three years ended December 31, 2012, we did not have any wholesale repurchase borrowings.
On March 31, 2009, Banner Bank completed an offering of $50 million of qualifying senior bank notes that were guaranteed by the FDIC under
the Temporary Liquidity Guarantee Program (TLGP). This debt, which was issued to strengthen our overall liquidity position as we adjusted
to a lower level of public funds deposits, matured and was repaid on March 31, 2012.
We have also issued $120 million of junior subordinated debentures in connection with the sale of trust preferred securities (TPS). The TPS
were issued from 2002 through 2007 by special purpose business trusts formed by Banner Corporation and were sold in private offerings to
pooled investment vehicles. The junior subordinated debentures associated with the TPS have been recorded as liabilities and are reported at
fair value on our Consolidated Statements of Financial Condition. All of the debentures issued to the Trusts, measured at their fair value, less
the common stock of the Trusts, qualified as Tier I capital as of December 31, 2012, under guidance issued by the Board of Governors of the
Federal Reserve System. We have invested substantially all of the proceeds from the issuance of the TPS as additional paid in capital at Banner
Bank. For additional information about deposits and other sources of funds, see Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Liquidity and Capital Resources,” and Notes 9, 10, 11 and 12 of the Notes to the Consolidated Financial
Statements.
Personnel
As of December 31, 2012, we had 1,074 full-time and 99 part-time employees. Banner Corporation has no employees except for those who are
also employees of Banner Bank, its subsidiaries, and Islanders Bank. The employees are not represented by a collective bargaining unit. We
believe our relationship with our employees is good.
Federal Taxation
Taxation
General: For tax reporting purposes, we report our income on a calendar year basis using the accrual method of accounting on a consolidated
basis. We are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the
reserve for bad debts. Reference is made to Note 13 of the Notes to the Consolidated Financial Statements for additional information concerning
the income taxes payable by us.
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State Taxation
Washington Taxation: We are subject to a Business and Occupation (B&O) tax which is imposed under Washington law at the rate of 1.80% of
gross receipts. For many years, this rate had been 1.50%. However, on April 12, 2010, the Washington State Legislature passed a law that
temporarily increased this rate to 1.80%. This new higher rate will be in effect for the period May 1, 2010 through June 30, 2013. Interest
received on loans secured by mortgages or deeds of trust on residential properties, residential mortgage-backed securities, and certain U.S.
Government and agency securities is not subject to this tax. Our B&O tax expense was $2.3 million, $2.2 million, and $2.3 million for the years
ended December 31, 2012, 2011 and 2010, respectively.
Oregon and Idaho Taxation: Corporations with nexus in the states of Oregon and Idaho are subject to a corporate level income tax. Our operations
in those states resulted in corporate income taxes of approximately $540,000, $30,000, and $60,000 for the years ended December 31, 2012,
2011 and 2010, respectively. As our operations in these states increase, the state income tax provision will have an increasing effect on our
effective tax rate and results of operations.
Competition
We encounter significant competition both in attracting deposits and in originating loans. Our most direct competition for deposits comes from
other commercial and savings banks, savings associations and credit unions with offices in our market areas. We also experience competition
from securities firms, insurance companies, money market and mutual funds, and other investment vehicles. We expect continued strong
competition from such financial institutions and investment vehicles in the foreseeable future, including competition from on-line Internet
banking competitors. Our ability to attract and retain deposits depends on our ability to provide transaction services and investment opportunities
that satisfy the requirements of depositors. We compete for deposits by offering a variety of accounts and financial services, including robust
electronic banking capabilities, with competitive rates and terms, at convenient locations and business hours, and delivered with a high level of
personal service and expertise.
Competition for loans comes principally from other commercial banks, loan brokers, mortgage banking companies, savings banks and credit
unions and for agricultural loans from the Farm Credit Administration. The competition for loans is intense as a result of the large number of
institutions competing in our market areas. We compete for loans primarily by offering competitive rates and fees and providing timely decisions
and excellent service to borrowers.
Banner Bank and Islanders Bank
Regulation
General: As state-chartered, federally insured commercial banks, Banner Bank and Islanders Bank (the Banks) are subject to extensive regulation
and must comply with various statutory and regulatory requirements, including prescribed minimum capital standards. The Banks are regularly
examined by the FDIC and state banking regulators and file periodic reports concerning their activities and financial condition with these banking
regulators. The Banks' relationship with depositors and borrowers also is regulated to a great extent by both federal and state law, especially in
such matters as the ownership of deposit accounts and the form and content of mortgage and other loan documents.
Federal and state banking laws and regulations govern all areas of the operation of the Banks, including reserves, loans, investments, deposits,
capital, issuance of securities, payment of dividends and establishment of branches. Federal and state bank regulatory agencies also have the
general authority to limit the dividends paid by insured banks and bank holding companies if such payments should be deemed to constitute an
unsafe and unsound practice. The respective primary federal regulators of Banner Corporation, Banner Bank and Islanders Bank have authority
to impose penalties, initiate civil and administrative actions and take other steps intended to prevent banks from engaging in unsafe or unsound
practices.
State Regulation and Supervision: As a Washington state-chartered commercial bank with branches in the States of Washington, Oregon and
Idaho, Banner Bank is subject to the applicable provisions of Washington, Oregon and Idaho law and regulations. State law and regulations
govern Banner Bank's ability to take deposits and pay interest thereon, to make loans on or invest in residential and other real estate, to make
consumer loans, to invest in securities, to offer various banking services to its customers and to establish branch offices. In a similar fashion,
Washington State laws and regulations for state-chartered commercial banks also apply to Islanders Bank.
Deposit Insurance: The Deposit Insurance Fund (“DIF”) of the FDIC insures deposit accounts of the Banks up to $250,000 per separately
insured depositor. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and to require
reporting by, FDIC-insured institutions. Banner Bank's and Islanders Bank's deposit insurance premiums expense for the year ended December
31, 2012, were $3.5 million and $195,000, respectively.
As a result of a decline in the reserve ratio (the ratio of the net worth of the DIF to estimated insured deposits) and concerns about expected
failure costs and available liquid assets in the DIF, the FDIC adopted a rule requiring each insured institution to prepay on December 30, 2009
the estimated amount of its quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012 (in addition to the
regular quarterly assessment for the third quarter which was due on December 30, 2009). The prepaid amount is recorded as an asset with a
zero risk weight and the institution will continue to record quarterly expenses for deposit insurance. For purposes of calculating the prepaid
amount, assessments were measured at the institution's assessment rate as of September 30, 2009, with a uniform increase of three basis points
effective January 1, 2011, and were based on the institution's assessment base for the third quarter of 2009, with growth assumed quarterly at
annual rate of 5%. If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess
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assessments in cash or receive a rebate of prepaid amounts not exhausted after collection of assessments due on June 30, 2013, as
applicable. Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment
system in the future. The balance of our prepaid assessment was $12.4 million at December 31, 2012.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) requires the FDIC's deposit insurance assessments to be
based on assets instead of deposits. The FDIC has issued rules, effective as of the second quarter of 2011, which specify that the assessment
base for a bank is equal to its total average consolidated assets less average tangible capital. The FDIC assessment rates range from approximately
five basis points to 35 basis points, depending on applicable adjustments for unsecured debt issued by an institution and brokered deposits (and
to further adjustment for institutions that hold unsecured debt of other FDIC-insured institutions), until such time as the FDIC's reserve ratio
equals 1.15%. Once the FDIC's reserve ratio reaches 1.15% and the reserve ratio for the immediately prior assessment period is less than 2.0%,
the applicable assessment rates may range from three basis points to 30 basis points (subject to adjustments as described above). If the reserve
ratio for the prior assessment period is equal to, or greater than 2.0% and less than 2.5%, the assessment rates may range from two basis points
to 28 basis points and if the prior assessment period is greater than 2.5%, the assessment rates may range from one basis point to 25 basis points
(in each case subject to adjustments as described above). No institution may pay a dividend if it is in default on its federal deposit insurance
assessment.
The FDIC conducts examinations of and requires reporting by state non-member banks, such as the Banks. The FDIC also may prohibit any
insured institution from engaging in any activity determined by regulation or order to pose a serious risk to the deposit insurance fund.
The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts
at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years,
as determined by the FDIC. Management is not aware of any existing circumstances which would result in termination of the deposit insurance
of either Banner Bank or Islanders Bank.
Prompt Corrective Action: Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution's category depends upon where its
capital levels are in relation to relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure and certain
other factors. The federal banking agencies have adopted regulations that implement this statutory framework. Under these regulations, an
institution is treated as well capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted
assets is 6% or more, its ratio of core capital to total assets (leverage ratio) is 5% or more, and it is not subject to any federal supervisory order
or directive to meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not
less than 8%, a core capital to risk-weighted assets ratio of not less than 4%, and a leverage ratio of not less than 4%. An institution that is not
well capitalized is subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits generally. Any
institution which is neither well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become
more extensive as an institution becomes more severely undercapitalized. Failure by either Banner Bank and Islanders Bank to comply with
applicable capital requirements would, if unremedied, result in progressively more severe restrictions on its activities and lead to enforcement
actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and, ultimately, the
appointment of the FDIC as receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions
that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may be dependent
on compliance with capital requirements.
At December 31, 2012, both Banner Bank and Islanders Bank were categorized as “well capitalized” under the prompt corrective action regulations
of the FDIC. For additional information, see Note 18 of the Notes to Consolidated Financial Statements.
Standards for Safety and Soundness: The federal banking regulatory agencies have prescribed, by regulation, guidelines for all insured depository
institutions relating to internal controls, information systems and internal audit systems; loan documentation; credit underwriting; interest rate
risk exposure; asset growth; asset quality; earnings; and compensation, fees and benefits. The guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes
impaired. Each insured depository institution must implement a comprehensive written information security program that includes
administrative, technical, and physical safeguards appropriate to the institution's size and complexity and the nature and scope of its activities. The
information security program must be designed to ensure the security and confidentiality of customer information, protect against any
unanticipated threats or hazards to the security or integrity of such information, protect against unauthorized access to or use of such information
that could result in substantial harm or inconvenience to any customer, and ensure the proper disposal of customer and consumer information. Each
insured depository institution must also develop and implement a risk-based response program to address incidents of unauthorized access to
customer information in customer information systems. If the FDIC determines that an institution fails to meet any of these guidelines, it may
require an institution to submit to the FDIC an acceptable plan to achieve compliance.
Capital Requirements: Federally insured financial institutions, such as Banner Bank and Islanders Bank, are required to maintain a minimum
level of regulatory capital. FDIC regulations recognize two types, or tiers, of capital: core (Tier 1) capital and supplementary (Tier 2) capital. Tier
1 capital generally includes common stockholders' equity, qualifying restricted core capital elements (other than cumulative perpetual preferred
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stock), less deductions for disallowed intangibles and disallowed deferred tax assets. Tier 2 capital, which recognizes up to 100% of Tier 1
capital for risk-based capital purposes includes such items as qualifying general loan loss reserves (up to 1.25% of risk-weighted assets), qualified
subordinated debt, redeemable preferred stock, other restricted core capital elements, cumulative perpetual preferred stock, and net unrealized
holding gains on equity securities (subject to certain limitations); provided, however, the amount of term subordinated debt and intermediate
term preferred stock that may be included in Tier 2 capital for risk-based capital purposes is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution's capital using a leverage limit together with certain risk-based ratios. The FDIC's minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average total assets. Most banks are required to maintain a minimum leverage
ratio of at least 3% to 4% of total assets. At December 31, 2012, Banner Bank and Islanders Bank had Tier 1 leverage capital ratios of 12.29%
and 13.02%, respectively. The FDIC retains the right to require an institution to maintain a higher capital level based on an institution's particular
risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets. Assets are placed
in one of four categories and given a percentage weight based on the relative risk of the category. In addition, certain off-balance-sheet items
are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the four categories. Under the guidelines,
the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%, and the ratio of Tier 1 capital to risk-
weighted assets must be at least 4%. In evaluating the adequacy of a bank's capital, the FDIC may also consider other factors that may affect
the bank's financial condition. Such factors may include interest rate risk exposure, liquidity, funding and market risks, the quality and level of
earnings, concentration of credit risk, risks arising from nontraditional activities, loan and investment quality, the effectiveness of loan and
investment policies, and management's ability to monitor and control financial operating risks. At December 31, 2012, Banner Bank and Islanders
Bank had Tier 1 risk-based capital ratios of 15.12% and 16.28%, respectively, and total risk-based capital ratios of 16.38% and 17.53%,
respectively.
FDIC capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally
sound, which are well-managed and have no material or significant financial weaknesses. The FDIC capital regulations state that, where the
FDIC determines that the financial history or condition, including off-balance-sheet risk, managerial resources and/or the future earnings prospects
of a bank are not adequate and/or a bank has a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the
FDIC may determine that the minimum adequate amount of capital for the bank is greater than the minimum standards established in the
regulation.
We believe that, under the current regulations, Banner Bank and Islanders Bank exceed their minimum capital requirements. However, events
beyond the control of the Banks, such as weak or depressed economic conditions in areas where they have most of their loans, could adversely
affect future earnings and, consequently, the ability of the Banks to meet their capital requirements. For additional information concerning
Banner Bank's and Islanders Bank's capital, see Note 18 of the Notes to the Consolidated Financial Statements.
New Proposed Capital Rules. In June 2012, the Federal Reserve, FDIC and the Office of the Comptroller of the Currency (OCC) approved
proposed rules that would substantially amend the regulatory risk-based capital rules applicable to Banner Corporation and the Banks. The
proposed rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to various
documents released by the Basel Committee on Banking Supervision. The proposed rules were subject to a public comment period that has
expired and there is no date set for the adoption of final rules.
The proposed rules include new minimum risk-based capital and leverage ratios, which would be phased in during 2013 and 2014, and would
refine the definitions of what constitutes “capital” for purposes of calculating those ratios. The proposed new minimum capital level requirements
applicable to Banner Corporation and the Banks under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier
1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4%.
The proposed rules would also establish a “capital conservation buffer” of 2.5% above each of the new regulatory minimum capital ratios which
would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total
capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-
weighted assets and would increase each year until fully implemented in January 2019. An institution would be subject to limitations on paying
dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations
would establish a maximum percentage of eligible retained income that could be utilized for such actions.
The proposed rules also implement other revisions to the current capital rules such as recognition of all unrealized gains and losses on available
for sale debt and equity securities, and provide that instruments that will no longer qualify as capital would be phased out over time.
The federal bank regulatory agencies also proposed revisions to the prompt corrective action framework, which is designed to place restrictions
on insured depository institutions, including the Banks, if their capital levels begin to show signs of weakness. These revisions would take effect
January 1, 2015. Under the prompt corrective action requirements, insured depository institutions would be required to meet the following
increased capital level requirements in order to qualify as “well capitalized”: (i) a new common equity Tier 1 risk-based capital ratio of 6.5%;
(ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a total risk-based capital ratio of 10% (unchanged from current rules); and
(iv) a Tier 1 leverage ratio of 5% (unchanged from the current rules).
The proposed rules set forth certain changes for the calculation of risk-weighted assets and utilize an increased number of credit risk and other
exposure categories and risk weights. In addition, the proposed rules also address: (i) a proposed alternative standard of creditworthiness
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consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity
exposures and past due loans; and (iv) revised capital treatment for derivatives and repurchase-style transactions.
In particular, the proposed rules would expand the risk-weighting categories from the current four categories (0%, 20%, 50% and 100%) to a
much larger and more risk-sensitive number of categories, generally ranging from 0% for U.S. government and agency securities, to 600% for
certain equity exposures. Higher risk weights would apply to a variety of exposure categories. Specifics include, among others:
• Applying a 150% risk weight instead of a 100% risk weight for certain high volatility commercial real estate acquisition, development
and construction loans.
• For residential mortgage exposures, the current approach of a 50% risk weight for high-quality seasoned mortgages and a 100% risk-
weight for all other mortgages is replaced with a risk weight of between 35% and 200% depending upon the mortgage's loan-to-value
ratio and whether the mortgage is a “category 1” or “category 2” residential mortgage exposure (based on eight criteria that include,
among others, the term, seniority of the lien, use of negative amortization, balloon payments and certain rate increases).
• Assigning a 150% risk weight to exposures (other than residential mortgage exposures) that are 90 days past due.
• Providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that
is not unconditionally cancellable (currently set at 0%).
• Providing for a 100% risk weight for claims on securities firms.
• Eliminating the current 50% cap on the risk weight for OTC derivatives.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: On July 21, 2010, the Dodd-Frank Act was signed into law. The
Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) imposes new restrictions and an expanded framework
of regulatory oversight for financial institutions, including depository institutions. The following discussion summarizes significant aspects of
the Dodd-Frank Act that may affect the Banks and Banner Corporation. For certain of these changes, implementing regulations have not been
promulgated, so we cannot determine the full impact of the Dodd-Frank Act on our business and operations at this time.
The following aspects of the Dodd-Frank Act are related to the operations of the Banks:
• The Consumer Financial Protection Bureau (“CFPB”), an independent consumer compliance regulatory agency within the Federal
Reserve has been established. The CFPB is empowered to exercise broad regulatory, supervisory and enforcement authority over financial
institutions with total assets of over $10 billion with respect to both new and existing consumer financial protection laws. Financial
institutions with assets of less than $10 billion, like the Banks, will continue to be subject to supervision and enforcement by their
primary federal banking regulator with respect to federal consumer financial protection laws. The CFPB also has authority to promulgate
new consumer financial protection regulations and amend existing consumer financial protection regulations;
• The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve
as a source of strength for their depository institution subsidiaries;
• The prohibition on payment of interest on demand deposits was repealed, effective July 21, 2011;
• Deposit insurance is permanently increased to $250,000;
• The deposit insurance assessment base for FDIC insurance is the depository institution's average consolidated total assets less the average
tangible equity during the assessment period; and
• The minimum reserve ratio of the FDIC's DIF increased to 1.35 percent of estimated annual insured deposits or the comparable percentage
of the assessment base; however, the FDIC is directed to "offset the effect" of the increased reserve ratio for insured depository institutions
with total consolidated assets of less than $10 billion. Pursuant to the Dodd-Frank Act, the FDIC recently issued a rule setting a designated
reserve ratio at 2.0% of insured deposits.
The following aspects of the Dodd-Frank Act are related to the operations of Banner Corporation:
• Tier 1 capital treatment for "hybrid" capital items like trust preferred securities is eliminated subject to various grandfathering and
transition rules. The federal banking agencies must promulgate new rules on regulatory capital within 18 months from July 21, 2010,
for both depository institutions and their holding companies, to include leverage capital and risk-based capital measures at least as
stringent as those now applicable to the Banks under the prompt corrective action regulations;
• Public companies are required to provide their shareholders with a non-binding vote: (i) at least once every three years on the
compensation paid to executive officers, and (ii) at least once every six years on whether they should have a "say on pay" vote every
one, two or three years;
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• A separate, non-binding shareholder vote is required regarding golden parachutes for named executive officers when a shareholder vote
takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments;
• Securities exchanges are required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for
certain "significant" matters, which include votes on the election of directors, executive compensation matters, and any other matter
determined to be significant;
• Stock exchanges are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its
policy on incentive compensation payable on the basis of financial information reportable under the securities laws, and (ii) the recovery
from current or former executive officers, following an accounting restatement triggered by material noncompliance with securities
law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which
the restatement was required that exceeds the amount that would have been paid on the basis of the restated financial information;
• Disclosure in annual proxy materials is required concerning the relationship between the executive compensation paid and the financial
performance of the issuer;
•
Item 402 of Regulation S-K is amended to require companies to disclose the ratio of the Chief Executive Officer's annual total
compensation to the median annual total compensation of all other employees; and
• Smaller reporting companies are exempt from complying with the internal control auditor attestation requirements of Section 404(b)
of the Sarbanes-Oxley Act.
Commercial Real Estate Lending Concentrations: The federal banking agencies have issued guidance on sound risk management practices for
concentrations in commercial real estate lending. The particular focus is on exposure to commercial real estate loans that are dependent on the
cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed
to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a
bank's commercial real estate lending but to guide banks in developing risk management practices and capital levels commensurate with the
level and nature of real estate concentrations. The guidance directs the FDIC and other bank regulatory agencies to focus their supervisory
resources on institutions that may have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in
commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following
supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:
• Total reported loans for construction, land development and other land represent 100% or more of the bank's capital; or
• Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank's total capital or the outstanding
balance of the bank's commercial real estate loan portfolio has increased 50% or more during the prior 36 months.
The guidance provides that the strength of an institution's lending and risk management practices with respect to such concentrations will be
taken into account in supervisory guidance on evaluation of capital adequacy. As of December 31, 2012, Banner Bank's and Islanders Bank's
aggregate loans for construction, land development and land loans were 92% and 51% of total capital, respectively. In addition, at December 31,
2012 Banner Bank's and Islanders Bank's loans on commercial real estate were 227% and 213% of total capital, respectively.
Activities and Investments of Insured State-Chartered Financial Institutions: Federal law generally limits the activities and equity investments
of FDIC insured, state-chartered banks to those that are permissible for national banks. An insured state bank is not prohibited from, among
other things, (1) acquiring or retaining a majority interest in a subsidiary, (2) investing as a limited partner in a partnership the sole purpose of
which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such
limited partnership investments may not exceed 2% of the bank's total assets, (3) acquiring up to 10% of the voting stock of a company that
solely provides or re-insures directors', trustees' and officers' liability insurance coverage or bankers' blanket bond group insurance coverage for
insured depository institutions, and (4) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
Washington State has enacted a law regarding financial institution parity. Primarily, the law affords Washington-chartered commercial banks
the same powers as Washington-chartered savings banks. In order for a bank to exercise these powers, it must provide 30 days notice to the
Director of the Washington Department of Financial Institutions and the Director must authorize the requested activity. In addition, the law
provides that Washington-chartered commercial banks may exercise any of the powers that the Federal Reserve has determined to be closely
related to the business of banking and the powers of national banks, subject to the approval of the Director in certain situations. The law also
provides that Washington-chartered savings banks may exercise any of the powers of Washington-chartered commercial banks, national banks
and federally-chartered savings banks, subject to the approval of the Director in certain situations. Finally, the law provides additional flexibility
for Washington-chartered commercial and savings banks with respect to interest rates on loans and other extensions of credit. Specifically, they
may charge the maximum interest rate allowable for loans and other extensions of credit by federally-chartered financial institutions to Washington
residents.
Environmental Issues Associated With Real Estate Lending: The Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA) is a federal statute that generally imposes strict liability on all prior and present “owners and operators” of sites containing hazardous
waste. However, Congress asked to protect secured creditors by providing that the term “owner and operator” excludes a person whose ownership
is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the
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subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property
that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including Banner Bank and Islanders
Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be
subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property.
Federal Reserve System: The Federal Reserve Board requires that all depository institutions maintain reserves on transaction accounts or non-
personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve
Bank. Interest-bearing checking accounts and other types of accounts that permit payments or transfers to third parties fall within the definition
of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a bank. At December 31,
2012, the Banks' deposits with the Federal Reserve Bank and vault cash exceeded their reserve requirements.
Affiliate Transactions: Banner Corporation, Banner Bank and Islanders Bank are separate and distinct legal entities. Federal laws strictly limit
the ability of banks to engage in certain transactions with their affiliates, including their bank holding companies. Transactions deemed to be a
“covered transaction” under Section 23A of the Federal Reserve Act and between a subsidiary bank and its parent company or any non-bank
subsidiary of the bank holding company are limited to 10% of the subsidiary bank's capital and surplus and, with respect to the parent company
and all such non-bank subsidiaries, to an aggregate of 20% of the subsidiary bank's capital and surplus. Further, covered transactions that are
loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that
covered transactions and certain other transactions listed in Section 23B of the Federal Reserve Act between a bank and its affiliates be on terms
as favorable to the bank as transactions with non-affiliates.
Community Reinvestment Act: Banner Bank and Islanders Bank are subject to the provisions of the Community Reinvestment Act of 1977
(CRA), which requires the appropriate federal bank regulatory agency to assess a bank's performance under the CRA in meeting the credit needs
of the community serviced by the bank, including low and moderate income neighborhoods. The regulatory agency's assessment of the bank's
record is made available to the public. Further, a bank's CRA performance rating must be considered in connection with a bank's application
to, among other things, to establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or
acquire the assets or assume the liabilities of, a federally regulated financial institution. Both Banner Bank and Islanders Bank received a
“satisfactory” rating during their most recent CRA examinations.
Dividends: The amount of dividends payable by the Banks to the Company will depend upon their earnings and capital position, and is limited
by federal and state laws, regulations and policies. Federal law further provides that no insured depository institution may make any capital
distribution (which includes a cash dividend) if, after making the distribution, the institution would be “undercapitalized,” as defined in the
prompt corrective action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid
by insured banks if such payments should be deemed to constitute an unsafe and unsound practice.
Privacy Standards: The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (GLBA) modernized the financial services industry
by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other
financial service providers. Banner Bank and Islanders Bank are subject to FDIC regulations implementing the privacy protection provisions
of the GLBA. These regulations require the Banks to disclose their privacy policy, including informing consumers of their information sharing
practices and informing consumers of their rights to opt out of certain practices.
Anti-Money Laundering and Customer Identification: In response to the terrorist events of September 11, 2001, the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law on
October 26, 2001. The USA Patriot Act gives the federal government new powers to address terrorist threats through enhanced domestic security
measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. Bank regulators
are directed to consider a holding company's effectiveness in combating money laundering when ruling on Bank Holding Company Act and
Bank Merger Act applications. Banner Bank's and Islanders Bank's policies and procedures comply with the requirements of the USA Patriot
Act.
Other Consumer Protection Laws and Regulations: The Banks are subject to a broad array of federal and state consumer protection laws and
regulations that govern almost every aspect of its business relationships with consumers. While the list set forth below is not exhaustive, these
include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfers Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit
Reporting Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Fair Credit Billing Act, the Homeowners
Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection
with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement
some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial
institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services. Failure to comply
with these laws and regulations can subject the Banks to various penalties, including but not limited to, enforcement actions, injunctions, fines,
civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.
Banner Corporation
General: Banner Corporation, as sole shareholder of Banner Bank and Islanders Bank, is a bank holding company registered with the Federal
Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of
1956, as amended, or the BHCA, and the regulations of the Federal Reserve. We are required to file quarterly reports with the Federal Reserve
19
and provide additional information as the Federal Reserve may require. The Federal Reserve may examine us, and any of our subsidiaries, and
charge us for the cost of the examination. The Federal Reserve also has extensive enforcement authority over bank holding companies, including,
among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company
divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and
unsafe or unsound practices. Banner Corporation is also required to file certain reports with, and otherwise comply with the rules and regulations
of the Securities and Exchange Commission.
The Bank Holding Company Act: Under the BHCA, we are supervised by the Federal Reserve. The Federal Reserve has a policy that a bank
holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations
in an unsafe or unsound manner. In addition, the Dodd-Frank Act and earlier Federal Reserve policy provide that a bank holding company
should serve as a source of strength to its subsidiary banks by having the ability to provide financial assistance to its subsidiary banks during
periods of financial distress to the banks. A bank holding company's failure to meet its obligation to serve as a source of strength to its subsidiary
banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve's
regulations or both. The Dodd-Frank Act requires new regulations to be promulgated concerning the source of strength. Banner Corporation
and any subsidiaries that it may control are considered “affiliates” within the meaning of the Federal Reserve Act, and transactions between
Banner Bank and affiliates are subject to numerous restrictions. With some exceptions, Banner Corporation, and its subsidiaries, are prohibited
from tying the provision of various services, such as extensions of credit, to other services offered by Banner Corporation, or by its affiliates.
Acquisitions: The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership or control of more than 5% of
the voting shares of any company that is not a bank or bank holding company and from engaging in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries. Under the BHCA, the Federal Reserve may approve the ownership of
shares by a bank holding company in any company, the activities of which the Federal Reserve has determined to be so closely related to the
business of banking or managing or controlling banks as to be a proper incident thereto. These activities include: operating a savings institution,
mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing
certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing
property on a full-payout, non-operating basis; selling money orders, travelers' checks and U.S. Savings Bonds; real estate and personal property
appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for
customers.
Federal Securities Laws: Banner Corporation's common stock is registered with the Securities and Exchange Commission under Section 12(b)
of the Securities Exchange Act of 1934, as amended. We are subject to information, proxy solicitation, insider trading restrictions and other
requirements under the Securities Exchange Act of 1934 (the Exchange Act).
Sarbanes-Oxley Act of 2002: The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act was signed into law on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with several accounting scandals. The stated goals of the Sarbanes-Oxley Act
are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies
and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley
Act generally applies to all companies, such as Banner Corporation, that file or are required to file periodic reports with the Securities and
Exchange Commission (SEC), under the Exchange Act.
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and corporate governance rules and requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain
issues by the SEC and the Comptroller General. Our policies and procedures have been updated to comply with the requirements of the Sarbanes-
Oxley Act.
Interstate Banking and Branching: The Federal Reserve must approve an application of a bank holding company to acquire control of, or acquire
all or substantially all of the assets of, a bank located in a state other than the holding company's home state, without regard to whether the
transaction is prohibited by the laws of any state. The Federal Reserve may not approve the acquisition of a bank that has not been in existence
for the minimum time period (not exceeding five years) specified by the statutory law of the host state. Nor may the Federal Reserve approve
an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the
United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. Federal
law does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank
holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states
may also waive the 30% state-wide concentration limit contained in the federal law.
The federal banking agencies are authorized to approve interstate merger transactions without regard to whether the transaction is prohibited by
the law of any state, unless the home state of one of the banks adopted a law prior to June 1, 1997 which applies equally to all out-of-state banks
and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches will be permitted only if the law
of the state in which the branch is located permits such acquisitions. Interstate mergers and branch acquisitions will also be subject to the
nationwide and statewide insured deposit concentration amounts described above. Under the Dodd-Frank Act, the federal banking agencies
may generally approve interstate de novo branching.
Dividends: The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses
its view that although there are no specific regulations restricting dividend payments by bank holding companies other than state corporate laws,
a bank holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company's net
20
income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the
company's capital needs, asset quality, and overall financial condition. The Federal Reserve policy statement also indicates that it would be
inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends.
Capital Requirements: The Federal Reserve has established capital adequacy guidelines for bank holding companies that generally parallel the
capital requirements of the FDIC for the Banks, although the Federal Reserve regulations provide for the inclusion of certain trust preferred
securities for up to 25% of Tier 1 capital in determining compliance with the guidelines. The Federal Reserve regulations provide that capital
standards will be applied on a consolidated basis in the case of a bank holding company with $500 million or more in total consolidated assets. The
guidelines require that a company's total risk-based capital must equal 8% of risk-weighted assets and one half of the 8% (4%) must consist of
Tier 1 (core) capital. As of December 31, 2012, Banner Corporation's total risk-based capital was 16.96% of risk-weighted assets and its Tier
1 (core) capital was 15.70% of risk-weighted assets. The Dodd-Frank Act required new capital regulations to be adopted in final form 18 months
after the July 21, 2010 enactment date of the Dodd-Frank Act. In June 2012, the Federal Reserve, FDIC and the OCC approved proposed rules
that would substantially amend the regulatory risk-based capital rules applicable to Banner Corporation and the Banks. The proposed rules were
subject to a public comment period that has expired and there is no date set for the adoption of final rules.
Stock Repurchases: A bank holding company, except for certain “well-capitalized” and highly rated bank holding companies, is required to give
the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the
purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve
months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines
that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order or any condition
imposed by, or written agreement with, the Federal Reserve. We did not repurchase any shares of common stock during the 2012 fiscal year.
Executive Officers
Management Personnel
The following table sets forth information with respect to the executive officers of Banner Corporation and Banner Bank as of December 31,
2012:
Name
Age
Position with Banner Corporation
Position with Banner Bank
Mark J. Grescovich
Lloyd W. Baker
Cynthia D. Purcell
Richard B. Barton
Steven W. Rust
Douglas M. Bennett
Tyrone J. Bliss
Gary W. Wagers
John T. Wagner
James T. Reed, Jr.
M. Kirk Quillin
48
64
55
69
65
60
55
52
62
50
50
President, Chief Executive Officer,
Director
President, Chief Executive Officer, Director
Executive Vice President,
Chief Financial Officer
Executive Vice President,
Chief Financial Officer
Executive Vice President,
Retail Banking and Administration
Executive Vice President,
Chief Lending Officer
Executive Vice President,
Chief Information Officer
Executive Vice President,
Real Estate Lending Operations
Executive Vice President,
Risk Management and Compliance Officer
Executive Vice President,
Retail Products and Services
Executive Vice President,
Corporate Administration
Senior Vice President,
Commercial Banking
Senior Vice President,
Commercial Banking
Biographical Information
Set forth below is certain information regarding the executive officers of Banner Corporation and Banner Bank. There are no family relationships
among or between the directors or executive officers.
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Mark J. Grescovich is President and Chief Executive Officer, and a director, of Banner Corporation and Banner Bank. Mr. Grescovich joined
the Bank in April 2010 and became Chief Executive Officer in August 2010 following an extensive banking career specializing in finance, credit
administration and risk management. Prior to joining the Bank, Mr. Grescovich was the Executive Vice President and Chief Corporate Banking
Officer for Akron, Ohio-based FirstMerit Corporation and FirstMerit Bank N.A., a commercial bank with $14.5 billion in assets and over 200
branch offices in three states. He assumed the role and responsibility for FirstMerit’s commercial and regional line of business in 2007, having
served since 1994 in various commercial and corporate banking positions, including that of Chief Credit Officer. Prior to joining FirstMerit,
Mr. Grescovich was a Managing Partner in corporate finance with Sequoia Financial Group, Inc. of Akron, Ohio and a commercial and corporate
lending officer and credit analyst with Society National Bank of Cleveland, Ohio.
Lloyd W. Baker joined First Savings Bank of Washington (now Banner Bank) in 1995 as Asset/Liability Manager, has been a member of the
executive management committee since 1998 and has served as the Chief Financial Officer of Banner Corporation and Banner Bank since
2000. His banking career began in 1972.
Cynthia D. Purcell was formerly the Chief Financial Officer of Inland Empire Bank (now Banner Bank), which she joined in 1981, and has
served in her current position as Executive Vice President since 2000. Ms. Purcell is responsible for Retail Banking and Administration.
Richard B. Barton joined Banner Bank in 2002 as Chief Credit Officer. Mr. Barton’s banking career began in 1972 with Seafirst Bank and Bank
of America, where he served in a variety of commercial lending and credit risk management positions. In his last positions at Bank of America
before joining Banner Bank, he served as the senior real estate risk management executive for the Pacific Northwest and as the credit risk
management executive for the west coast home builder division. Mr. Barton was named Chief Lending Officer in 2008.
Steven W. Rust joined Banner Bank in October 2005. Mr. Rust has over 34 years of relevant industry experience prior to joining Banner Bank
and was founder and President of InfoSoft Technology, through which he worked for nine years as a technology consultant and interim Chief
Information Officer for banks and insurance companies. He worked 19 years with US Bank/West One Bancorp as Senior Vice President &
Manager of Information Systems.
Douglas M. Bennett, who joined First Federal Savings and Loan (now Banner Bank) in 1974, has over 36 years of experience in real estate
lending. He has served as a member of Banner Bank’s executive management committee since 2004.
Tyrone J. Bliss joined Banner Bank in 2002. Mr. Bliss is a Certified Regulatory Compliance Manager with more than 33 years of commercial
banking experience. Prior to joining Banner Bank, his career included senior risk management and compliance positions with Bank of America’s
Consumer Finance Group, Barnett Banks, Inc., and Florida-based community banks.
Gary W. Wagers joined Banner Bank as Senior Vice President, Consumer Lending Administration in 2002 and was named to his current position
in Retail Products and Services in January 2008. Mr. Wagers began his banking career in 1982 at Idaho First National Bank. Prior to joining
Banner Bank, his career included senior management positions in retail lending and branch banking operations with West One Bank and US
Bank.
John T. Wagner began his banking career in 1972 with Norwest Bank. He worked for Seafirst Bank and Bank of America from 1977 to 2003,
concluding his career there as Market President for Eastern Washington and Idaho. He joined F&M Bank in October, 2003 as President and
Chief Operating Officer. Currently, Mr. Wagner serves as Executive Vice President at Banner Bank. He is a graduate of the University of
Montana with a bachelor’s degree in Finance. He is a 1986 graduate of the Pacific Coast Banking School and has completed the Executive
Management Program at Duke University.
James T. Reed, Jr. joined Towne Bank (now Banner Bank) as a Vice President and Commercial Branch Manager in July 1995 and was named
to his current position as the West Region Commercial Banking Executive in July 2012. He is responsible for Commercial Banking in Western
Washington and Western Oregon as well as Specialty Banking. Mr. Reed began his banking career with Rainier Bank which later became
Security Pacific Bank and later still West One Bank. He earned a Bachelor of Arts in Interdisciplinary Arts and Sciences from the University
of Washington, and earned certificates from Pacific Coast Banking School, Northwest Intermediate Banking School and Northwest Intermediate
Commercial Lending School. Currently, Mr. Reed sits on the University of Washington Bothell Advisory Board and the University of Washington
Foundation Board.
M. Kirk Quillin joined Banner Bank's commercial banking group in 2002 as a Senior Vice President and commercial loan manager and was
named to his current position as the East Region Commercial Banking Executive in July 2012. He is responsible for commercial and specialty
banking for all locations in Eastern Washington, Eastern Oregon and Idaho. Mr. Quillin began his career in the banking industry in 1984 with
Idaho First National Bank, which is now U.S. Bank. His career also included management positions in commercial lending with Washington
Mutual. He earned a B.S. in Finance and Economics from Boise State University and was certified by the Pacific Coast Banking School and
Northwest Intermediate Commercial Lending School.
Corporate Information
Our principal executive offices are located at 10 South First Avenue, Walla Walla, Washington 99362. Our telephone number is (509)
527-3636. We maintain a website with the address www.bannerbank.com. The information contained on our website is not included as a part
of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own Internet access charges, we make available
22
free of charge through our website our Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and
amendments to these reports, as soon as reasonably practicable after we have electronically filed such material with, or furnished such material
to, the Securities and Exchange Commission.
23
Item 1A – Risk Factors
An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should
carefully consider the risks and uncertainties described below together with all of the other information included in this report. In
addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently
deem to be immaterial also may materially and adversely affect our business, financial condition, capital levels, cash flows, liquidity,
results of operations and prospects. The market price of our common stock could decline significantly due to any of these identified or
other risks, and you could lose some or all of your investment. The risks discussed below also include forward-looking statements, and
our actual results may differ substantially from those discussed in these forward-looking statements. This report is qualified in its
entirety by these risk factors.
Risks Factors Related to Our Business
Our business may continue to be adversely affected by downturns in the national economy and the regional economies on which we
depend.
Our operations are significantly affected by national and regional economic conditions. Weakness in the national economy or the economies of
the markets in which we operate could have a material adverse effect on our financial condition, results of operations and prospects. Substantially
all of our loans are to businesses and individuals in the states of Washington, Oregon and Idaho. All of our branches and most of our deposit
customers are also located in these three states. Beginning in 2008, Washington, Oregon and Idaho have experienced significant home price
declines, increased foreclosures and high unemployment rates, and each state continues to face fiscal challenges, which may have adverse long
term effects on economic conditions in those states. As a result of the high concentration of our customer base in the Puget Sound area of
Washington State, the deterioration of businesses in the Puget Sound area, or one or more businesses with a large employee base in that area,
could have a material adverse effect on our business, financial condition, liquidity, results of operations and prospects. In addition, weakness
in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade.
A further deterioration in economic conditions or a prolonged delay in economic recovery in the market areas we serve, in particular the Puget
Sound area of Washington State, the Portland, Oregon metropolitan area, Spokane, Washington, Boise, Idaho and the agricultural regions of the
Columbia Basin, could result in the following consequences, any of which could have a material adverse effect on our business, financial
condition, liquidity and results of operations:
• demand for our products and services may decline;
•
•
loan delinquencies, problem assets and foreclosures may increase;
collateral for loans, especially real estate, may decline further in value, in turn reducing customers’ borrowing power, reducing the
value of assets and collateral associated with existing loans; and
the amount of our low-cost or non-interest-bearing deposits may decrease.
•
A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products
and services, which could have adverse effect on our results of operations.
The ongoing debate in Congress regarding the national debt ceiling and federal budget deficit and concerns over the United States' credit rating
(which was downgraded by Standard & Poor's), the European sovereign debt crisis, the overall weakness in the economy and continued high
unemployment in the United States, among other economic indicators, have contributed to increased volatility in the capital markets and
diminished expectations for the economy.
A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly
affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further
declines in real estate values and sales volumes and continued high unemployment levels may result in higher than expected loan delinquencies
and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital,
liquidity, and financial condition.
Furthermore, the Board of Governors of the Federal Reserve System, in an attempt to help the overall economy, has, among other things, kept
interest rates low through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. If the Federal Reserve
increases the federal funds rate, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic
recovery. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our
borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial
performance.
Declines in property value have increased the loan-to-value ratios on a significant portion of our residential mortgage loan portfolio,
which exposes us to greater risk of loss.
Many of our residential mortgage loans are secured by liens on mortgage properties in which the borrowers have little or no equity because
either we originated the loan with a relatively high combined loan-to-value ratio or because of the decline in home values in our market
areas. Residential loans with high combined loan-to-value ratios will be more sensitive to declining property values than those with lower
combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers
24
sell their homes, such borrowers may be unable to repay their loans in full from the sale proceeds. As a result, these loans may experience higher
rates of delinquencies, defaults and losses.
Our loan portfolio includes loans with a higher risk of loss.
We originate construction and land loans, commercial and multifamily mortgage loans, commercial business loans, consumer loans, agricultural
mortgage loans and agricultural loans primarily within our market areas. We had $2.42 billion outstanding in these types of higher risk loans
at December 31, 2012 compared to $2.65 billion at December 31, 2011. These loans typically present different risks to us for a number of
reasons, including those discussed below:
• Construction and Land Loans. At December 31, 2012, construction and land loans were $305 million or 9% of our total loan
portfolio. This type of lending contains the inherent difficulty in estimating both a property’s value at completion of the project and
the estimated cost (including interest) of the project. If the estimate of construction cost proves to be inaccurate, we may be required
to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion
proves to be inaccurate, we may be confronted at, or prior to, the maturity of the loan with a project the value of which is insufficient
to assure full repayment. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold,
and thus pose a greater potential risk to us than construction loans to individuals on their personal residences. Loans on land under
development or held for future construction also pose additional risk because of the lack of income being produced by the property and
the potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions. As a result,
this type of lending often involves the disbursement of substantial funds with repayment dependent on the success of the ultimate project
and the ability of the borrower to sell the property, rather than the ability of the borrower or guarantor to independently repay principal
and interest. While our origination of these types of loans has decreased significantly in the last five years, we continue to have significant
levels of construction and land loan balances. At December 31, 2012, construction and land loans that were non-performing were $4
million, or 11% of our total non-performing loans.
• Commercial and Multifamily Real Estate Loans. At December 31, 2012, commercial and multifamily real estate loans were $1.211
billion, or 37% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans. Repayment
is dependent upon income being generated from the property securing the loan in amounts sufficient to cover operating expenses and
debt service, which may be adversely affected by changes in the economy or local market conditions. In addition, many of our commercial
and multifamily real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments
may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk
of default or non-payment. This risk is exacerbated in the current economic environment. At December 31, 2012, commercial and
multifamily real estate loans that were non-performing were $7 million, or 19% of our total non-performing loans.
• Commercial Business Loans. At December 31, 2012, commercial business loans were $618 million, or 19% of our total loan portfolio.
Our commercial loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided
by the borrower. The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Most
often, this collateral is accounts receivable, inventory, equipment or real estate. In the case of loans secured by accounts receivable,
the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts
due from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise, may be illiquid and may
fluctuate in value based on the success of the business. At December 31, 2012, commercial business loans that were non-performing
were $5 million, or 14% of our total non-performing loans.
• Agricultural Loans. At December 31, 2012, agricultural loans were $230 million, or 7% of our total loan portfolio. Repayment is
dependent upon the successful operation of the business, which is greatly dependent on many things outside the control of either us or
the borrowers. These factors include weather, commodity prices, and interest rates among others. Collateral securing these loans may
be difficult to evaluate, manage or liquidate and may not provide an adequate source of repayment. At December 31, 2012, there were
no agricultural loans that were non-performing .
• Consumer Loans. At December 31, 2012, consumer loans were $291 million, or 9% of our total loan portfolio. Consumer loans (such
as personal lines of credit) are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due
to depreciation, damage, or loss. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability,
and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered
on these loans. At December 31, 2012, consumer loans that were non-performing were $4 million, or 10% of our total non-performing
loans.
If our allowance for loan losses is not adequate, we may be required to make further increases in our provisions for loan losses and to
charge off additional loans in the future, which could adversely affect our financial condition, liquidity and results of operations.
For the year ended December 31, 2012, we recorded a provision for loan losses of $13.0 million, compared to $35.0 million for the year ended
December 31, 2011. We also recorded net loan charge-offs of $18.4 million for the year ended December 31, 2012, compared to $49.5 million
for the year ended December 31, 2011. Despite the decrease from the prior year, we are still experiencing elevated levels of loan delinquencies
and credit losses by historical standards. At December 31, 2012, our total non-performing loans had decreased to $34.4 million compared to
$75.3 million at December 31, 2011. If current weak conditions in the housing and real estate markets continue, we expect that we will continue
25
to experience higher than normal delinquencies and credit losses. Moreover, if weak economic conditions in our market areas persist, we could
experience significantly higher delinquencies and credit losses. As a result, we may be required to make further increases in our provision for
loan losses and to charge off additional loans in the future, which could materially adversely affect our financial condition and results of operations.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio which would cause our results of
operations, liquidity and financial condition to be adversely affected.
Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or
that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
•
•
•
•
•
cash flow of the borrower and/or the project being financed;
in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral;
the duration of the loan;
the character and creditworthiness of a particular borrower; and
changes in economic and industry conditions.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe
is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through
periodic reviews and consideration of several factors, including, but not limited to:
• our general reserve, based on our historical default and loss experience, certain macroeconomic factors, and management’s expectations
of future events;
• our specific reserve, based on our evaluation of non-performing loans and their underlying collateral; and
•
an unallocated reserve to provide for other credit losses inherent in our portfolio that may not have been contemplated in the other loss
factors.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to
make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the
value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance
for loan losses, we review our loans and loss and delinquency experience, and evaluate economic conditions and make significant estimates of
current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan losses
may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in
the provision for loan losses. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans,
identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for
loan losses. Our allowance for loan losses was 2.39% of total loans outstanding and 225% of non-performing loans at December 31, 2012. In
addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible
loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs
in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases
in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results
of operations and capital.
If our non-performing assets increase, our earnings will be adversely affected.
At December 31, 2012 and 2011, our non-performing assets (which consist of nonaccruing loans, accruing loans 90 days or more past due, non-
performing investment securities, and real estate owned (REO)) were $50.2 million and $118.9 million, respectively, or 1.18% and 2.79% of
total assets, respectively. Our non-performing assets adversely affect our net income in various ways:
• We do not record interest income on nonaccrual loans, non-performing investment securities, or REO.
• We must provide for probable loan losses through a current period charge to the provision for loan losses.
• Non-interest expense increases when we must write down the value of properties in our REO portfolio to reflect changing market values
or recognize other-than-temporary impairment on non-performing investment securities.
• There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance
fees related to our REO.
• The resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable
activity.
If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our non-performing assets, our
losses and troubled assets could increase significantly, which could have a material adverse effect on our financial condition, liquidity and results
of operations.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is
needed or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We may at some point, however,
need to raise additional capital to support continued growth or be required by our regulators to increase our capital resources. Our ability to
26
raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial
condition and performance. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are
acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially
impaired and our financial condition and liquidity could be materially and adversely affected. In addition, if we are unable to raise additional
capital when required by our bank regulators, we may be subject to adverse regulatory action.
We may have significant variation in our annual and quarterly results.
We reported net income of $59.1 million available to common shareholders during the year ended December 31, 2012 compared to a net loss
of $2.4 million during the year ended December 31, 2011. Our operating results in recent periods have been significantly influenced by the
relatively high, although declining, levels of delinquencies, non-performing loans, and related provision for loan losses, net loan charge-offs and
charges related to REO. In addition, several other factors affecting our business can cause significant variations in our quarterly results of
operations. In particular, variations in the volume of our loan originations and sales, the differences between our cost of funds and the average
interest rate earned on investments, special FDIC insurance charges, significant changes in real estate valuations and the fair valuation of our
junior subordinated debentures or our investment securities portfolio could have a material adverse effect on our results of operations, financial
condition and liquidity.
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase
our valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property taken in as
REO and at certain other times during the assets holding period. Our net book value (NBV) in the loan at the time of foreclosure and thereafter
is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any
excess in the asset’s NBV over its fair value. If our valuation process is incorrect, or if property values decline, the fair value of the investments
in real estate may not be sufficient to recover our carrying value in such assets, resulting in the need for additional charge-offs. Significant
charge-offs to our investments in real estate could have a material adverse effect on our financial condition, liquidity and results of operations.
In addition, bank regulators periodically review our REO and may require us to recognize further charge-offs. Any increase in our charge-offs,
as required by the bank regulators, may have a material adverse effect on our financial condition, liquidity and results of operations.
The value of securities in our investment securities portfolio may be negatively affected by disruptions in securities markets.
The market for some of the investment securities held in our portfolio has been generally disrupted, uncertain and inefficient in recent years. These
market conditions have affected and may further detrimentally affect the value of these securities, such as through reduced valuations because
of the perception of heightened credit and liquidity risks. There can be no assurance that the declines in market value associated with this
disruption and lack of activity will not result in other-than-temporary impairments of these assets, which would lead to accounting charges that
could have a material adverse effect on our net income and capital levels.
An increase in interest rates, change in the programs offered by secondary market purchasers or our ability to qualify for their programs
may reduce our mortgage banking revenues, which would negatively impact our non-interest income.
Our mortgage banking operations provide a significant portion of our non-interest income. We generate mortgage revenues primarily from gains
on the sale of single-family mortgage loans pursuant to programs currently offered by Fannie Mae, Freddie Mac, Ginnie Mae and non-GSE
investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any future changes in these
programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such
entities could, in turn, materially adversely affect our results of operations. Mortgage banking is generally considered a volatile source of income
because it depends largely on the level of loan volume which, in turn, depends largely on prevailing market interest rates. In a rising or higher
interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This
would result in a decrease in mortgage banking revenues and a corresponding decrease in non-interest income. In addition, our results of
operations are affected by the amount of non-interest expense associated with mortgage banking activities, such as salaries and employee benefits,
occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations
may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations. In addition,
although we sell loans into the secondary market without recourse, we are required to give customary representations and warranties about the
loans to the buyers. If we breach those representations and warranties, the buyers may require us to repurchase the loans and we may incur a
loss on the repurchase.
Our results of operations, liquidity and cash flows are subject to interest rate risk.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are
beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the
Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and
investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect (i) our ability to originate loans
and obtain deposits, (ii) the fair value of our financial assets and liabilities and (iii) the average duration of our mortgage-backed securities
portfolio and other interest-earning assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest
rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also
27
be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and
other borrowings. In addition, a substantial amount of our loans have adjustable interest rates. As a result, these loans may experience a higher
rate of default in a rising interest rate environment. Further, a significant portion of our adjustable rate loans have interest rate floors below
which the loan’s contractual interest rate may not adjust. Approximately 64% of our loan portfolio was comprised of adjustable or floating-rate
loans at December 31, 2012, and approximately $1.5 billion, or 72%, of those loans contained interest rate floors, below which the loans’
contractual interest rate may not adjust. At December 31, 2012, the weighted average floor interest rate of these loans was 5.08%. At that date,
approximately $1.3 billion, or 86%, of these loans were at their floor interest rate. The inability of our loans to adjust downward can contribute
to increased income in periods of declining interest rates, although this result is subject to the risks that borrowers may refinance these loans
during periods of declining interest rates. Also, when loans are at their floors, there is a further risk that our interest income may not increase
as rapidly as our cost of funds during periods of increasing interest rates which could have a material adverse effect on our results of operations.
Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition, liquidity
and results of operations. Further, a prolonged period of exceptionally low market interest rates, such as we are currently experiencing, could
have an adverse effect on our results of operations as a result of substantially reduced asset yields. Also, our interest rate risk modeling techniques
and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating
results.
Historically low interest rates may adversely affect our net interest income and profitability.
During the last four years, it has been the policy of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to maintain
interest rates at historically low levels through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities.
As a result, yields on securities we have purchased, and market rates on the loans we have originated, have been at levels lower than were
available prior to 2008. Consequently, the average yield on our interest-earning assets has decreased during the recent low interest rate
environment. As a general matter, our interest-bearing liabilities re-price or mature more quickly than our interest-earning assets, which has
contributed to increases in net interest income in the short term. However, our ability to lower our interest expense is limited at these interest
rate levels, while the average yield on our interest-earning assets may continue to decrease. The Federal Reserve has indicated its intention to
maintain low interest rates in the near future. Accordingly, our net interest income may decrease, which may have an adverse affect on our
profitability. For information with respect to changes in interest rates, see “Risk Factors- Our results of operations, liquidity and cash flows are
subject to interest rate risk.”
If our investment in the Federal Home Loan Bank of Seattle becomes impaired, our earnings and shareholders' equity could
decrease.
At December 31, 2012, the Company had recorded $36.7 million in FHLB stock, compared to $37.4 million at December 31, 2011. The Banks'
investments in FHLB stock are generally viewed as a long-term investment and are carried at par value ($100 per share), which reasonably
approximates its fair value. It does not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member
institutions and can only be purchased and redeemed at par. As members of the FHLB system, the Banks are required to maintain a minimum
level of investment in FHLB stock based on specific percentages of their outstanding FHLB advances. For the years ended December 31, 2012,
2011 and 2010, the Banks did not receive any dividend income on FHLB stock.
Management periodically evaluates FHLB stock for impairment. Management's determination of whether these investments are impaired is
based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of
whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of
the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the
FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB,
(3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position
of the FHLB.
The Seattle FHLB announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (the FHFA),
its primary regulator, as of December 31, 2008, and that it would suspend future dividends and the repurchase and redemption of outstanding
common stock. The FHLB of Seattle announced September 7, 2012 that the FHFA now considers the FHLB of Seattle to be adequately capitalized.
Dividends on, or repurchases of, the FHLB of Seattle stock continue to require consent of the FHFA. The FHFA subsequently approved the
repurchase of portions of FHLB of Seattle stock, and as of December 31, 2012, the FHLB had repurchased $665,900 of the Banks' stock. The
Company will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of Banner's
investment. Based on the above, the Company has determined there is not any impairment on the FHLB stock investment as of December 31,
2012.
The Dodd-Frank Wall Street Reform and Consumer Protection Act has, among other things, tightened capital standards, created a new
Consumer Financial Protection Bureau and will result in new laws and regulations that are expected to increase our costs of operations.
The Banks are subject to extensive examination, supervision and comprehensive regulation by the FDIC and the Washington DFI, and Banner
Corporation is subject to examination and supervision by the Federal Reserve. The FDIC, Washington DFI and the Federal Reserve govern the
activities in which we may engage, primarily for the protection of depositors and the Deposit Insurance Fund. These regulatory authorities have
extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on an institution's
28
operations, reclassify assets, determine the adequacy of an institution's allowance for loan losses and determine the level of deposit insurance
premiums assessed.
Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) has significantly changed the bank
regulatory structure and has affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding
companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to
prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting and implementing rules
and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or
years.
Certain provisions of the Dodd-Frank Act are expected to have a near term impact on us. For example, a provision of the Dodd-Frank Act
eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts.
Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense.
The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total
assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit
insurance for banks, savings institutions and credit unions to $250,000 per depositor.
The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called
“golden parachute” payments. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to
bank holding company executives, regardless of whether the company is publicly traded.
The Dodd-Frank Act created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection
laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to
all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial
Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.
Financial institutions such as the Banks with $10 billion or less in assets will continue to be examined for compliance with the consumer laws
by their primary bank regulators.
It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will
have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase
our interest expense. Any additional changes in our regulation and oversight, whether in the form of new laws, rules or regulations, could make
compliance more difficult or expensive or otherwise materially adversely affect our business, financial condition or prospects.
The short-term and long-term impact of the changing regulatory capital requirements and anticipated new capital rules is uncertain.
In June 2012, the Federal Reserve, FDIC and the OCC proposed rules that would substantially amend the regulatory risk-based capital rules
applicable to Banner Corporation and the Banks. The proposed rules were subject to a public comment period that has expired and there is no
date set for the adoption of final rules.
Various provisions of the Dodd-Frank Act increase the capital requirements of bank holding companies, such as Banner Corporation. The leverage
and risk-based capital ratios of these entities may not be lower than the leverage and risk-based capital ratios for insured depository institutions.
The proposed rules include new minimum risk-based capital and leverage ratios, which would be phased in during 2013 and 2014, and would
refine the definition of what constitutes “capital” for purposes of calculating those ratios. The proposed new minimum capital level requirements
applicable to Banner Corporation and the Banks under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier
1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4%
for all institutions. The proposed rules would also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital
ratios, and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and
(iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625%
of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution would be subject to limitations
on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These
limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions. While the proposed Basel
III changes and other regulatory capital requirements will likely result in generally higher regulatory capital standards, it is difficult at this time
to predict when or how any new standards will ultimately be applied to Banner Corporation and the Banks.
In addition, in the current economic and regulatory environment, regulators of banks and bank holding companies have become more likely to
impose capital requirements on bank holding companies and banks that are more stringent than those required by applicable existing regulations.
The application of more stringent capital requirements for Banner Corporation and the Banks could, among other things, result in lower returns
on invested capital, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such
requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our
having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Implementation of
changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional
capital conservation buffers could result in management modifying its business strategy and could limit our ability to make distributions, including
paying out dividends or buying back shares.
29
Increases in deposit insurance premiums and special FDIC assessments will negatively impact our earnings.
The Dodd-Frank Act established 1.35% of total insured deposits as the minimum reserve ratio. The FDIC has adopted a plan under which it
will meet this ratio by the statutory deadline of September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect on institutions
with assets less than $10 billion of the increase in the minimum reserve ratio to 1.35% from the former minimum of 1.15%. The FDIC has not
announced how it will implement this offset. In addition to the statutory minimum ratio, the FDIC must set a designated reserve ratio or DRR,
which may exceed the statutory minimum. The FDIC has set 2.0% as the DRR.
As required by the Dodd-Frank Act, the FDIC has adopted final regulations under which insurance premiums are based on an institution's total
assets minus its tangible equity instead of its deposits. While our FDIC insurance premiums initially have been reduced by these regulations,
it is possible that our future insurance premiums will increase under the final regulations.
Failure to manage our growth may adversely affect our performance.
Our financial performance and profitability depend on our ability to manage past and possible future growth. Future acquisitions and growth
may present operating, integration and other issues that could have a material adverse effect on our business, financial condition, liquidity or
results of operations.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
Liquidity is essential to our business and the inability to obtain adequate funding may negatively affect growth and, consequently, our earnings
capability and capital levels. An inability to raise funds through deposits, borrowings, the sale of loans or investment securities and other sources
could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities on terms
which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors
that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn
in the Washington, Oregon or Idaho markets in which our loans are concentrated, negative operating results or adverse regulatory action against
us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative
views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and
the continued uncertainty in credit markets. In particular, our liquidity position could be significantly constrained if we are unable to access
funds from the Federal Home Loan Bank of Seattle, the Federal Reserve Bank of San Francisco or other wholesale funding sources or if adequate
financing is not available at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources, our
revenues may not increase proportionately to cover our costs. In this case, our results of operations and financial condition would be negatively
affected. In addition, changes in recent years in the collateralization requirements and other provisions of the Washington and Oregon public
funds deposit programs have changed the economic benefit associated with accepting public funds deposits, which may affect our need to utilize
alternative sources of liquidity.
We may engage in FDIC-assisted transactions, which could present additional risks to our business.
We may have opportunities to acquire the assets and liabilities of failed banks in FDIC-assisted transactions, including transactions in the states
of Washington, Oregon and Idaho. Although these FDIC-assisted transactions typically provide for FDIC assistance to an acquirer to mitigate
certain risks, such as sharing exposure to loan losses and providing indemnification against certain liabilities of the failed institution, we are
(and would be in future transactions) subject to many of the same risks we would face in acquiring another bank in a negotiated transaction,
including risks associated with maintaining customer relationships and failure to realize the anticipated acquisition benefits in the amounts and
within the time frames we expect. In addition, because these acquisitions are structured in a manner that would not allow us the time and access
to information normally associated with preparing for and evaluating a negotiated acquisition, we may face additional risks in FDIC-assisted
transactions, including additional strain on management resources, management of problem loans, problems related to integration of personnel
and operating systems and impact to our capital resources requiring us to raise additional capital. We cannot provide assurance that we would
be successful in overcoming these risks or any other problems encountered in connection with FDIC-assisted transactions. Our inability to
overcome these risks could have a material adverse effect on our business, financial condition and results of operations.
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of
operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit
insurance funds and consumers, not to benefit our shareholders. Regulatory authorities have extensive discretion in connection with their
supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by
the institution and the adequacy of an institution's allowance for loan losses. The significant federal and state banking regulations that affect us
are described in this report under the heading “Item 1. Business-Regulation.” These regulations, along with the currently existing tax, accounting,
securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial
institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws,
regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.
Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions,
investments, access to capital, the location of banking offices, and/or increase the ability of non-banks to offer competing financial services and
30
products, among other things. For example, regulatory changes to the rules for overdraft fees for debit transactions and interchange fees have
the potential to reduce our fee income which would result in a reduction of our non-interest income. Further, legislative proposals limiting our
rights as a creditor could result in credit losses or increased expense in pursuing our remedies as a creditor. If proposals such as these, or other
proposals limiting our rights as a creditor, were to be implemented, we could experience increased credit losses on our loans, or increased expense
in pursuing our remedies as a creditor. Our failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies,
civil money penalties and/or reputational damage, which could have a material adverse effect on our business, financial condition, liquidity and
results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such
violations will not occur.
Our litigation-related costs might continue to increase.
The Banks are subject to a variety of legal proceedings that have arisen in the ordinary course of the Banks’ business. In the current economic
environment, the Banks’ involvement in litigation has increased significantly, primarily as a result of defaulted borrowers asserting claims to
defeat or delay foreclosure proceedings. There can be no assurance that our loan workout and other activities will not expose us to additional
legal actions, including lender liability or environmental claims. The Banks believe that they have meritorious defenses in legal actions where
they have been named as defendants and are vigorously defending these suits. Although management, based on discussion with litigation counsel,
believes that such proceedings will not have a material adverse effect on the financial condition, liquidity and results of operations of the Banks,
there can be no assurance that a resolution of any pending or future legal matter will not result in significant liability to the Banks nor have a
material adverse impact on their financial condition, liquidity and results of operations or the Banks’ ability to meet applicable regulatory
requirements. Moreover, the expenses of any legal proceedings will adversely affect the Banks’ results of operations until they are resolved.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with
knowledge of, and experience in, the community banking industry where the Banks conduct their business. The process of recruiting personnel
with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree
upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and
upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent
upon the abilities of key executives, including our President, and certain other employees. In addition, our success has been and continues to
be highly dependent upon the services of our directors, many of whom are at or nearing retirement age, and we may not be able to identify and
attract suitable candidates to replace such directors.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of loss due to
fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced
losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, there can be
no assurance that such losses will not occur.
Managing reputational risk is important to attracting and maintaining customers, investors and employees.
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices,
employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent
activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies
and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may
result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.
We operate in a highly competitive industry and market areas.
The Banks face substantial competition in all phases of their operations from a variety of different competitors. Our future growth and success
will depend on our ability to compete effectively in this highly competitive environment. To date, the Banks have been competitive by focusing
on their business lines in their market areas and emphasizing the high level of service and responsiveness desired by their customers. We compete
for loans, deposits and other financial services with other commercial banks, thrifts, credit unions, brokerage houses, mutual funds, insurance
companies and specialized finance companies. Many of our competitors offer products and services which we do not offer, and many have
substantially greater resources and lending limits, name recognition and market presence that benefit them in attracting business. In addition,
larger competitors may be able to price loans and deposits more aggressively than the Banks do, and newer competitors may also be more
aggressive in terms of pricing loan and deposit products than we are in order to obtain a share of the market. Some of the financial institutions
and financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding
companies, federally insured state-chartered banks and national banks and federal savings banks. As a result, these non-bank competitors have
certain advantages over us in accessing funding and in providing various services.
Our ability to compete successfully depends on a number of factors including the following:
•
the ability to develop, maintain and build upon long-term customer relationships based on top-quality service, high ethical standards and
safe, sound assets;
31
•
•
•
•
•
the ability to expand our market position;
the scope, relevance and pricing of products and services offered to meet customer needs and demands;
the rate at which we introduce new products and services relative to our competitors;
customer satisfaction with our level of service; and
industry and general economic trends.
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and
profitability, which, in turn, could have a material adverse effect on our financial condition, liquidity and results of operations.
We rely on communications, information, operating and financial control systems technology from third-party service providers, and
we may suffer an interruption in those systems.
We rely heavily on third-party service providers for much of our communications, information, operating and financial control systems technology,
including our Internet banking services and data processing systems. Any failure or interruption of these services or systems or breaches in
security of these systems could result in failures or interruptions in our customer relationship management, general ledger, deposit, servicing
and/or loan origination systems. The occurrence of any failures or interruptions may require us to identify alternative sources of such services,
and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found
in our existing systems without the need to expend substantial resources, if at all.
Item 1B – Unresolved Staff Comments
None.
Item 2 – Properties
Banner Corporation maintains its administrative offices and main branch office, which is owned by us, in Walla Walla, Washington. In total, as
of December 31, 2012, we have 88 branch offices located in Washington, Oregon and Idaho. Three of those 88 are Islanders Bank branches and
85 are Banner Bank branches. Sixty-four branches are located in Washington, fifteen in Oregon and nine in Idaho. Of those offices, approximately
half are owned and the other half are leased facilities. We also have seven leased locations for loan production offices spread throughout the
same three-state area. The lease terms for our branch and loan production offices are not individually material. Lease expirations range from
one to 25 years. Administrative support offices are primarily in Washington, where we have eight facilities, of which we own four and lease
four. Additionally, we have one leased administrative support office in Idaho and own one located in Oregon. In the opinion of management,
all properties are adequately covered by insurance, are in a good state of repair and are appropriately designed for their present and future use.
Item 3 – Legal Proceedings
In the normal course of business, we have various legal proceedings and other contingent matters outstanding. These proceedings and the
associated legal claims are often contested and the outcome of individual matters is not always predictable. These claims and counter-claims
typically arise during the course of collection efforts on problem loans or with respect to action to enforce liens on properties in which we hold
a security interest. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial
condition or operations.
Item 4 – Mine Safety Disclosures
Not applicable.
32
PART II
Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Price Range of Common Stock and Dividend Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol “BANR.” Shareholders of record as of December 31,
2012 totaled 1,604 based upon securities position listings furnished to us by our transfer agent. This total does not reflect the number of persons
or entities who hold stock in nominee or “street” name through various brokerage firms. The following tables show the reported high and low
sale prices of our common stock for the periods presented, adjusted for the one-for-seven reverse stock split of June 2011, as well as the cash
dividends declared per share of common stock for each of those periods.
Year Ended December 31, 2012
High
Low
First quarter
Second quarter
Third quarter
Fourth quarter
First quarter
Second quarter
Third quarter
Fourth quarter
Year Ended December 31, 2011
$
$
$
$
22.97
22.80
27.41
31.32
18.48
20.23
19.25
18.45
High
Low
Cash Dividend
Declared
0.01
0.01
0.01
0.01
Cash Dividend
Declared
0.07
0.01
0.01
0.01
$
$
17.13
18.05
20.04
26.49
14.00
15.56
12.37
11.67
The timing and amount of cash dividends paid on our common stock depends on our earnings, capital requirements, financial condition and
other relevant factors and is subject to the discretion of our board of directors. After consideration of these factors, beginning in the third quarter
of 2008, we reduced our dividend payout to preserve our capital and further reduced our dividend in the first quarter of 2009. Our aggregate
dividend payments were also reduced by our one-for-seven reverse stock split effective June 1, 2011. There can be no assurance that we will
pay dividends on our common stock in the future.
Our ability to pay dividends on our common stock depends primarily on dividends we receive from Banner Bank and Islanders Bank. Under
federal regulations, the dollar amount of dividends the Banks may pay depends upon their capital position and recent net income. Generally, if
a bank satisfies its regulatory capital requirements, it may make dividend payments up to the limits prescribed under state law and FDIC
regulations. In addition, an institution that has converted to a stock form of ownership may not declare or pay a dividend on, or repurchase any
of, its common stock if the effect thereof would cause the regulatory capital of the institution to be reduced below the amount required for the
liquidation account which was established in connection with the conversion. Banner Bank, our primary subsidiary, converted to a stock form
of ownership and is therefore subject to the limitation described in the preceding sentence. The Washington DFI has the power to require any
bank to suspend the payment of any and all dividends. In addition, under Washington law, no bank may declare or pay any dividend in an amount
greater than its retained earnings without the prior approval of the Washington DFI.
Further, under Washington law, Banner Corporation is prohibited from paying a dividend if, after making such dividend payment, it would be
unable to pay its debts as they become due in the usual course of business, or if its total liabilities, plus the amount that would be needed, in the
event Banner Corporation were to be dissolved at the time of the dividend payment, to satisfy preferential rights on dissolution of holders of
preferred stock ranking senior in right of payment to the capital stock on which the applicable distribution is to be made, exceed our total assets.
In addition to the foregoing regulatory considerations, there are numerous governmental requirements and regulations that affect our business
activities. A change in applicable statutes, regulations or regulatory policy may have a material effect on our business and on our ability to pay
dividends on our common stock.
Payments of the distributions on our trust preferred securities from the special purpose subsidiary trusts we sponsored are fully and unconditionally
guaranteed by us. The junior subordinated debentures that we have issued to our subsidiary trusts are ranked senior to our shares of common
stock. We must make required payments on the junior subordinated debentures before any dividends can be paid on our TPS and our common
stock and, in the event of our bankruptcy, dissolution or liquidation, the interest and principal obligations under the junior subordinated debentures
must be satisfied before any distributions can be made on our common stock. We may defer the payment of interest on each of the junior
subordinated debentures for a period not to exceed 20 consecutive quarters, provided that the deferral period does not extend beyond the stated
maturity. During such deferral period, distributions on the corresponding trust preferred securities will also be deferred and we may not pay
cash dividends to the holders of shares of our common stock. At December 31, 2012, we are current on all interest payments.
Issuer Purchases of Equity Securities
We did not repurchase any of our common stock during 2012.
33
Equity Compensation Plan Information
The equity compensation plan information presented under Part III, Item 12 of this report is incorporated herein by reference.
Performance Graph. The following graph compares the cumulative total shareholder return on Banner Corporation common stock with the
cumulative total return on the NASDAQ (U.S. Stock) Index, a peer group of the SNL $1 Billion to $5 Billion Asset Bank Index and a peer group
of the SNL NASDAQ Bank Index. Total return assumes the reinvestment of all dividends.
Index
Banner Corporation
NASDAQ Composite
SNL Bank $1B-$5B
SNL Bank NASDAQ
Period Ended
12/31/07
12/31/08
12/31/09
12/31/10
12/31/11
12/31/12
100.00
100.00
100.00
100.00
34.08
60.02
82.94
72.62
9.80
87.24
59.45
58.91
8.61
103.08
67.39
69.51
9.19
102.26
61.46
61.67
16.49
120.42
75.78
73.51
*Assumes $100 invested in Banner Corporation common stock and each index at the close of business on December 31, 2007 and that all
dividends were reinvested. Information for the graph was provided by SNL Financial L.C. © 2013.
34
Item 6 – Selected Financial Data
The following condensed consolidated statements of financial condition and operations and selected performance ratios as of December 31,
2012, 2011, 2010, 2009, and 2008 and for the years then ended have been derived from our audited consolidated financial statements. Certain
information for prior years has been restated in accordance with the U.S. Securities and Exchange Commission Staff Accounting Bulletin No.
108 which addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current
year financial statements.
The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8, Financial Statement and Supplementary
Data.”
FINANCIAL CONDITION DATA:
(In thousands)
2012
2011
2010
2009
2008
December 31
Total assets
Loans receivable, net
Cash and securities (1)
Deposits
Borrowings
Common stockholders’ equity
Total stockholders’ equity
$ 4,265,564
3,158,223
811,902
3,557,804
160,000
506,919
506,919
$ 4,257,312
3,213,426
754,396
3,475,654
212,649
411,748
532,450
$ 4,406,082
3,305,716
729,345
3,591,198
267,761
392,472
511,472
$ 4,722,221
3,694,852
640,657
3,865,550
414,315
287,721
405,128
$ 4,584,368
3,886,211
419,718
3,778,850
318,421
317,433
433,348
Shares outstanding
Shares outstanding excluding unearned, restricted
shares held in ESOP
19,455
17,553
16,165
19,421
17,519
16,130
3,077
3,042
2,450
2,416
OPERATING DATA:
(In thousands)
Interest income
Interest expense
For the Year Ended December 31
2012
2011
2010
2009
2008
$
$
187,162
19,514
$
197,563
32,992
$
218,082
60,312
$
237,370
92,797
273,158
125,345
Net interest income before provision for loan losses
Provision for loan losses
Net interest income
Deposit fees and other service charges
Mortgage banking operations revenue
Other-than-temporary impairment recoveries (losses)
Net change in valuation of financial instruments carried at
fair value
All other operating income
Total other operating income
Goodwill write-off
REO operations
All other operating expenses
Total other operating expense
Income (loss) before provision for income tax expense
(benefit)
Provision for income tax expense (benefit)
167,648
13,000
154,648
25,266
12,940
(409)
(16,515)
5,620
26,902
—
3,354
138,099
141,453
40,097
(24,785)
164,571
35,000
129,571
22,962
5,068
3,000
(624)
3,584
33,990
—
22,262
135,842
158,104
5,457
—
157,770
70,000
87,770
22,009
6,370
(4,231)
1,747
3,253
29,148
—
26,025
134,776
160,801
(43,883)
18,013
144,573
109,000
35,573
21,394
8,893
(1,511)
12,529
2,385
43,690
—
7,147
134,933
142,080
147,813
62,500
85,313
21,540
6,045
—
9,156
2,888
39,629
121,121
2,283
136,616
260,020
(62,817)
(27,053)
(135,078)
(7,085)
Net income (loss)
$
64,882
$
5,457
$
(61,896) $
(35,764) $
(127,993)
(footnotes follow)
35
PER COMMON SHARE DATA:
Net income (loss):
Basic
Diluted
Common stockholders’ equity per share (2)(9)
Common stockholders’ tangible equity
per share (2)(9)
Cash dividends
Dividend payout ratio (basic)
Dividend payout ratio (diluted)
OTHER DATA:
Full time equivalent employees
Number of branches
KEY FINANCIAL RATIOS:
At or For the Years Ended December 31
2012
2011
2010
2009
2008
$
3.17
3.16
26.10
25.88
0.04
1.26%
1.27%
2012
1,074
88
$
$
(0.15)
(0.15)
23.50
(7.21)
(7.21)
24.33
$
(16.31)
(16.31)
94.58
$
(55.58)
(55.58)
131.39
23.14
0.10
(66.67)%
(66.67)%
23.80
0.28
(3.88)%
(3.88)%
90.94
0.28
(1.72)%
(1.72)%
125.71
3.50
(6.30)%
(6.30)%
As of December 31
2011
1,078
89
2010
1,060
89
2009
1,060
89
2008
1,095
86
Performance Ratios:
Return on average assets (3)
Return on average common equity (4)
Average common equity to average assets
Interest rate spread (5)
Net interest margin (6)
Non-interest income to average assets
Non-interest expense to average assets
Efficiency ratio (7)
Average interest-earning assets to interest- bearing
liabilities
Selected Financial Ratios:
Allowance for loan losses as a percent of total loans at
end of period
Net charge-offs as a percent of average outstanding
loans during the period
Non-performing assets as a percent of total assets
Allowance for loan losses as a percent of non-
performing loans (8)
Common stockholders’ tangible equity to tangible
assets (9)
Consolidated Capital Ratios:
Total capital to risk-weighted assets
Tier 1 capital to risk-weighted assets
Tier 1 leverage capital to average assets
At or For the Years Ended December 31
2012
2011
2010
2009
2008
1.54%
14.03
10.96
4.13
4.17
0.64
3.35
72.71
0.13%
1.37
9.31
3.99
4.05
0.79
3.69
79.62
(1.36)%
(17.19)
7.90
3.61
3.67
0.64
3.53
86.03
(0.78)%
(11.69)
6.71
3.23
3.33
0.96
3.12
75.47
(2.78)%
(30.90)
8.99
3.36
3.45
0.86
5.65
138.72
109.1
106.90
104.32
104.55
103.21
2.39
0.57
1.18
2.52
1.50
2.79
225.33
110.09
11.80
9.54
16.96
15.70
12.74
18.07
16.80
13.44
2.86
1.88
5.77
64.30
8.73
16.92
15.65
12.24
2.51
2.28
6.27
44.55
5.87
12.73
11.47
9.62
1.90
0.84
4.56
40.14
6.64
13.11
11.86
10.32
Includes securities available-for-sale and held-to-maturity.
(1)
(2) Calculated using shares outstanding excluding unearned restricted shares held in ESOP and adjusted for 1-for-7 reverse stock split.
(3) Net income divided by average assets.
(4) Net income divided by average common equity.
36
(5) Difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(6) Net interest income before provision for loan losses as a percent of average interest-earning assets.
(7) Other operating expenses divided by the total of net interest income before loan losses and other operating income (non-interest
income).
(8) Non-performing loans consist of nonaccrual and 90 days past due loans.
(9) Common stockholders’ tangible equity per share and the ratio of tangible common stockholders’ equity to tangible assets are non-GAAP
financial measures. We calculate tangible common equity by excluding the balance of goodwill, other intangible assets and preferred
equity from stockholders’ equity. We calculate tangible assets by excluding the balance of goodwill and other intangible assets from total
assets. We believe that this is consistent with the treatment by our bank regulatory agencies, which exclude goodwill and other intangible
assets from the calculation of risk-based capital ratios. In addition, excluding preferred equity, the level of which may vary from company
to company, allows investors to more easily compare our capital adequacy to other companies in the industry that also use this
measure. Management believes that these non-GAAP financial measures provide information to investors that is useful in understanding
the basis of our capital position. However, these non-GAAP financial measures are supplemental and are not a substitute for any analysis
based on GAAP. Because not all companies use the same calculation of tangible common equity and tangible assets, this presentation may
not be comparable to other similarly titled measures as calculated by other companies. For a reconciliation of these non-GAAP measures,
see Item 7, "Management's Discussion and Analysis of Financial Condition-Executive Overview."
37
Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis of results of operations is intended to assist in understanding our financial condition and results of
operations. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying
Notes to the Consolidated Financial Statements of this Form 10-K.
Executive Overview
We are a bank holding company incorporated in the State of Washington and own two subsidiary banks, Banner Bank and Islanders Bank. Banner
Bank is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and, as of December 31,
2012, its 85 branch offices and seven loan production offices located in Washington, Oregon and Idaho. Islanders Bank is also a Washington-
chartered commercial bank and conducts its business from three locations in San Juan County, Washington. As of December 31, 2012, we had
total consolidated assets of $4.3 billion, net loans of $3.2 billion, total deposits of $3.6 billion and total stockholders’ equity of $507 million.
Banner Bank is a regional bank which offers a wide variety of commercial banking services and financial products to individuals, businesses
and public sector entities in its primary market areas. Islanders Bank is a community bank which offers similar banking services to individuals,
businesses and public entities located in the San Juan Islands. The Banks’ primary business is that of traditional banking institutions, accepting
deposits and originating loans in locations surrounding their offices in portions of Washington, Oregon and Idaho. Banner Bank is also an active
participant in the secondary market, engaging in mortgage banking operations largely through the origination and sale of one- to four-family
residential loans.
Banner Corporation experienced marked improvement in asset quality and operating results 2011, which continued and accelerated throughout
2012. Highlights for the year included further improvement in our asset quality metrics, additional customer account growth, significantly
increased non-interest-bearing deposit balances, exceptional mortgage banking activity and record revenues from core operations. As a result,
substantially reduced credit costs, significant improvement in our net interest margin and strong non-interest revenues all contributed to
meaningfully increased profitability in 2012. For the year ended December 31, 2012, we had net income of $64.9 million which, after providing
for the preferred stock dividend, related discount accretion and gains on repurchases of preferred stock, resulted in a net income available to
common shareholders of $59.1 million, or $3.16 per diluted share. This compares to a net income of $5.5 million, but a net loss to common
shareholders of $2.4 million, or ($0.15) per diluted share, for the year ended December 31, 2011. Also notable during 2012 was the repurchase
and retirement of all of our Series A Preferred Stock. As a result of these repurchase transactions, we realized gains of $2.5 million.
Although there continue to be indications that economic conditions are improving from the recent recessionary downturn, the pace of recovery
has been modest and uneven and ongoing stress in the economy will likely continue to be challenging going forward. As a result, our future
operating results and financial performance will be significantly affected by the course of recovery. However, over the past four years we have
significantly improved our risk profile by aggressively managing and reducing our problem assets which contributed substantially to our return
to profitability in 2012 and 2011 and which we believe provide the foundation for sustainable improvement to our operating results in future
periods.
Our provision for loan losses was $13.0 million for the year ended December 31, 2012, compared to $35.0 million in 2011 and $70 million in
2010. The decrease from a year earlier reflects significant progress in reducing the levels of delinquencies, non-performing loans and net charge-
offs, particularly for loans for the construction of one- to four-family homes and for acquisition and development of land for residential properties.
From 2008 through 2011, higher than historical provision for loan losses was the most significant factor adversely affecting our operating results.
Looking forward, we anticipate that our continuing efforts to decrease non-performing loans should result in a return to more normal levels of
loan loss provisioning in future periods. (See Note 6 of the Notes to the Consolidated Financial Statements, as well as “Asset Quality” below.)
Aside from the level of loan loss provision, our operating results depend primarily on our net interest income. As more fully explained below,
our net interest income before provision for loan losses increased $3.1 million , or 2%, for the year ended December 31, 2012 to $167.6 million,
which followed an increase of $6.8 million for the prior year, primarily as a result of an expansion of our net interest spread and net interest
margin due to a lower cost of funds and a reduction in the adverse impact of non-performing assets. The trend to lower funding costs and the
resulting increase in the net interest margin was driven by rapidly declining interest expense on deposits and represents an important improvement
in our core operating fundamentals. The increase in net interest income occurred despite a modest decline in average earning assets in 2012, as
we continued to make changes in our mix of assets and liabilities designed to reduce our risk profile and produce more sustainable earnings.
Our net income also is affected by the level of our other operating income, including deposit fees and service charges, loan origination and
servicing fees, and gains and losses on the sale of loans and securities, as well as our non-interest operating expenses and income tax provisions. In
addition, our net income is affected by the net change in the value of certain financial instruments carried at fair value and in certain periods by
other-than-temporary impairment (OTTI) charges or recoveries. (See Note 22 of the Notes to the Consolidated Financial Statements.) For the
year ended December 31, 2012, we recorded a net charge of $16.5 million in fair value adjustments compared to a net charge of $624,000 for
the year ended December 31, 2011. Also, for the year ended December 31, 2012, our net income included a $409,000 net OTTI charge. By
comparison, for the year ended December 31, 2011, we had a net OTTI recovery of $3.0 million as a result of the full cash repayment on a
security that had been written off as an OTTI charge in 2010.
Our other operating income for the year ended December 31, 2012 was $26.9 million, compared to $34.0 million for the year ended December 31,
2011. However, other operating income, excluding fair value and OTTI adjustments, was $43.8 million for the year ended December 31, 2012,
an increase of $12.2 million compared to a year earlier. Our total revenues (net interest income before the provision for loan losses plus other
38
operating income) for 2012 were $194.6 million compared to $198.6 million for 2011. Our revenues excluding fair value and OTTI adjustments,
which we believe is more indicative of our core operations, increased $15.2 million, or 8%, to $211.4 million for the year ended December 31,
2012, compared to $196.2 million for the year ended December 31, 2011. This growth in core revenues was the result of the meaningful increases
in our net interest income, and deposit fees and service charges, as well as a substantial increase in revenues from mortgage banking activities.
Our other operating expenses decreased to $141.5 million for the year ended December 31, 2012, compared to $158.1 million for the year ended
December 31, 2011, largely as a result of decreased costs related to REO operations, FDIC deposit insurance and professional services, which
were partially offset by increased compensation expenses. While much lower in 2012 than in 2011, both years’ expenses reflect significant costs
associated with problem loan collection activities, including professional services and valuation charges related to REO, which we believe will
decline further in future periods provided reductions in non-performing assets continue.
In addition, reflecting our return to profitability and expectation of sustainable profitability in future periods, during 2012, we reversed all of
the valuation allowance against our net deferred tax assets and significantly adjusted the fair value estimate for our junior subordinated debentures.
The substantial changes to both of these significant accounting estimates were directly linked to our improved performance and profitability.
For the year ended December 31, 2012, the elimination of the deferred tax asset valuation allowance, combined with the Company's pre-tax
income, resulted in a net tax benefit of $24.8 million, which substantially added to our net income for the year.
As noted above, for the years ended December 31, 2012 and 2011, our net income included significant adjustments related to the valuation of
selected financial assets and liabilities we record at fair value, as well as OTTI losses in 2012 and an OTTI recovery in 2011. However, for
comparison purposes we often present information excluding these fair value and OTTI adjustments. Revenues and other earnings information
excluding the change in valuation of financial instruments carried at fair value and OTTI recoveries or losses represent non-GAAP financial
measures. Management has presented these non-GAAP financial measures in this discussion and analysis because it believes that they provide
useful and comparative information to assess trends in our core operations. Where applicable, we have also presented comparable earnings
information using GAAP financial measures. For a reconciliation of these non-GAAP measures, see the tables below, as well as the discussion
related to tangible common stockholders' equity per share and the ratio of common stockholders' tangible equity to tangible assets in footnote
number 9 to the Key Financial Ratios tables. These non-GAAP financial measures are supplemental and are not a substitute for any analysis
based on GAAP. Because not all companies use the same calculations, our presentation may not be comparable to other similarly titled measures
as calculated by other companies. See “Comparison of Results of Operations for the Years Ended December 31, 2012 and 2011” for more
detailed information about our financial performance.
The following tables set forth reconciliations of non-GAAP financial measures discussed in this report (dollars in thousands):
Total other operating income
Exclude other-than-temporary impairment losses (recoveries)
Exclude change in valuation of financial instruments carried at fair value
Total other operating income, excluding fair value adjustments and OTTI
Net interest income before provision for loan losses
Total other operating income
Total revenue
Exclude other-than-temporary impairment losses (recoveries)
Exclude change in valuation of financial instruments carried at fair value
Total revenue, excluding fair value adjustments and OTTI
Net income (loss)
Exclude other-than-temporary impairment losses (recoveries)
Exclude change in valuation of financial instruments carried at fair value
Exclude related tax expense
$
$
$
$
$
For the Years Ended December 31
2012
26,902
409
16,515
$
2011
2010
$
33,990
(3,000)
624
29,148
4,231
(1,747)
43,826
$
31,614
$
31,632
167,648
26,902
194,550
409
16,515
$
$
164,571
33,990
198,561
(3,000)
624
157,770
29,148
186,918
4,231
(1,747)
211,474
$
196,185
$
189,402
$
64,882
409
16,515
(5,923)
$
5,457
(3,000)
624
855
(61,896)
4,231
(1,747)
(869)
Total earnings (loss), excluding fair value adjustments and OTTI, net of related tax
effects
$
75,883
$
3,936
$
(60,281)
39
Stockholders’ equity
Other intangible assets, net
Tangible equity
Preferred equity
Tangible common stockholders’ equity
Total assets
Other intangible assets, net
Tangible assets
December 31
2012
2011
2010
$
$
$
506,919
4,230
502,689
—
502,689
4,265,564
4,230
$
$
$
532,450
6,331
526,119
120,702
405,417
4,257,312
6,331
$
$
$
511,472
8,609
502,863
119,000
383,863
4,406,082
8,609
$
4,261,334
$
4,250,981
$
4,397,473
Tangible common stockholders’ equity to tangible assets
11.80%
9.54%
8.73%
Common stockholders' equity per share-GAAP
Adjustment for other intangibles, net, per share
Common stockholders' tangible equity per share
$
$
26.10
0.22
25.88
$
$
23.50
0.36
23.14
$
$
24.33
0.47
23.80
We offer a wide range of loan products to meet the demands of our customers. Our lending activities are primarily directed toward the origination
of real estate and commercial loans. Until recent periods, real estate lending activities were significantly focused on residential construction
and first mortgages on owner-occupied, one- to four-family residential properties; however, over the previous four years our origination of
construction and land development loans declined materially and the proportion of the portfolio invested in these types of loans has declined
substantially. More recently, we have experienced increased demand for one- to four-family construction loans and outstanding balances have
increased modestly. Our residential mortgage loan originations also decreased during the earlier years of this cycle, although less significantly
than the decline in construction and land development lending as exceptionally low interest rates supported demand for loans to refinance existing
debt as well as loans to finance home purchases. Refinancing activity was particularly significant in 2012, leading to a meaningful increase in
residential mortgage originations compared to the same period a year earlier. Despite the recent increase in these loan originations, our outstanding
balances for residential mortgages have continued to decline, as most of the new originations have been sold in the secondary market while
existing residential loans have been repaying at an accelerated pace. Our real estate lending activities also include the origination of multifamily
and commercial real estate loans. While reduced from periods prior to the economic slowdown, our level of activity and investment in these
types of loans has been relatively stable in recent periods. Our commercial business lending is directed toward meeting the credit and related
deposit needs of various small to medium-sized business and agribusiness borrowers operating in our primary market areas. Reflecting the weak
economy, in recent periods demand for these types of commercial business loans has been modest and, aside from seasonal variations, total
outstanding balances have remained relatively unchanged. Our consumer loan activity is primarily directed at meeting demand from our existing
deposit customers and, while we have increased our emphasis on consumer lending in recent years, demand for consumer loans also has been
modest during this period of economic weakness as we believe many consumers have been focused on reducing their personal debt. At
December 31, 2012, our net loan portfolio totaled $3.158 billion compared to $3.213 billion at December 31, 2011.
Deposits, customer retail repurchase agreements and loan repayments are the major sources of our funds for lending and other investment
purposes. We compete with other financial institutions and financial intermediaries in attracting deposits and we generally attract deposits within
our primary market areas. Much of the focus of our earlier branch expansion and current marketing efforts have been directed toward attracting
additional deposit customer relationships and balances . The long-term success of our deposit gathering activities is reflected not only in the
growth of deposit balances, but also in increases in the level of deposit fees, service charges and other payment processing revenues compared
to periods prior to that expansion. For the two years ended December 31, 2012, we have had a meaningful increase of transaction and savings
accounts (checking, savings and money market accounts) and related fees and payment processing revenues, as we have remained focused on
growing these core deposits. Total deposits at December 31, 2012 increased $82 million to $3.558 billion, compared to $3.476 billion a year
earlier. However, the mix of our deposits significantly changed as certificates of deposit decreased $221 million, while core deposits increased
$303 million, with particularly strong growth in non-interest-bearing checking accounts, which increased $203 million for the year.
Critical Accounting Policies
In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of
Operations, Comprehensive Income, Changes in Stockholders’ Equity and Cash Flows reflect all adjustments (which include reclassification
and normal recurring adjustments) that are necessary for a fair presentation in conformity with U.S. Generally Accepted Accounting Principles
(GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
amounts reported in the financial statements.
40
Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other
subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions
inherent in those policies, are critical to an understanding of our financial statements. These policies relate to (i) the methodology for the
recognition of interest income, (ii) determination of the provision and allowance for loan and lease losses, (iii) the valuation of financial assets
and liabilities recorded at fair value, including OTTI losses, (iv) the valuation of intangibles, such as core deposit intangibles and mortgage
servicing rights, (v) the valuation of real estate held for sale and (vi) the valuation of or recognition of deferred tax assets and liabilities. These
policies and judgments, estimates and assumptions are described in greater detail below. Management believes that the judgments, estimates
and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However,
given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could
result in material differences in our results of operations or financial condition. Further, subsequent changes in economic or market conditions
could have a material impact on these estimates and our financial condition and operating results in future periods. There have been no significant
changes in our application of accounting policies since December 31, 2011. For additional information concerning critical accounting policies,
see Notes 1, 6, 13, 21 and 22 of the Notes to the Consolidated Financial Statements and the following:
Interest Income: (Notes 1 and 6) Interest on loans and securities is accrued as earned unless management doubts the collectability of the asset
or the unpaid interest. Interest accruals on loans are generally discontinued when loans become 90 days past due for payment of interest and
the loans are then placed on nonaccrual status. All previously accrued but uncollected interest is deducted from interest income upon transfer
to nonaccrual status. For any future payments collected, interest income is recognized only upon management’s assessment that there is a strong
likelihood that the full amount of a loan will be repaid or recovered. A loan may be put on nonaccrual status sooner than this policy would dictate
if, in management’s judgment, the amounts owed, principal or interest, may be uncollectable. While less common, similar interest reversal and
nonaccrual treatment is applied to investment securities if their ultimate collectability becomes questionable.
Provision and Allowance for Loan Losses: (Notes 1 and 6) The provision for loan losses reflects the amount required to maintain the allowance
for losses at an appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves. We maintain an
allowance for loan losses consistent in all material respects with the GAAP guidelines outlined in ASC 450, Contingencies. We have established
systematic methodologies for the determination of the adequacy of our allowance for loan losses. The methodologies are set forth in a formal
policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual
problem loans. We increase our allowance for loan losses by charging provisions for probable loan losses against our income and value impaired
loans consistent with the accounting guidelines outlined in ASC 310, Receivables.
The allowance for losses on loans is maintained at a level sufficient to provide for probable losses based on evaluating known and inherent risks
in the loan portfolio and upon our continuing analysis of the factors underlying the quality of the loan portfolio. These factors include, among
others, changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience, current and anticipated economic
conditions, detailed analysis of individual loans for which full collectability may not be assured, and determination of the existence and realizable
value of the collateral and guarantees securing the loans. Realized losses related to specific assets are applied as a reduction of the carrying
value of the assets and charged immediately against the allowance for loan loss reserve. Recoveries on previously charged off loans are credited
to the allowance. The reserve is based upon factors and trends identified by us at the time financial statements are prepared. Although we use
the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions
beyond our control. The adequacy of general and specific reserves is based on our continuing evaluation of the pertinent factors underlying the
quality of the loan portfolio as well as individual review of certain large balance loans. Loans are considered impaired when, based on current
information and events, we determine that it is probable that we will be unable to collect all amounts due according to the contractual terms of
the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, the
value of the underlying collateral and the current status of the economy. Impaired loans are measured based on the present value of expected
future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value
of collateral if the loan is collateral dependent. Subsequent changes in the value of impaired loans are included within the provision for loan
losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Large
groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment
include residential real estate and consumer loans and, as appropriate, smaller balance non-homogeneous loans. Larger balance non-homogeneous
residential construction and land, commercial real estate, commercial business loans and unsecured loans are individually evaluated for
impairment.
Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an
allocated formula allowance and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and
estimable. General loan loss reserves are established to provide for inherent loan portfolio risks not specifically provided for. The level of
general reserves is based on analysis of potential exposures existing in our loan portfolio including evaluation of historical trends, current market
conditions and other relevant factors identified by us at the time the financial statements are prepared. The formula allowance is calculated by
applying loss factors to outstanding loans, excluding those loans that are subject to individual analysis for specific allowances. Loss factors are
based on our historical loss experience adjusted for significant environmental considerations, including the experience of other banking
organizations, which in our judgment affect the collectability of the portfolio as of the evaluation date. The unallocated allowance is based upon
our evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. This methodology
may result in losses or recoveries differing significantly from those provided in the Consolidated Financial Statements.
While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no
assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not
exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition
41
and results of operations. In addition, the determination of the amount of the Banks’ allowance for loan losses is subject to review by bank
regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information
available to them at the time of their examination.
Fair Value Accounting and Measurement: (Notes 1 and 22) We use fair value measurements to record fair value adjustments to certain financial
assets and liabilities and to determine fair value disclosures. We include in the Notes to the Consolidated Financial Statements information about
the extent to which fair value is used to measure financial assets and liabilities, the valuation methodologies used and the impact on our results
of operations and financial condition. Additionally, for financial instruments not recorded at fair value we disclose, where appropriate, our
estimate of their fair value. For more information regarding fair value accounting, please refer to Note 22 in the Notes to the Consolidated
Financial Statements.
Other Intangible Assets: (Notes 1 and 21) Other intangible assets consists primarily of core deposit intangibles (CDI), which are amounts
recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the
customer relationships associated with the deposits. Core deposit intangibles are being amortized on an accelerated basis over a weighted average
estimated useful life of eight years. These assets are reviewed at least annually for events or circumstances that could impact their
recoverability. These events could include loss of the underlying core deposits, increased competition or adverse changes in the economy. To
the extent other identifiable intangible assets are deemed unrecoverable, impairment losses are recorded in other non-interest expense to reduce
the carrying amount of the assets.
Mortgage Servicing Rights: Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of
loans. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage loans, the value of the
servicing right is estimated and capitalized. Fair value is based on market prices for comparable mortgage servicing contracts. Capitalized
servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated
future net servicing income of the underlying financial assets.
Real Estate Held for Sale: (Notes 1 and 7) Property acquired by foreclosure or deed in lieu of foreclosure is recorded at the lower of the estimated
fair value of the property, less expected selling costs, or the carrying value of the defaulted loan. Development and improvement costs relating
to the property may be capitalized, while other holding costs are expensed. The carrying value of the property is periodically evaluated by
management and, if necessary, allowances are established to reduce the carrying value to net realizable value. Gains or losses at the time the
property is sold are charged or credited to operations in the period in which they are realized. The amounts the Banks will ultimately recover
from real estate held for sale may differ substantially from the carrying value of the assets because of market factors beyond the Banks’ control
or because of changes in the Banks’ strategies for recovering the investment.
Income Taxes and Deferred Taxes: (Note 13) The Company and its wholly-owned subsidiaries file consolidated U.S. federal income tax returns,
as well as state income tax returns in Oregon and Idaho. Income taxes are accounted for using the asset and liability method. Under this method
a deferred tax asset or liability is determined based on the enacted tax rates which are expected to be in effect when the differences between the
financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax
returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Under
GAAP (ASC 740), a valuation allowance is required to be recognized if it is “more likely than not” that all or a portion of our deferred tax assets
will not be realized.
Accounting Standards Recently Adopted or Issued
Accounting Standards Recently Adopted
In April 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-03, Reconsideration of
Effective Control for Repurchase Agreements. This guidance is effective for the first interim or annual period beginning on or after December
15, 2011. The guidance has been applied prospectively to transactions or modifications of existing transactions that occur on or after the effective
date. Early adoption is not permitted. The amendments remove the transferor’s ability criterion from the consideration of effective control for
repurchase and other agreements that both entitle and obligate the transferor to repurchase or redeem financial assets before their maturity. The
adoption of this ASU has not had a material effect on the Company’s Consolidated Financial Statements.
In May 2011, FASB issued ASU No. 2011-04, Fair Value Measurement - Amendments to Achieve Common Fair Value Measurements and
Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 amends Topic 820, Fair Value Measurements and Disclosures, to converge
the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU
2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional
fair value disclosures. ASU 2011-04 became effective for the first interim or annual period beginning on or after December 15, 2011 and did
not have a significant impact on the Company's Consolidated Financial Statements.
In June 2011, FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. The amendments in this ASU is required to be applied
retrospectively. The amendments are effective for fiscal years and interim periods within those years, beginning after December 15, 2011. Early
adoption is permitted. The FASB decided to eliminate the option to present components of other comprehensive income as part of the statement
of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single
continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, the amendments require the
consecutive presentation of the statement of net income and other comprehensive income and require the presentation of reclassification
42
adjustments on the face of the financial statements from other comprehensive income to net income. See also ASU No. 2011-12. The adoption
of this ASU has not had a material effect on the Company’s Consolidated Financial Statements.
In December 2011, FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of
Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-05. This update was made to allow the Board time to redeliberate
whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the
components of net income and other comprehensive income for all periods presented. The amendments in this Update are effective at the same
time as the amendments in Update 2011-05 so that entities were not required to comply with the presentation requirements in Update 2011-05
until this ASU becomes effective. The adoption of this ASU has not had a material effect on the Company’s Consolidated Financial Statements.
Comparison of Financial Condition at December 31, 2012 and 2011
General. Total assets in aggregate were nearly unchanged at $4.266 billion at December 31, 2012, compared to $4.257 billion at December 31,
2011. However, net loans receivable (gross loans less deferred fees and discounts, and allowance for loan losses) decreased $55 million, or 2%,
to $3.158 billion at December 31, 2012, from $3.213 billion at December 31, 2011. The contraction in net loans primarily reflects decreases in
residential and non-owner occupied commercial real estate loans, as continued refinancing activity resulted in significant levels of loan
prepayments. One- to four-family residential real estate loans decreased $61 million during 2012, while non-owner occupied commercial real
estate loans decreased $38 million. In addition, residential and commercial land and land development loans, in aggregate, decreased $22 million
during 2012 and commercial construction loans decreased $12 million. These decreases were partially offset by increases in commercial loans,
including owner-occupied commercial real estate, and commercial and agricultural business loans. During 2012, owner-occupied commercial
real estate loans increased $20 million, while commercial business loans increased $17 million and agricultural business loans increased by $12
million. The net decrease in loans was partially offset by a reduction of $5 million in the allowance for loan losses, as net charge-offs modestly
exceeded the provision for loan losses during the year ended December 31, 2012. The decrease in aggregate loan balances for the year in part
also reflects our efforts to reduce our exposure to certain weaker credits as we continued to aggressively manage problem assets. While demand
for consumer loans remained weak and utilization of existing credit lines for consumer and commercial borrowers was low, our production of
new commercial real estate and commercial and agricultural business loans was again encouraging. Importantly, the change in total assets also
reflects a $27 million decrease in REO which was more than offset by a $35 million increase in deferred tax assets primarily as the result of the
elimination of the valuation allowance for those assets.
Securities increased to $631 million at December 31, 2012, from $622 million at December 31, 2011, and the aggregate total of securities and
interest-bearing deposits increased $54 million, or 8%, to $746 million at December 31, 2012, compared to $692 million a year earlier. Securities
acquired during the year generally have expected maturities ranging from six months to six years and were purchased to generate a modest
increase in yield compared to interest-bearing cash balances. With the exception of certain trust preferred securities, aggregate fair value
adjustments to the securities portfolio were modest during the first nine months of 2012. At December 31, 2012, the fair value of our trading
securities was $19 million less than their amortized cost. The reduction reflected in the fair value of these securities compared to their amortized
cost primarily was centered in single-issuer trust preferred securities and collateralized debt obligations secured by pools of trust preferred
securities issued by bank holding companies and insurance companies, partially offset by modest gains in all other trading securities. (See Note
4 of the Notes to the Consolidated Financial Statements.) Our available-for-sale portfolio grew during the year, as purchases of primarily U.S.
Government and agency mortgage-related and asset-backed securities exceeded net repayments, sales and maturities of other securities by $7
million. Periodically, we also acquire securities (primarily municipal bonds) which are generally designated as held-to-maturity and this portfolio
increased by $11 million from the prior year-end balances.
REO decreased $27 million, to $16 million at December 31, 2012 compared to $43 million at December 31, 2011, continuing the improving
trend with respect to these non-earning assets. The December 31, 2012 total included $10 million in land or land development projects, $1
million in commercial real estate and $5 million in single-family homes and related residential construction. During the year ended December 31,
2012, we transferred $14 million of loans into REO, capitalized additional investments of $300,000 in acquired properties, disposed of
approximately $41 million of properties and recognized $452,000 of charges against current earnings for valuation adjustments for REO properties
net of gains related to properties sold. (See “Asset Quality” discussion below.)
Deposits increased $82 million, or 2%, to $3.558 billion at December 31, 2012, from $3.476 billion at December 31, 2011. Non-interest-bearing
deposits increased by $203 million, or 26%, to $981 million from $778 million, and interest-bearing transaction and savings accounts increased
by $99 million, or 7%, to $1.547 billion at December 31, 2012 from $1.448 billion at December 31, 2011. Offsetting these increases, certificates
of deposit decreased $221 million, or 18%, to $1.029 billion at December 31, 2012 from $1.250 billion at December 31, 2011. The growth in
non-interest-bearing deposits and other transaction and savings accounts was particularly notable and significantly contributed to our improved
net interest margin and deposit fee revenues. A portion of the decrease in certificates of deposit was in brokered certificates which decreased
$33 million from the prior year-end balance; however, much of the decrease reflects management’s pricing decisions designed to allow maturing
higher priced retail certificates to migrate off the balance sheet or into core deposits.
FHLB advances decreased $229,000, to $10.3 million at December 31, 2012 from $10.5 million at December 31, 2011, while other borrowings
decreased $75 million to $77 million at December 31, 2012. The modest decrease in FHLB advances reflects a limited amount of maturities
and no additional borrowing as a part of our short-term cash management activities. Other borrowings at December 31, 2012 were comprised
of $77 million of retail repurchase agreements that are primarily related to customer cash management accounts as compared to $102 million
at December 31, 2011. Retail repurchase agreement balances decreased during the year as many customers elected to keep more of their funds
in the related non-interest-bearing transaction accounts to receive earnings credit to offset the service fees associated with those accounts or
utilized funds for alternative purposes including paying down credit lines. Included in other borrowings at December 31, 2011 was $50 million
43
of qualifying senior bank notes covered by the FDIC Temporary Liquidity Guarantee Program (TLGP) with a fixed interest rate of 2.625%. This
debt, which was issued in March 2009 to strengthen our overall liquidity position as we adjusted to a lower level of public funds deposits, was
repaid on March 31, 2012. No additional junior subordinated debentures were issued or matured during the year; however, the estimated fair
value of these instruments increased to $73 million from $50 million a year ago as a result of a significant change in the discount rate used to
estimate fair value of these financial instruments. For more information, see Notes 10, 11 and 12 of the Notes to the Consolidated Financial
Statements.
Total stockholders’ equity decreased $25 million to $507 million at December 31, 2012 compared to $532 million at December 31, 2011, primarily
due to the redemption of the $124 million of Series A Preferred Stock, which was partially offset by capital raised through our Dividend
Reinvestment and Stock Purchase and Sale Plan (DRIP) and retained earnings from operations. During the year ended December 31, 2012, we
issued 1,901,493 additional shares of common stock for $37 million at an average net per share price of $19.33 through our DRIP. The increase
in paid in capital from stock issuances, as well as additions to retained earnings as a result of net income from operations and changes in
accumulated other comprehensive income, were reduced by the accrual and payment of preferred and common stock dividends and the redemption
of the Series A Preferred Stock, resulting in the net $25 million decrease in total stockholders’ equity. Tangible common stockholders' equity,
which excludes the Series A Preferred Stock and intangible assets, increased $97 million to $503 million, or 11.80% of tangible assets at December
31, 2012. During the year ended December 31, 2012, we did not repurchase any shares of Banner Corporation common stock.
Investments: At December 31, 2012, our consolidated investment portfolio totaled $631 million and consisted principally of U.S. Government
and agency obligations, mortgage-backed and mortgage-related securities, municipal bonds, corporate debt obligations, and asset-backed
securities. From time to time, our investment levels may be increased or decreased depending upon yields available on investment alternatives
and management’s projections as to the demand for funds to be used in our loan origination, deposit and other activities. During the year ended
December 31, 2012, our aggregate investment in securities increased $9 million. Holdings of mortgage-backed securities increased $176 million,
municipal bonds increased $28 million, and corporate bonds increased $6 million while asset-backed securities, which were all purchased during
the year, increased $43 million. Partially offsetting these increases was a net decrease in U.S. Government and agency obligations of $243
million.
U.S. Government and Agency Obligations: Our portfolio of U.S. Government and agency obligations had a carrying value of $99 million ($98
million at amortized cost, with a fair value adjustment of $1 million) at December 31, 2012, a weighted average contractual maturity of 4.1 years
and a weighted average coupon rate of 1.22%. Most of the U.S. Government and agency obligations we own include call features which allow
the issuing agency the right to call the securities at various dates prior to the final maturity. Certain agency obligations also include step-up
provisions which provide for periodic increases in the coupon rate if the call options are not exercised.
Mortgage-Backed Obligations: At December 31, 2012, our mortgage-backed and mortgage-related securities had a carrying value of $306
million ($301 million at amortized cost, with a fair value adjustment of $5 million). The weighted average coupon rate of these securities was
3.23% and the weighted average contractual maturity was 11.7 years, although we receive principal payments on these securities each period
resulting in a much shorter expected average life. As of December 31, 2012, 97% of the mortgage-backed and mortgage-related securities pay
interest at a fixed rate and 3% pay at an adjustable-interest rate. We do not believe that any of our mortgage-backed obligations had a meaningful
exposure to sub-prime mortgages.
Municipal Bonds: The carrying value of our tax-exempt bonds at December 31, 2012 was $104 million (also with an amortized cost of $104
million), and was comprised of general obligation bonds (i.e., backed by the general credit of the issuer) and revenue bonds (i.e., backed by
revenues from the specific project being financed) issued by cities and counties and various housing authorities, and hospital, school, water and
sanitation districts located in the states of Washington, Oregon and Idaho, our primary service area. We also had taxable bonds in our municipal
bond portfolio, which at December 31, 2012 had a carrying value of $31 million (also $31 million at amortized cost). Many of our qualifying
municipal bonds are not rated by a nationally recognized credit rating agency due to the smaller size of the total issuance and a portion of these
bonds have been acquired through direct private placement by the issuers. We have not experienced any defaults or payment deferrals on our
municipal bonds. At December 31, 2012, our municipal bond portfolio, including taxable and tax-exempt, had a weighted average maturity of
approximately 8.8 years and a weighted average coupon rate of 3.86%.
Corporate Bonds: Our corporate bond portfolio, which had a carrying value of $49 million ($70 million at amortized cost) at December 31,
2012, was comprised principally of long-term adjustable-rate capital securities issued by financial institutions, including single issuers, trust
preferred securities and collateralized debt obligations secured by pools of trust preferred securities issued by bank holding companies and
insurance companies. The market for these capital securities deteriorated significantly in 2008 and 2009 and in our opinion is still not currently
functioning in a meaningful manner. As a result, the fair value estimates for many of these securities are more subjective than in periods before
2008 when they were acquired. Nonetheless, it is apparent that the values have declined appreciably since purchase, which is reflected in our
financial statements and results of operations. In addition to the disruption in the market for these securities, the decline in value also reflects
deterioration in the financial condition of some of the issuing financial institutions and payment deferrals and defaults by certain institutions.
(See “Critical Accounting Policies” above and Note 22 of the Notes to the Consolidated Financial Statements.) At December 31, 2012, the
portfolio had a weighted average maturity of 19.4 years and a weighted average coupon rate of 2.40%.
Asset-Backed Securities: At December 31, 2012, our asset-backed securities portfolio had a carrying value of $43 million ($42 million at
amortized cost), and was comprised primarily of securitized pools of student loans issued or guaranteed by the Student Loan Marketing Association
(SLMA). The weighted average coupon rate of these adjustable-rate securities was 1.40%, the adjustments are tied to changes in three-month
LIBOR and the weighted average contractual maturity was 9.5 years.
44
The following tables set forth certain information regarding carrying values and percentage of total carrying values of our portfolio of securities
—trading and securities—available-for-sale, both carried at estimated fair market value, and securities—held-to-maturity, carried at amortized
cost as of December 31, 2012, 2011 and 2010 (dollars in thousands):
Table 1: Securities—Trading
2012
As of December 31,
2011
2010
Carrying
Value
Percent of
Total
Carrying
Value
Percent of
Total
Carrying
Value
Percent of
Total
U.S. Government and agency obligations
$
1,637
2.3% $
2,635
3.3% $
4,379
4.6%
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
—
5,684
5,684
—
8.0
8.0
420
5,542
5,962
0.5
6.9
7.4
693
5,705
6,398
0.7
6.0
6.7
Corporate bonds
35,741
50.2
35,055
43.4
34,724
36.4
Mortgage-backed or related securities:
1-4 residential agency guaranteed
Total mortgage-backed or related
securities
Equity securities
28,107
28,107
63
39.4
39.4
0.1
36,673
36,673
402
45.4
45.4
0.5
49,688
49,688
190
52.1
52.1
0.2
Total securities—trading
$
71,232
100.0% $
80,727
100.0% $
95,379
100.0%
Table 2: Securities—Available-for-Sale
2012
As of December 31,
2011
2010
Carrying
Value
Percent of
Total
Carrying
Value
Percent of
Total
Carrying
Value
Percent of
Total
U.S. Government and agency obligations
$
96,980
20.5% $
338,971
72.8% $
135,428
67.6%
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Mortgage-backed or related securities:
1-4 residential agency guaranteed
1-4 residential other
Multifamily agency guaranteed
Multifamily other
Total mortgage-backed or related
securities
Asset-backed securities:
21,153
23,785
44,938
10,729
87,859
1,299
177,940
10,659
277,757
42,516
4.5
5.0
9.5
2.3
18.6
0.3
37.6
2.2
58.7
9.0
10,581
16,729
27,310
6,260
70,500
1,835
20,919
—
93,254
—
2.3
3.6
5.9
1.3
15.1
0.4
4.5
—
20.0
—
775
4,621
5,396
0.4
2.3
2.7
22,522
11.2
33,337
3,544
—
—
36,881
—
16.7
1.8
—
—
18.5
—
Total securities—available-for-sale
$
472,920
100.0% $
465,795
100.0% $
200,227
100.0%
45
Table 3: Securities—Held-to-Maturity
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Total securities—held-to-maturity
Estimated market value
As of December 31,
2012
2011
2010
Carrying
Value
Percent of
Total
Carrying
Value
Percent of
Total
Carrying
Value
Percent of
Total
$
$
$
10,326
74,076
84,402
11.9% $
85.7
97.6
7,496
66,692
74,188
9.9% $
88.4
98.3
5,654
65,183
70,837
7.8%
90.4
98.2
2,050
2.4
1,250
1.7
1,250
1.8
86,452
100.0% $
75,438
100.0% $
72,087
100.0%
92,458
$
80,107
$
73,916
46
The following table shows the maturity or period to repricing of our consolidated portfolio of securities—trading at fair value as of December 31, 2012 (dollars in thousands):
Table 4: Securities–Trading Maturity/Repricing and Rates
Securities—Trading at December 31, 2012
One Year or Less
Over One to Five
Years
Over Five to Ten Years
Over Ten to Twenty
Years
Over Twenty Years
Total
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield (1)
U.S. Government and agency
obligations:
Fixed-rate
$
Municipal bonds:
Fixed-rate tax exempt
Corporate bonds:
Adjustable-rate
Mortgage-backed or related
securities:
Fixed-rate
Adjustable-rate
Equity securities
Total securities—trading—
carrying value
Total securities—trading—
amortized cost
—
—
—
—
30,909
30,909
—
5,276
5,276
63
—% $
—
—
—
—% $
—
180
180
6.00% $
6.00
1,457
1,457
5.19% $
5.19
—
—
2.28
2.28
—
4.04
4.04
—
1,767
1,767
4,832
4,832
3,100
—
3,100
—
3.91
3.91
2.41
2.41
5.33
—
5.33
—
3,569
3,569
—
—
11,786
—
11,786
—
5.60
5.60
—
—
4.48
—
4.48
—
—
—
—
—
4,854
—
4,854
—
—
—
—
—
5.36
—
5.36
—
—
—
348
348
—
—
3,091
—
3,091
—
—% $
—
1,637
1,637
5.30%
5.30
2.63
2.63
—
—
4.73
—
4.73
—
5,684
5,684
35,741
35,741
22,831
5,276
28,107
63
4.91
4.91
2.29
2.29
4.82
4.04
4.67
—
$ 36,248
2.43
$
9,699
3.43
$ 15,535
4.78
$ 56,771
$ 10,496
$ 14,251
$
$
6,311
5.32
5,629
$
$
3,439
4.51
$ 71,232
3.17
3,192
$ 90,339
(1) Yields on tax-exempt municipal bonds are not calculated as tax equivalent.
47
The following table shows the maturity or period to repricing of our consolidated portfolio of securities—available-for-sale at fair value as of December 31, 2012 (dollars in thousands):
Table 5: Securities–Available-for-Sale Maturity/Repricing and Rates
Securities—Available-for-Sale at December 31, 2012
One Year or Less
Over One to Five
Years
Over Five to Ten Years
Over Ten to Twenty
Years
Over Twenty Years
Total
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield (1)
$ 10,005
1,709
11,714
0.80% $ 61,182
0.63
—
61,182
0.78
0.93% $ 23,508
—
23,508
—
0.93
590
3,777
4,367
2,021
2,021
—
3,380
3,380
—
32,474
32,474
0.39
1.09
0.99
1.11
1.11
—
2.86
2.86
—
1.04
1.04
18,579
17,110
35,689
8,708
8,708
101,568
—
101,568
—
—
—
1.46
1.35
1.41
0.98
0.98
1.06
—
1.06
—
—
—
1,497
2,898
4,395
—
—
78,389
—
78,389
10,042
—
10,042
0.59% $
—
0.59
0.77
1.66
1.36
—
—
1.19
—
1.19
1.65
—
1.65
576
—
576
487
—
487
—
—
21,861
—
21,861
—
—
—
1.47% $
—
1.47
2.20
—
2.20
—
—
2.12
—
2.12
—
—
—
—
—
—
—
—
—
—
—
72,559
—
72,559
—
—
—
—% $ 95,271
1,709
—
96,980
—
0.84%
0.63
0.83
—
—
—
—
—
2.55
—
2.55
—
—
—
21,153
23,785
44,938
10,729
10,729
274,377
3,380
277,757
10,042
32,474
42,516
1.40
1.35
1.37
1.01
1.01
1.57
2.86
1.59
1.65
1.04
1.18
$ 53,956
1.09
$ 207,147
1.08
$ 116,334
1.12
$ 22,924
2.10
$ 72,559
2.55
$ 472,920
1.36
U.S. Government and agency
obligations:
Fixed-rate
Adjustable-rate
Municipal bonds:
Fixed rate taxable
Fixed rate tax exempt
Corporate bonds:
Fixed-rate
Mortgage-backed or related
securities:
Fixed-rate
Adjustable-rate
Asset-backed securities:
Fixed-rate
Adjustable-rate
Total securities—available-for-
sale—carrying value
Total securities—available-for sale
amortized cost
$ 53,753
$ 205,913
$ 115,289
$ 23,084
$ 71,611
$ 469,650
(1) Yields on tax-exempt municipal bonds are not calculated as tax equivalent.
48
The following table shows the maturity or period to repricing of our consolidated portfolio of securities held-to-maturity as of December 31, 2012 (dollars in thousands):
Table 6: Securities–Held-to-Maturity Maturity/Repricing and Rates
Securities—Held-to-Maturity at December 31, 2012
One Year or Less
Over One to Five
Years
Over Five to Ten Years
Over Ten to Twenty
Years
Over Twenty Years
Total
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield
Carrying
Value
Weighted
Average
Yield (1)
$
100
2,973
3,073
6.25% $
3.46
3.55
4,098
8,543
12,641
4.07% $
3.63
3.78
3,330
9,165
12,495
4.30% $
2.80
3.20
2,768
50,263
53,031
4.59% $
4.34
4.36
30
3,132
3,162
5.78% $ 10,326
74,076
4.08
84,402
4.10
4.31%
4.02
4.06
250
250
2.00
2.00
1,000
1,000
3.00
3.00
800
800
4.00
4.00
—
—
—
—
—
—
—
—
2,050
2,050
3.27
3.27
Municipal bonds:
Fixed rate taxable
Fixed rate tax exempt
Corporate bonds:
Fixed-rate
Total securities held-to-maturity—
carrying value
$
3,323
3.44
$ 13,641
3.72
$ 13,295
3.25
$ 53,031
4.36
$
3,162
4.10
$ 86,452
4.04
Total securities held-to-maturity—
estimated market value
$
3,410
$ 14,335
$ 13,452
$ 57,868
$
3,393
$ 92,458
(1) Yields on tax-exempt municipal bonds are not calculated as tax equivalent.
49
Loans and Lending. Our loan portfolio decreased $61 million, or 2%, during the year ended December 31, 2012, compared to a decrease of
$107 million, or 3%, during the year ended December 31, 2011. While we originate a variety of loans, our ability to originate each type of loan
is dependent upon the relative customer demand and competition in each market we serve. Reflecting the recession in 2008 and 2009 and
subsequent modest pace of recovery, loan demand, other than for lower rate refinancing of real estate loans, has been weak for most of the past
five years as consumers and businesses have been cautious in their use of credit. However, we have implemented strategies designed to capture
more market share and achieve increases in targeted loans and our loan originations increased meaningfully in 2011 and 2012. Nonetheless,
looking forward, new loan originations and portfolio balances will continue to be significantly affected by the course of the recovery from the
current sluggish economic environment. For the years ended December 31, 2012, 2011 and 2010, we originated loans, net of repayments and
charge-offs, of $460 million, $270 million and $114 million, respectively. The level of net originations during all three years was significantly
impacted by a substantial amount of loan repayments and charge-offs. We generally sell a significant portion of our newly originated one- to
four-family residential mortgage loans to secondary market purchasers. Proceeds from sales of loans for the years ended December 31, 2012,
2011 and 2010 totaled $505 million, $282 million and $351 million, respectively. See “Loan Servicing Portfolio” below. Loans held for sale
increased to $12.0 million at December 31, 2012, compared to $3 million at December 31, 2011.
At various times, we also purchase whole loans and participation interests in loans. During the years ended December 31, 2012, 2011and 2010,
we purchased $15 million, $5 million and $341,000, respectively, of loans and loan participation interests.
One- to Four-Family Residential Real Estate Lending: At December 31, 2012, $582 million, or 18%, of our loan portfolio, consisted of permanent
loans on one- to four-family residences. We are active originators of one- to four-family residential loans in communities where we have
established offices in Washington, Oregon and Idaho. Our originations of one- to four-family residential loans were particularly strong in 2012;
however, since most of these new loans were sold in the secondary market and principal repayments on existing loans were substantial, we had
a $61 million decrease in the balance of loans on one- to four-family residences compared to the prior year. Our one- to four-family loan
originations totaled $538 million for the year ended December 31, 2012, compared to $358 million and $468 million for the years ended December
31, 2011 and 2010, respectively.
Construction and Land Lending: Historically, we invested a significant proportion of our loan portfolio in residential construction loans, as well
as land loans and loans for the construction of commercial and multifamily real estate. However, as housing markets weakened in 2008, we
significantly reduced our origination of new construction and land development loans. The slower pace of originations coupled with repayments
as a result of home sales and restructuring opportunities as well as charge-off and foreclosure actions caused our portfolio of one- to four-family
construction loans to decrease substantially through 2011. Reversing this trend during the year ended December 31, 2012, one- to four-family
construction loans increased by $17 million to $161 million. Land development loans (both residential and commercial) decreased by $22
million to $91 million at December 31, 2012. Although significantly below our production levels prior to the beginning of the housing downturn,
our construction loan originations have increased for each of the past three years as builders have adjusted to new price levels and certain sub-
markets have become more active. Our construction and land development loan originations totaled $492 million for the year ended December 31,
2012, compared to $376 million for the year ended December 31, 2011, and $295 million in 2010. At December 31, 2012, construction and
land loans totaled $305 million (including $161 million of one- to four-family construction loans, $77 million of residential land or land
development loans, $53 million of commercial and multifamily real estate construction loans and $14 million of commercial land or land
development loans), or 9% of total loans, compared to $319 million, or 10%, at December 31, 2011. The geographic distribution of our
construction and land development loans is approximately 36% in the greater Puget Sound market and 42% in the greater Portland, Oregon
market, with the remaining 22% in the various eastern Washington, eastern Oregon and western Idaho markets we serve. While delinquencies
and defaults in residential construction and land development loans had a material adverse effect on our results of operations for much of the
recent economic cycle, at December 31, 2012, only $4 million were classified as non-performing loans. For the year ended December 31, 2012,
performing construction loans made an important contribution to our net interest income and profitability.
Commercial and Multifamily Real Estate Lending: We also originate loans secured by multifamily and commercial real estate. Multifamily
and commercial real estate loans originated by us are both fixed- and adjustable-rate loans generally with intermediate terms of five to ten
years. Our commercial real estate portfolio consists of loans on a variety of property types with no significant concentrations by property type,
borrowers or locations. We experienced reasonable demand for both multifamily and commercial real estate loans in 2012, though total balances
in these categories decreased $20 million or 2% from the prior year end. At December 31, 2012, our loan portfolio included $1.073 billion of
commercial real estate loans, or 33% of the total loan portfolio. Our portfolio of multifamily loans was much smaller, at $138 million, or 4%
of total loans.
Commercial Business Lending: We are active in small- to medium-sized business lending. In addition to providing earning assets, this type of
lending has helped increase our deposit base. Reflecting the relatively weak economic environment, demand for new loans remained modest
and line utilizations continued to be low in 2012; however, our production levels for targeted loans were encouraging and resulted in a $17
million, or 3%, increase in commercial business loan balances for the year. This growth occurred despite our successful efforts to reduce our
exposure to certain weak or non-performing borrowers. At December 31, 2012, commercial business loans totaled $618 million, or 19% of total
loans, compared to $601 million, or 18%, at December 31, 2011.
Agricultural Lending: Agriculture is a major industry in many Washington, Oregon and Idaho locations in our service area. While agricultural
loans are not a large part of our portfolio, we routinely make agricultural loans to borrowers with a strong capital base, sufficient management
depth, proven ability to operate through agricultural cycles, reliable cash flows and adequate financial reporting. Payments on agricultural loans
depend, to a large degree, on the results of operation of the related farm entity. The repayment is also subject to other economic and weather
conditions as well as market prices for agricultural products, which can be highly volatile at times. Generally, in recent years, weather conditions,
production levels and market prices have been good for most of our agricultural borrowers. Our 2012 production levels for agricultural loans
50
were consistent with recent years and at December 31, 2012, agricultural loans totaled $230 million, or 7% of the loan portfolio, compared to
$218 million, or 7%, at December 31, 2011.
Consumer and Other Lending: We originate a variety of consumer loans, including home equity lines of credit, automobile, recreational vehicle
and boat loans, credit cards and loans secured by deposit accounts. Consumer lending has traditionally been a modest part of our business with
loans made primarily to accommodate our existing customer base. In recent years, including 2012, demand for consumer loans has been restrained
and outstanding balances have decreased modestly. During the fourth quarter of 2012, we purchased approximately $13 million of consumer
loans originated by another northwest financial institution that are secured by recreational boats. At December 31, 2012, we had $291 million,
or 9% of our loan portfolio, in consumer loans, compared to $284 million, or 9%, at December 31, 2011. As of December 31, 2012, 59% of our
consumer loans were secured by one- to four-family real estate, including home equity lines of credit. Credit card balances totaled $21 million
at December 31, 2012 compared to $20 million a year earlier.
Loan Servicing Portfolio: At December 31, 2012, we were servicing $1.031 billion of loans for others and held $5.0 million in escrow for our
portfolio of loans serviced for others. The loan servicing portfolio at December 31, 2012 was composed of $687 million of Freddie Mac residential
mortgage loans, $212 million of Fannie Mae residential mortgage loans and $132 million of both residential and non-residential mortgage loans
serviced for a variety of private investors. The portfolio included loans secured by property located primarily in the states of Washington, Oregon
and Idaho. For the year ended December 31, 2012, we recognized $872,000 of loan servicing fees in our results of operations, which were net
of $2.6 million of amortization for mortgage servicing rights (MSRs) and a $400,000 impairment charge for a valuation adjustment to MSRs.
Mortgage Servicing Rights: We record MSRs with respect to loans we originate and sell in the secondary market on a servicing-retained
basis. The value of MSRs is capitalized and amortized in proportion to, and over the period of, the estimated future net servicing income. For
the years ended December 31, 2012, 2011 and 2010, we capitalized $3.7 million, $1.9 million, and $1.7 million, respectively, of MSRs relating
to loans sold with servicing retained. No MSRs were purchased in those periods. Amortization of MSRs for the years ended December 31,
2012, 2011 and 2010 was $2.6 million, $1.8 million, and $2.0 million, respectively. Management periodically evaluates the estimates and
assumptions used to determine the carrying values of MSRs and the amortization of MSRs. These carrying values are adjusted when the valuation
indicates the carrying value is impaired. At December 31, 2012, our MSRs were carried at a value of $6.2 million, net of amortization, compared
to $5.6 million at December 31, 2011.
51
Table 7: Loan Portfolio Analysis
The following table sets forth the composition of the Company’s loan portfolio, including loans held for sale, by type of loan as of the dates indicated (dollars in thousands):
2012
2011
December 31
2010
2009
2008
Amount
Percent of
Total
Amount
Percent of
Total
Amount
Percent of
Total
Amount
Percent of
Total
Amount
Percent of
Total
Commercial real estate
Owner-occupied
$
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development
Residential
Commercial
Commercial business
Agricultural business, including
secured by farmland
One- to four-family real estate
Consumer secured by one- to four-
family real estate
Consumer—other
489,581
583,641
137,504
30,229
22,581
160,815
77,010
13,982
618,049
230,031
581,670
170,123
120,498
15.1% $
18.0
4.3
0.9
0.7
5.0
2.4
0.4
19.1
7.1
18.0
5.3
3.7
469,806
621,622
139,710
42,391
19,436
144,177
97,491
15,197
601,440
218,171
642,501
181,049
103,347
14.2% $
18.9
4.2
1.3
0.6
4.4
3.0
0.5
18.2
6.6
19.5
5.5
3.1
515,093
550,610
134,634
62,707
27,394
153,383
167,764
32,386
585,457
204,968
682,924
186,036
99,761
15.1% $
16.2
4.0
1.8
0.8
4.5
4.9
1.0
17.2
6.0
20.1
5.5
2.9
509,464
573,495
153,497
80,236
57,422
239,135
284,331
43,743
637,823
205,307
703,277
191,454
110,937
13.4% $
15.1
4.1
2.1
1.5
6.3
7.5
1.2
16.8
5.4
18.6
5.1
2.9
459,446
554,263
151,274
104,495
33,661
420,673
401,129
62,128
679,867
204,142
599,169
175,646
115,515
11.6%
14.0
3.8
2.6
0.8
10.6
10.1
1.6
17.2
5.2
15.1
4.5
2.9
Total loans outstanding
3,235,714
100.0%
3,296,338
100.0%
3,403,117
100.0%
3,790,121
100.0%
3,961,408
100.0%
Less allowance for loan losses
(77,491)
(82,912)
(97,401)
(95,269)
(75,197)
Net loans
$
3,158,223
$
3,213,426
$
3,305,716
$
3,694,852
$
3,886,211
52
Table 8: Loans by Geographic Concentration
The following table sets forth the Company’s loans by geographic concentration at December 31, 2012 (dollars in thousands):
Commercial real estate
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development
Residential
Commercial
Commercial business
Agricultural business, including secured by farmland
One-to four-family real estate
Consumer secured by one- to four-family real estate
Consumer—other
Total loans outstanding
Percent of total loans
Washington
Oregon
Idaho
Other
Total
$
$
366,422
450,142
117,654
20,839
12,383
88,090
41,680
8,979
396,935
108,671
360,625
114,405
80,209
$
57,903
85,416
11,309
6,107
10,198
71,663
33,478
3,092
72,594
51,286
195,364
42,395
34,668
$
61,379
42,774
8,249
934
—
1,062
1,852
1,911
58,416
70,074
23,596
12,644
5,621
3,877
5,309
292
2,349
—
—
—
—
90,104
—
2,085
679
—
$
489,581
583,641
137,504
30,229
22,581
160,815
77,010
13,982
618,049
230,031
581,670
170,123
120,498
$ 2,167,034
$
675,473
$
288,512
$
104,695
$ 3,235,714
67.0%
20.9%
8.9%
3.2%
100.0%
The following table sets forth certain information at December 31, 2012 regarding the dollar amount of loans maturing in our portfolio based
on their contractual terms to maturity, but does not include scheduled payments or potential prepayments. Demand loans, loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Loan balances are net of unamortized
premiums and discounts, include loans held for sale and exclude the allowance for loan losses (in thousands):
Table 9: Loans by Maturity
Commercial real estate
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development
Residential
Commercial
Commercial business
Agricultural business, including secured
by farmland
One- to four-family real estate
Consumer secured by one- to four-family
real estate
Consumer—other
Total loans
Maturing
Within One
Year
Maturing
After One to
Three Years
Maturing
After Three
to Five Years
Maturing
After Five to
Ten Years
Maturing
After Ten
Years
Total
$
$
28,135
70,302
13,042
14,121
10,671
92,270
28,617
7,291
241,193
90,844
22,258
1,323
14,662
$
34,120
75,891
16,911
7,347
10,198
52,508
47,529
1,191
126,924
51,263
20,589
3,785
10,649
$
56,595
94,839
8,400
—
718
929
560
3,777
113,069
25,341
13,384
1,361
15,202
$
263,008
288,431
56,985
6,477
994
170
53
1,155
103,793
52,114
26,288
11,349
21,309
$
107,723
54,178
42,166
2,284
—
14,938
251
568
33,070
10,469
499,151
152,305
58,676
489,581
583,641
137,504
30,229
22,581
160,815
77,010
13,982
618,049
230,031
581,670
170,123
120,498
$
634,729
$
458,905
$
334,175
$
832,126
$
975,779
$ 3,235,714
Contractual maturities of loans do not necessarily reflect the actual life of such assets. The average life of loans typically is substantially less
than their contractual maturities because of principal repayments and prepayments. In addition, due-on-sale clauses on certain mortgage loans
generally give us the right to declare loans immediately due and payable in the event that the borrower sells the real property subject to the
mortgage and the loan is not repaid. The average life of mortgage loans tends to increase; however, when current mortgage loan market rates
53
are substantially higher than rates on existing mortgage loans and, conversely, decreases when rates on existing mortgage loans are substantially
higher than current mortgage loan market rates.
The following table sets forth the dollar amount of all loans maturing after December 31, 2012 which have fixed interest rates and floating or
adjustable interest rates (in thousands):
Table 10: Loans Maturing after One Year
Commercial real estate
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development
Residential
Commercial
Commercial business
Agricultural business, including secured by farmland
One- to four-family real estate
Consumer secured by one- to four-family real estate
Consumer—other
Fixed Rates
Floating or
Adjustable
Rates
Total
$
$
57,424
121,659
44,649
7,945
994
17,690
13,317
478
168,208
37,698
431,615
12,005
91,718
$
404,023
391,679
79,813
8,163
10,916
50,856
35,077
6,212
208,649
101,489
127,796
156,794
14,118
461,447
513,338
124,462
16,108
11,910
68,546
48,394
6,690
376,857
139,187
559,411
168,799
105,836
Total loans maturing after one year
$
1,005,400
$
1,595,585
$
2,600,985
Deposits: We made further progress in 2012 implementing our strategies to strengthen our franchise by remixing our deposits away from high
cost certificates of deposit and emphasizing core deposit activity in non-interest-bearing and other transaction and savings accounts. Increasing
core deposits (transaction and savings accounts) is a fundamental element of our business strategy. This strategy continues to improve our cost
of funds and increase the opportunity for deposit fee revenues, while stabilizing our funding base. Total deposits increased $82 million, to $3.558
billion at December 31, 2012 from $3.476 billion at December 31, 2011, non-interest-bearing deposits increased by $203 million, or 26%, to
$981 million at year end from $778 million at December 31, 2011, and interest-bearing transaction and savings accounts increased by $100
million, or 7%, to $1.547 billion at December 31, 2012 compared to $1.448 billion a year earlier. This core deposit growth augmented similarly
strong results in 2011 and coupled with significantly better pricing was primarily responsible for the much improved net interest margin we
experienced in 2012. Offsetting these increases, certificates of deposit decreased $221 million, or 18%, to $1.029 billion at December 31, 2012
from $1.250 billion at December 31, 2011. A portion of the decrease in certificates of deposit was in brokered certificates, which decreased $33
million from the prior year-end balances; however, much of the decrease reflects a reduction in retail certificates as a result of management’s
pricing decisions designed to allow maturing higher priced certificates to migrate off the balance sheet or into core deposit accounts.
54
The following table sets forth the balances of deposits in the various types of accounts offered by the Banks at the dates indicated (dollars in thousands):
Table 11: Deposits
Non-interest-bearing checking
Interest-bearing checking
Regular savings
Money market
Total transaction and savings accounts
Certificates which mature:
Within 1 year
After 1 year, but within 2 years
After 2 years, but within 5 years
After 5 years
Total certificate accounts
2012
December 31
2011
2010
Amount
Percent of
Total
Increase
(Decrease)
Amount
Percent of
Total
Increase
(Decrease)
Amount
Percent of
Total
$
981,240
410,316
727,957
408,998
2,528,511
759,626
153,371
112,772
3,524
1,029,293
27.6% $
11.5
20.5
11.5
71.1
$
203,677
47,774
58,361
(6,458)
303,354
777,563
362,542
669,596
415,456
2,225,157
22.4% $
10.4
19.3
11.9
64.0
$
177,106
4,840
53,084
(43,578)
191,452
600,457
357,702
616,512
459,034
2,033,705
21.3
4.3
3.2
0.1
28.9
(212,689)
(15,982)
7,169
298
(221,204)
972,315
169,353
105,603
3,226
1,250,497
28.0
4.9
3.0
0.1
36.0
(213,090)
(94,335)
499
(70)
(306,996)
1,185,405
263,688
105,104
3,296
1,557,493
16.7%
10.0
17.2
12.8
56.7
33.0
7.3
2.9
0.1
43.3
Total Deposits
$ 3,557,804
100.0% $
82,150
$ 3,475,654
100.0% $
(115,544) $ 3,591,198
100.0%
Included in Total Deposits:
Public transaction accounts
Public interest-bearing certificates
Total public deposits
Total brokered deposits
$
$
$
79,955
60,518
140,473
2.2% $
1.7
3.9% $
7,891
(6,594)
1,297
$
$
72,064
67,112
139,176
2.1% $
1.9
4.0% $
$
7,582
(14,697)
64,482
81,809
(7,115) $
146,291
1.8%
2.3
4.1%
15,702
0.4% $
(33,492) $
49,194
1.4% $
(53,790) $
102,984
2.9%
55
The following table indicates the amount of the Banks’ certificates of deposit with balances equal to or greater than $100,000 by time remaining
until maturity as of December 31, 2012 (in thousands):
Table 12: Maturity Period—$100,000 or greater CDs
Due in three months or less
Due after three months through six months
Due after six months through twelve months
Due after twelve months
Total
Table 13: Geographic Concentration of Deposits
Certificates of
Deposit $100,000
or Greater
$
$
157,149
86,898
167,525
159,516
571,088
The following table provides additional detail on geographic concentrations of our deposits at December 31, 2012 (in thousands):
Washington
Oregon
Idaho
Total
Deposits by State
$
2,718,396
$
600,179
$
239,229
$
3,557,804
Borrowings: The FHLB-Seattle serves as our primary borrowing source. To access funds, we are required to own a sufficient level of capital
stock in the FHLB-Seattle and may apply for advances on the security of such stock and certain of our mortgage loans and securities provided
that certain creditworthiness standards have been met. At December 31, 2012, we had $10 million of borrowings from the FHLB-Seattle (at
fair value) at a weighted average rate of 2.45%, a decrease of $229,000 compared to a year earlier. Also at December 31, 2012, we had an
investment of $37 million in FHLB-Seattle capital stock. At that date, Banner Bank was authorized by the FHLB-Seattle to borrow up to $889
million under a blanket floating lien security agreement, while Islanders Bank was approved to borrow up to $26 million under a similar agreement.
Table 14: FHLB Advances Outstanding
The following table provides additional detail on our FHLB advances as of December 31, 2012 and 2011 (dollars in thousands):
December 31
2012
2011
Amount
Weighted
Average Rate
Amount
Weighted
Average Rate
$
Due in one year or less
Due after one year through three years
Due after three years through five years
Due after five years
Total FHLB advances, at par
Fair value adjustment
Total FHLB advances, carried at fair value
$
10,000
—
—
210
10,210
94
10,304
2.38% $
—
—
5.94
2.45
$
—
10,000
—
217
10,217
316
10,533
—%
2.38
—
5.94
2.45
At certain times the Federal Reserve Bank has also served as an important source of borrowings. The Federal Reserve Bank provides credit
based upon acceptable loan collateral, which includes certain loan types not eligible for pledging to the FHLB-Seattle. At December 31, 2012,
based upon our available unencumbered collateral, Banner Bank was eligible to borrow $595 million from the Federal Reserve Bank; however,
at that date we had no funds borrowed under this arrangement.
We also issue retail repurchase agreements to customers that are primarily related to customer cash management accounts and in the past have
borrowed funds through the use of secured wholesale repurchase agreements with securities brokers. In each case, the repurchase agreements
are generally due within 90 days. At December 31, 2012, retail repurchase agreements totaling $77 million, with a weighted average rate of
0.30%, were secured by a pledge of certain mortgage-backed securities and agency securities with a market value of $109 million. Retail
repurchase agreement balances, which are primarily associated with sweep account arrangements, decreased $25 million, or 25%, from the 2011
year-end balance. We had no outstanding borrowings under wholesale repurchase agreements at December 31, 2012 or 2011.
56
We have issued an aggregate of $120 million, net of repayments, of trust preferred securities (TPS) since 2002. The junior subordinated debentures
associated with the TPS have been recorded as liabilities on our Consolidated Statements of Financial Condition, although portions of the TPS
qualify as Tier 1 or Tier II capital for regulatory capital purposes. The junior subordinated debentures are carried at fair value on our Consolidated
Statements of Financial Condition and have an estimated fair value of $73 million at December 31, 2012. At December 31, 2012, the TPS had
a weighted average rate of 2.42%. See Notes 1 and 12 of the Notes to the Consolidated Financial Statements for additional information with
respect to the TPS.
Asset Quality: While non-performing assets declined substantially in 2012 and 2011, beginning in the third quarter of 2008 and continuing
throughout 2009 and 2010, housing markets deteriorated in many of our primary service areas and we experienced significantly higher levels
of delinquencies and non-performing assets, primarily in our construction and land development loan portfolios. During this period, home and
lot sales activity was exceptionally slow, causing stress on builders’ and developers’ cash flows and their ability to service debt, which was
reflected in our increased non-performing asset totals. Further, property values generally declined, reducing the value of the collateral securing
loans. In addition, other non-housing-related segments of the loan portfolio developed signs of stress and increasing levels of non-performing
loans as the effects of the recessionary economy became more evident and the pace of the recovery remained slow. As a result, our provision
for loan losses was significantly higher than historical levels and our normal expectations. This higher than normal level of delinquencies and
non-accruals also had a material adverse effect on operating income as a result of foregone interest revenues, increased loan collection costs and
carrying costs and valuation adjustments for real estate acquired through foreclosure. While our non-performing assets have been significantly
reduced, resulting in materially reduced credit costs in 2012, and we are actively engaged with our borrowers in resolving remaining problem
assets, our future results will continue to be meaningfully influenced by the course of recovery from the economic recession. However, our
reserve levels are substantial and, as a result of our impairment analysis and charge-off actions, reflect current appraisals and valuation estimates
as well as recent regulatory examination results.
Non-performing assets decreased to $50 million, or 1.18% of total assets, at December 31, 2012, from $119 million, or 2.79% of total assets, at
December 31, 2011, and $254 million, or 5.77% of total assets, at December 31, 2010. Construction and land development loans, including
related REO, represented approximately 27% of our non-performing assets at December 31, 2012. Reflecting lingering weakness in the economy
and property values which now have generally stabilized but are lower than when many of the related loans were originated, we continued to
provide for loan losses at a relatively high level during 2012 and maintained a substantial allowance for loan losses at year end even though non-
performing loans and total loans outstanding declined. At December 31, 2012, our allowance for loan losses was $77 million, or 2.39% of total
loans and 225% of non-performing loans, compared to $83 million, or 2.52% of total loans and 110% of non-performing loans at December 31,
2011. Included in our allowance at December 31, 2012 was an unallocated portion of $12 million, which is based upon our evaluation of various
factors that are not directly measured in the determination of the formula and specific allowances. We continue to believe our level of non-
performing loans and assets, which declined significantly during the past two years, is manageable and we believe that we have sufficient capital
and human resources to manage the collection of our non-performing assets in an orderly fashion.
The primary components of the $50 million in non-performing assets are $31 million in nonaccrual loans and $16 million in REO and other
repossessed assets. The geographic distribution of non-performing assets included approximately $18 million, or 35%, in the Puget Sound
region, $17 million, or 33%, in the greater Portland market area, $2 million, or 5%, in the greater Boise market area, and $14 million, or 27%,
in other areas of Washington, Oregon and Idaho.
Loans are reported as restructured when we grant concessions to a borrower experiencing financial difficulties that we would not otherwise
consider. As a result of these concessions, restructured loans are impaired as the Banks will not collect all amounts due, both principal and
interest, in accordance with the terms of the original loan agreement. If any restructured loan becomes delinquent or other matters call into
question the borrower's ability to repay full interest and principal in accordance with the restructured terms, the restructured loan(s) would be
reclassified as nonaccrual. At December 31, 2012, we had $57 million of restructured loans currently performing under their restructured terms.
57
The following table sets forth information with respect to our non-performing assets and restructured loans, at the dates indicated (dollars in
thousands):
Table 15: Non-Performing Assets
Nonaccrual loans: (1)
Secured by real estate:
Commercial
Multifamily
Construction/land
One- to four-family
Commercial business
Agricultural business, including secured by farmland
Consumer
Loans more than 90 days delinquent, still on accrual:
Secured by real estate:
One- to four-family
Commercial business
Consumer
December 31
2012
2011
2010
2009
2008
$
6,579
—
3,672
12,964
4,750
—
3,396
$
9,226
362
27,731
17,408
13,460
1,896
2,905
$
24,727
1,889
75,734
16,869
21,100
5,853
2,332
$
7,300
383
159,264
14,614
21,640
6,277
3,923
$
12,879
—
154,823
8,649
8,617
1,880
130
31,361
72,988
148,504
213,401
186,978
2,877
—
152
3,029
2,147
4
173
2,324
2,955
—
30
2,985
358
—
91
449
124
—
243
367
Total non-performing loans
34,390
75,312
151,489
213,850
187,345
Securities on nonaccrual
REO assets held for sale, net (2)
Other repossessed assets held for sale, net
—
15,778
75
500
42,965
74
1,896
100,872
73
4,232
77,743
59
—
21,782
104
Total non-performing assets
$
50,243
$ 118,851
$ 254,330
$ 295,884
$ 209,231
Total non-performing loans to net loans before allowance for
loan losses
Total non-performing loans to total assets
Total non-performing assets to total assets
1.06%
0.81%
1.18%
2.28%
1.77%
2.79%
4.45%
3.44%
5.77%
5.64%
4.53%
6.27%
4.73%
4.09%
4.56%
Restructured loans (3)
Loans 30-89 days past due and on accrual
$
$
57,462
11,685
$
$
54,533
9,962
$
$
60,115
28,847
$
$
43,683
34,156
$
$
23,635
61,124
(1)
Includes $8.0 million of non-accrual restructured loans. For the year ended December 31, 2012, $3.2 million in interest income would
have been recorded had nonaccrual loans been current, and no interest income on these loans was included in net income for this period.
(2) Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate held for sale until it is
sold. When property is acquired, it is recorded at the lower of the estimated fair value of the property, less expected selling costs, or the
carrying value of the defaulted loan. Subsequent to foreclosure, the property is carried at the lower of the foreclosed amount or net
realizable value. Upon receipt of a new appraisal and market analysis, the carrying value is written down through the establishment of
a specific reserve to the anticipated sales price, less selling and holding costs.
(3) These loans are performing under their restructured terms.
In addition to the non-performing loans noted in Table 15, as of December 31, 2012, we had classified loans with an aggregate outstanding
balance of $100 million that are not on nonaccrual status, with respect to which known information concerning possible credit problems with
the borrowers or the cash flows of the properties securing the respective loans has caused management to be concerned about the ability of the
borrowers to comply with present loan repayment terms. This may result in the future inclusion of such loans in the nonaccrual loan category.
58
The following table provides additional detail and geographic concentration of non-performing assets at December 31, 2012 (dollars in thousands):
Table 16: Non-Performing Assets by Geographic Concentration
Secured by real estate:
Commercial
Construction and land
One- to four-family construction
Residential land acquisition & development
Residential land improved lots
Residential land unimproved
Commercial land improved
Total construction and land
One- to four-family
Commercial business
Consumer
Total non-performing loans
REO and repossessed assets
Washington
Oregon
Idaho
Total
$
5,814
$
— $
765
$
6,579
1,565
—
119
245
46
1,975
11,932
4,676
2,623
27,020
5,850
—
1,422
276
—
—
1,698
2,487
74
423
4,682
9,557
—
—
—
—
—
—
1,422
—
501
2,688
446
1,565
1,422
395
245
46
3,673
15,841
4,750
3,547
34,390
15,853
Total non-performing assets at end of the period
$
32,870
$
14,239
$
3,134
$
50,243
Percent of non-performing assets
65.5%
28.3%
6.2%
100.0%
Table 17: Non-Performing Loan Summary
Within our non-performing loans, we have a total of six nonaccrual lending relationships, each with aggregate loan exposures in excess of $1
million that collectively comprise $8 million, or 24% of our total non-performing loans as of December 31, 2012, and the single largest relationship
totaled $1.8 million at that date. The most significant of our non-performing loan exposures at December 31, 2012 are included in the following
table (dollars in thousands):
Amount
Percent of Total
Non-Performing
Loans
Collateral Securing the Indebtedness
Geographic Location
$
1,819
1,432
1,405
1,306
1,190
1,086
5.3% Accounts receivable and inventory
Greater Seattle-Puget Sound area
4.2
4.1
3.8
3.5
3.1
Commercial building
Central Washington
Business assets, accounts receivable, and vehicles
Greater Spokane, WA area
Seven single family residences
Greater Portland, OR area
Seven single family residences
Greater Seattle-Puget Sound area
Four commercial lots and one commercial acreage lot
Greater Portland, OR area
26,152
76.0
Relationships under $1 million; various collateral
Sum of 164 loans spread throughout the
franchise
$
34,390
100.0% Total non-performing loans
59
Table 18: Real Estate Owned Summary
At December 31, 2012, we had $15.8 million of REO, the most significant component of which is a subdivision in the greater Portland, Oregon
area consisting of 13 residential buildable lots and 33.2 acres of undeveloped land with a book value of $2.1 million. The second largest REO
holding is 5.9 acres of undeveloped land in the greater Portland, Oregon area with a book value $1.7 million. The third largest holding is 20.5
acres of undeveloped residential land in the greater Portland, Oregon area with a book value of $1.1 million. All other REO holdings have
individual book values of less than $586,000. The table below summarizes our REO by geographic location and property type (dollars in
thousands):
Amount
$
10,594
Percent of
Total REO
REO Description
Geographic Location
67.2% 13 single family residences
18 residential lots
83 acres undeveloped buildable residential land
Greater Portland, OR area
1,658
10.5
Five single family residences
One residential lot
Three parcels of undeveloped residential land
One acre of buildable residential land
819
5.2
One single family residences
21 residential lots
One parcel of residential land
Three commercial office buildings
63 acres of forest land
One parcel of undeveloped waterfront land
445
2.8
One single family residence
53 residential lots
Three commercial lots
One commercial office building
2,194
13.9
Three single family residences
21 residential lots
One single family residence under construction
13 acres of undeveloped land
One residence with 31 acres of agricultural land
One parcel of bare land
One 79 acre farm
Greater Seattle-Puget Sound area
Greater Spokane, WA area
Greater Boise, ID area
Other Washington locations
68
0.4
One single family residence
Other Oregon locations
$
15,778
100.0%
Comparison of Results of Operations for the Years Ended December 31, 2012 and 2011
Following three difficult years and despite a still challenging economy, Banner Corporation returned to profitability in 2011 and achieved
significantly increased profitability in 2012. While this return to profitability largely resulted from a material decrease in credit costs, particularly
our provision for loan losses, it also reflected strong revenue generation from our core operations. The decrease in credit costs reflects a
substantially reduced level of non-performing assets while the increase in revenues was driven by improvement in our net interest income and
deposit fees and other service charges fueled by growth in core deposits and, in 2012, significantly increased revenues from mortgage banking
operations and a substantial net benefit from income taxes. For the year ended December 31, 2012, we had net income of $64.9 million, which,
after providing for the preferred stock dividend of $4.9 million, the related discount accretion of $3.3 million, and including a $2.5 million gain
on repurchase and retirement of preferred stock, resulted in net income to common shareholders of $59.1 million, or $3.16 per diluted share. This
compares to net income of $5.5 million, which, after providing for the preferred stock dividend of $6.2 million and related discount accretion
of $1.7 million, resulted in a net loss to common shareholders of $2.4 million, or ($0.15) per diluted share, for the year ended December 31,
2011. Our provision for loan losses was $13.0 million for the year ended December 31, 2012, compared to $35.0 million for the prior year. For
the year ending December 31, 2012, our results also include a net tax benefit of $24.8 million, primarily the result of a reversal of a full valuation
allowance for our net deferred tax assets.
Aside from credit costs, our operating results depend largely on our net interest income which, as explained below, increased by $3.1 million to
$167.7 million, primarily because of a significant reduction in deposit costs and a reduction in the adverse effect of non-performing assets. Our
operating results for the year ended December 31, 2012 also reflected a decrease in other operating income, which was particularly influenced
by a net charge of $16.5 million as a result of changes in the valuation of financial instruments carried at fair value that was only partially offset
by increases in deposit fees and service charges, revenues from mortgage banking operations and miscellaneous other operating income. By
comparison, for the year ended December 31, 2011, we recorded a $3 million recovery of a previous OTTI charge, which was partially offset
by $624,000 in net fair value losses. Excluding these fair value and OTTI adjustments, our other operating income increased by $12.2 million
60
to $43.8 million for the year ended December 31, 2012 compared to $31.6 million the preceding year, due primarily to a $7.9 million increase
in mortgage banking revenue, a $2.3 million increase in deposit fees and service charges and a $2.2 million increase in miscellaneous other
operating income. Other operating expenses decreased to $141.5 million for the year ended December 31, 2012, a decrease of 11% from the
prior year, largely as a result of decreased costs related to REO and FDIC deposit insurance.
Net Interest Income. Net interest income before provision for loan losses increased by $3.1 million, or 2%, to $167.7 million for the year ended
December 31, 2012, compared to $164.6 million one year earlier, primarily as a result of an increase in the net interest margin and despite a
modest decrease in average interest-earning assets. The net interest margin of 4.17% for the year ended December 31, 2012 increased 12 basis
points from the prior year, largely as a result of the effect of a much lower cost of deposits which more than offset a further decrease in asset
yields. While less severe than in the preceding year as a result of the significant reduction in problem assets, our net interest margin continued
to be adversely affected by the level of nonaccrual loans and other non-performing assets. However, nonaccruing loans reduced the margin by
just eight basis points during the year ended December 31, 2012, a meaningful improvement compared to a 22 basis point reduction for the prior
year. In addition, the mix of earning assets changed to include fewer loans and more securities and interest-bearing deposits as our on-balance-
sheet liquidity remained high. This continued shift in the mix during the still very low interest rate environment had a further adverse effect on
earning asset yields. Reflecting generally lower market interest rates as well as changes in asset mix, the yield on earning assets for the year
ended December 31, 2012 decreased by 20 basis points compared to the prior year. Importantly, however, funding costs were also significantly
lower, especially deposit costs which decreased 31 basis points to 0.44% from 0.75% a year earlier, more than offsetting the decline in asset
yields. As a result, the net interest spread expanded to 4.13% for the year ended December 31, 2012 compared to 3.99% for the prior year and
was only partially offset by the 1% decline in average interest-earning assets.
Interest Income. Interest income for the year ended December 31, 2012 was $187.2 million, compared to $197.6 million for the prior year, a
decrease of $10.4 million, or 5%. The decrease in interest income occurred as a result of a $46 million decrease in the average balance of interest-
earning assets, as well as a 20 basis point decrease in the average yield on those assets. The yield on average interest-earning assets decreased
to 4.66% for the year ended December 31, 2012, compared to 4.86% one year earlier, largely as a result of changes in the mix of assets and the
impact of lower market rates on the loan and securities portfolios. The Federal Reserve continued monetary policy actions during the year
designed to maintain short-term market interest rates at the extremely low levels of the past four years and initiated further actions to move
intermediate- and longer-term rates even lower in 2012. Despite the pressure from lower market interest rates, our loan yields were only modestly
lower at 5.41% for the year ended December 31, 2012 compared to 5.59% in the preceding year largely because of a decrease in the amount of
non-performing loans. Looking forward, loan yields will likely continue to decline in the current interest rate environment as refinance activity
will be reflective of market rates that are below the average portfolio yield and opportunities to further reduce the impact of non-performing
loans have diminished. Average loans receivable for the year ended December 31, 2012 decreased $74 million, or 2%, to $3.224 billion, compared
to $3.298 billion for the prior year. Interest income on loans decreased by $10.1 million, or 5%, to $174.3 million for the year from $184.4
million for the year ended December 31, 2011, reflecting the decreased average balance and the lower average yield on loans.
The combined average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock increased
by $28 million (excluding the effect of fair value adjustments) for the year ended December 31, 2012; however the interest and dividend income
from those investments decreased by $366,000 compared to the prior year. The effect of the increased average balance was offset as the average
yield on the securities portfolio and cash equivalents decreased to1.61% for the year ended December 31, 2012, from 1.72% one year earlier. The
adverse impact of lower market rates on the combined yield on these investments was partially offset by changes in the mix to include lower
balances of daily interest-bearing deposits and more investment securities; however, yields on this portfolio should continue to decline in future
periods given continuation of the currently low interest rate environment.
Interest Expense. Interest expense for the year ended December 31, 2012 was $19.5 million, compared to $33.0 million for the prior year, a
decrease of $13.5 million, or 41%. The sharp decline in interest expense occurred as a result of a 34 basis point decrease in the average cost of
all interest-bearing liabilities to 0.53% for the year ended December 31, 2012, from 0.87% one year earlier, and a $119 million, or 3%, decrease
in average interest-bearing liabilities. The decrease in average interest-bearing balances reflects a substantial decrease in the average balance
of certificates of deposit, as well as decreases in FHLB advances and other borrowings, which were only partially offset by increases in transaction
and savings accounts. The growth in non-interest-bearing deposits and other transaction and savings accounts during the past two years has
significantly contributed to our improved net interest margin in 2012.
Deposit interest expense decreased $11.1 million, or 42%, to $15.1 million for the year ended December 31, 2012 compared to $26.2 million
for the prior year as a result of a 31 basis point decrease in the cost of deposits and a $62 million decrease in the average balance of deposits. Average
deposit balances decreased to $3.448 billion for the year ended December 31, 2012, from $3.510 billion for the year ended December 31, 2011,
while the average rate paid on deposit balances decreased to 0.44% in the current year from 0.75% for the prior year. Deposit costs are significantly
affected by changes in the level of market interest rates; however, changes in the average rate paid for interest-bearing deposits frequently tend
to lag changes in market interest rates as evidenced by the continuing decline in our deposit costs despite relatively stable short-term market
interest rates over the past twelve months.
While we do not anticipate further reductions in market interest rates, we do expect additional modest declines in deposits costs over the near
term as maturities of certificates of deposit will present further repricing opportunities and competitive pricing should remain restrained in
response to modest loan demand in the current economic environment. Further, continuing changes in our deposit mix, especially growth in
lower cost transaction and savings accounts, in particular non-interest-bearing deposits, have meaningfully contributed to the decrease in our
funding costs compared to earlier periods, and should also result in lower deposit costs going forward.
61
Average FHLB advances (excluding the effect of fair value adjustments) decreased to $10 million for the year ended December 31, 2012,
compared to $15 million for the prior year. The decline in outstanding FHLB advances was almost entirely responsible for the $116,000 decrease
in the related interest expense as the average rate paid on FHLB advances remained nearly unchanged for the years ended December 31, 2012
and 2011 at 2.49% and 2.52%, respectively.
Other borrowings consist of retail repurchase agreements with customers secured by certain investment securities and, prior to March 31, 2012,
the $50 million of senior bank notes issued under the TLGP. The senior bank notes had a fixed rate of 2.625%, plus a 1.00% guarantee fee, and
matured on March 31, 2012. Repaying these notes resulted in a significant reduction in the cost of borrowings for 2012. Primarily as a result
of repaying the senior bank notes, the average balance for other borrowings decreased $52 million to $102 million at December 31, 2012 compared
to $154 million a year earlier. The rate on these other borrowings likewise decreased to 0.74% from 1.47% a year earlier and the related interest
expense for other borrowings decreased by $1.5 million to $758,000 for the year ended December 31, 2012, from $2.3 million one year earlier.
Junior subordinated debentures which were issued in connection with our trust preferred securities had an average balance (excluding the effect
of fair value adjustments) of $124 million for both the years ended December 31, 2012 and 2011. These junior subordinated debentures are
adjustable-rate instruments with repricing frequencies of three months based upon the three-month LIBOR index. During 2012, the average
rate decreased to 2.72% compared to 3.39% for 2011. The lower average cost of the junior subordinated debentures in the current year was
primarily the result of the expiration on February 29, 2012 of a five-year fixed-rate period on one debenture and its repricing from a fixed rate
of 6.56% to an adjustable rate of LIBOR plus 1.62%, or 1.99% at December 31, 2012.
Table 19, Analysis of Net Interest Spread, presents, for the periods indicated, our condensed average balance sheet information, together with
interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing
liabilities. Average balances are computed using daily average balances. (See the footnotes to the tables for more information on average
balances.)
62
The following table provides an analysis of our net interest spread for the last three years (dollars in thousands):
Table 19: Analysis of Net Interest Spread
Interest-earning assets:
Mortgage loans
Commercial/agricultural loans
Consumer and other loans
Total loans (1)
Mortgage-backed securities
Other securities
Interest-bearing deposits with banks
FHLB stock
Total investment securities
Total interest-earning assets
Non-interest-earning assets
Total assets
Interest-bearing liabilities:
Savings accounts
Checking and interest-bearing checking accounts (2)
Money market accounts
Certificates of deposit
Total deposits
Other interest-bearing liabilities:
FHLB advances
Other borrowings
Junior subordinated debentures
Total borrowings
Total interest-bearing liabilities
Non-interest-bearing liabilities (3)
Total liabilities
Stockholders’ equity
Year Ended December 31, 2012
Year Ended December 31, 2011
Year Ended December 31, 2010
Average
Balance
Interest and
Dividends
Yield/
Cost (4)
Average
Balance
Interest and
Dividends
Yield/
Cost (4)
Average
Balance
Interest and
Dividends
Yield/
Cost (4)
131,523
36,836
5,963
174,322
4,176
8,328
336
—
12,840
187,162
1,825
491
1,319
11,472
15,107
254
758
3,395
4,407
19,514
$
$ 2,380,308
751,486
91,983
3,223,777
188,806
431,580
138,179
37,263
795,828
4,019,605
199,561
$ 4,219,166
$
682,173
1,203,991
411,453
1,150,288
3,447,905
10,215
102,193
123,716
236,124
3,684,029
(22,757)
3,661,272
557,894
139,102
39,127
6,128
184,357
3,455
9,245
506
—
13,206
197,563
3,119
811
2,469
19,765
26,164
370
2,265
4,193
6,828
32,992
$
5.53% $ 2,464,462
744,439
4.90
88,749
6.48
3,297,650
5.41
87,463
2.21
423,612
1.93
219,025
0.24
37,371
—
767,471
1.61
4.66
0.27
0.04
0.32
1.00
0.44
2.49
0.74
2.74
1.87
0.53
4,065,121
215,646
$ 4,280,767
$
648,262
1,035,100
437,561
1,389,351
3,510,274
14,699
154,140
123,716
292,555
3,802,829
(40,266)
3,762,563
518,204
152,270
47,052
6,462
205,784
4,045
7,546
707
—
12,298
218,082
5,153
1,606
4,992
40,569
52,320
1,318
2,448
4,226
7,992
60,312
$
5.64% $ 2,735,285
780,662
5.26
91,204
6.90
3,607,151
5.59
89,310
3.95
271,616
2.18
291,968
0.23
37,371
—
690,265
1.72
4.86
0.48
0.08
0.56
1.42
0.75
2.52
1.47
3.39
2.33
0.87
4,297,416
262,888
$ 4,560,304
$
591,886
935,387
458,053
1,783,422
3,768,748
51,411
175,509
123,716
350,636
4,119,384
(37,378)
4,082,006
478,298
5.57%
6.03
7.09
5.70
4.53
2.78
0.24
—
1.78
5.07
0.87
0.17
1.09
2.27
1.39
2.56
1.39
3.42
2.28
1.46
Total liabilities and stockholders’ equity
$ 4,219,166
$ 4,280,767
$ 4,560,304
Net interest income/rate spread
$
167,648
4.13%
$
164,571
3.99%
$
157,770
3.61%
Net interest margin
Ratio of average interest-earning assets to average
interest-bearing liabilities
4.17%
109.11%
(footnotes follow)
63
4.05%
106.90%
3.67%
104.32%
(1) Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past due. Amortization of net deferred
loan fees/costs is included with interest on loans.
(2) Average balances include non-interest-bearing deposits.
(3) Average non-interest-bearing liabilities include fair value adjustments related to FHLB advances and junior subordinated debentures.
(4) Yields and costs have not been adjusted for the effect of tax-exempt interest.
The following table sets forth the effects of changing rates and volumes on our net interest income during the periods shown (in
thousands). Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied
by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Effects on interest
income attributable to changes in rate and volume (changes in rate multiplied by changes in volume) have been allocated between changes in
rate and changes in volume (in thousands):
Table 20: Rate/Volume Analysis
Interest-earning assets:
Mortgage loans
Commercial/agricultural loans
Consumer and other loans
Total loans (1)
Mortgage-backed securities
Other securities
Interest-bearing deposits with banks
FHLB stock
Total investment securities
Year Ended December 31, 2012
Compared to Year Ended
December 31, 2011
Increase (Decrease) in
Income/Expense Due to
Year Ended December 31, 2011
Compared to Year Ended
December 31, 2010
Increase (Decrease) in
Income/Expense Due to
Rate
Volume
Net
Rate
Volume
Net
$
(2,891) $
(2,658)
(383)
(4,688) $
367
218
(7,579) $
(2,291)
(165)
(5,932)
(4,103)
(10,035)
(2,005)
(1,088)
26
—
(3,067)
2,726
171
(196)
—
2,701
721
(917)
(170)
—
(366)
2,092
(5,816)
(162)
(3,886)
(508)
(1,869)
(31)
—
(2,408)
$ (15,260) $ (13,168)
(7,925)
(334)
(2,109)
(172)
(17,541)
(21,427)
(82)
3,568
(170)
—
3,316
(590)
1,699
(201)
—
908
Total net change in interest income on interest- earning
assets
(8,999)
(1,402)
(10,401)
(6,294)
(14,225)
(20,519)
Interest-bearing liabilities:
Deposits (2)
FHLB advances
Other borrowings
Junior subordinated debentures
(8,159)
(4)
(897)
(798)
(2,898)
(112)
(610)
—
(11,057)
(116)
(1,507)
(798)
(18,832)
(24)
126
(33)
(7,324)
(924)
(309)
—
(26,156)
(948)
(183)
(33)
Total borrowings
(1,699)
(722)
(2,421)
69
(1,233)
(1,164)
Total net change in interest expense on interest-bearing
liabilities
(9,858)
(3,620)
(13,478)
(18,763)
(8,557)
(27,320)
Net change in net interest income
$
859
$
2,218
$
3,077
$
12,469
$
(5,668) $
6,801
(1)
(2)
Includes loans accounted for on a nonaccrual basis and loans 90 days or more past due. Amortization of net deferred loan fees/costs is
included with interest on loans.
Includes non-interest-bearing deposits.
Provision and Allowance for Loan Losses. During the year ended December 31, 2012, the provision for loan losses was $13 million, compared
to $35 million for the year ended December 31, 2011. As discussed in the “Summary of Critical Accounting Policies” section above and in Note
1 of the Notes to the Consolidated Financial Statements, the provision and allowance for loan losses is one of the most critical accounting
estimates included in our Consolidated Financial Statements. The provision for loan losses reflects the amount required to maintain the allowance
for losses at an appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves, trends in delinquencies
and net charge-offs and current economic conditions.
Our provision for loan losses was substantially less in the year ended December 31, 2012 than in 2011. Nonetheless, it remained elevated in
relation to historical loss rates prior to the economic downturn, particularly during the first half of 2012, in response to still high levels of
delinquencies, non-performing assets and net charge-offs as well as diminished property values and uncertain economic conditions. However,
64
all of our asset quality indicators improved significantly throughout the years 2011 and 2012, allowing us to decrease the level of provisioning
as each year progressed.
Reflecting lingering weakness in the economy and lower property values, during 2012, we continued to provide for loan losses at a relatively
high level and maintained a substantial allowance for loan losses at December 31, 2012 even though non-performing loans and total loans
outstanding declined. Although the allowance for loan losses at December 31, 2012 continued to reflect material levels of delinquencies and
net charge-offs for land and land development loans, our exposure to these types of loans was further reduced during the year as additional
problem asset resolutions occurred. The allowance for loan losses also continues to reflect our concerns that the significant number of distressed
sellers in the market and additional expected lender foreclosures may further disrupt certain housing markets and adversely affect home prices
and the demand for building lots. These concerns have remained elevated during the past four years as price declines for housing and related
lot and land markets have occurred in most areas of the Puget Sound and Portland regions where a significant portion of our one- to four-family
residential and construction and development loans are located. Nonetheless, more recently we have been encouraged by evidence of stabilization
or modest improvement in certain markets in our service areas. Aside from housing-related construction and development loans, non-performing
loans often reflect unique operating difficulties for the individual borrower; however, the weak pace of general economic activity and declining
commercial real estate values have been significant contributing factors to more recent late-cycle defaults in other non-housing-related segments
of the portfolio.
We recorded net charge-offs of $18 million for the year ended December 31, 2012, compared to $49 million for the prior year, and non-performing
loans decreased by $41 million during the year to $34 million at December 31, 2012, compared to $75 million at December 31, 2011. A
comparison of the allowance for loan losses at December 31, 2012 and 2011 reflects a decrease of $6 million, or 7%, to $77 million at December 31,
2012, from $83 million at December 31, 2011. Included in our allowance at December 31, 2012 was an unallocated portion of $12 million,
which is based upon our evaluation of various factors that are not directly measured in the determination of the formula and specific allowances.
The allowance for loan losses as a percentage of total loans (loans receivable excluding allowance for losses) decreased to 2.39% at December 31,
2012, compared to 2.52% at December 31, 2011. However, as a result of the reduction in problem loans, the allowance as a percentage of non-
performing loans increased to 225% at December 31, 2012, compared to 110% a year earlier.
As of December 31, 2012, we had identified $92 million of impaired loans. Impaired loans are comprised of loans on nonaccrual, TDRs that
are performing under their restructured terms and loans that are 90 days or more past due, but are still on accrual. Impaired loans may be
evaluated for reserve purposes using either a specific impairment analysis or collectively evaluated as part of homogeneous pools. For more
information on these impaired loans, refer to Note 6 and 22 of the Notes to the Consolidated Financial Statements.
We believe that the allowance for loan losses as of December 31, 2012 was adequate to absorb the known and inherent risks of loss in the loan
portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable,
there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future
provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our
financial condition and results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review
by bank regulators as part of the routine examination process, which may result in the establishment of additional reserves based upon their
judgment of information available to them at the time of their examination.
65
The following table sets forth an analysis of our allowance for loan losses for the periods indicated (dollars in thousands):
Table 21: Changes in Allowance for Loan Losses
Balance, beginning of period
$
82,912
$
97,401
$
95,269
$
75,197
$
45,827
Provision
13,000
35,000
70,000
109,000
62,500
Years Ended December 31
2012
2011
2010
2009
2008
Recoveries of loans previously charged off:
Commercial real estate
Construction and land
Commercial business
Agricultural business, including secured by farmland
One- to four-family real estate
Consumer
Loans charged off:
Commercial real estate
Multifamily real estate
Construction and land
Commercial business
Agricultural business, including secured by farmland
One- to four-family real estate
Consumer
921
2,954
2,425
49
586
531
7,466
(4,065)
—
(6,546)
(6,485)
(456)
(5,328)
(3,007)
(25,887)
53
1,602
1,082
20
356
304
3,417
(6,079)
(682)
(26,328)
(8,396)
(477)
(9,910)
(1,034)
(52,906)
—
897
2,865
45
136
284
4,227
(1,668)
—
(43,592)
(15,244)
(1,940)
(7,860)
(1,791)
(72,095)
—
715
545
38
138
275
1,711
(1)
—
(64,456)
(11,541)
(3,877)
(8,795)
(1,969)
(90,639)
1,530
192
471
1,048
45
185
3,471
(7)
—
(27,020)
(7,323)
(60)
(934)
(1,257)
(36,601)
Net charge-offs
(18,421)
(49,489)
(67,868)
(88,928)
(33,130)
Balance, end of period
$
77,491
$
82,912
$
97,401
$
95,269
$
75,197
Allowance for loan losses as a percent of total loans
Net loan charge-offs as a percent of average outstanding
loans during the period
Allowance for loan losses as a percent of non-performing
loans
2.39%
0.57%
225%
2.52%
1.50%
110%
2.86%
1.88%
64%
2.51%
2.28%
45%
1.90%
0.84%
40%
66
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated (dollars in thousands):
Table 22: Allocation of Allowance for Loan Losses
2012
2011
December 31
2010
2009
2008
Specific or allocated loss allowances (1):
Commercial real estate
Multifamily real estate
Construction and land
Commercial business
Agricultural business, including secured by
farmland
One- to four-family real estate
Consumer
Total allocated
Amount
$
15,322
4,506
14,991
9,957
2,295
16,475
1,348
64,894
Estimated allowance for undisbursed commitments
758
Unallocated (1)
11,839
Percent
of Loans
in Each
Category
to Total
Loans
Amount
Percent
of Loans
in Each
Category
to Total
Loans
Amount
Percent
of Loans
in Each
Category
to Total
Loans
Amount
Percent
of Loans
in Each
Category
to Total
Loans
Amount
Percent
of Loans
in Each
Category
to Total
Loans
33.1% $
4.3
9.4
19.1
7.1
18.0
9.0
n/a
n/a
16,457
3,952
18,184
15,159
1,548
12,299
1,253
68,852
678
13,382
33.1% $
4.2
9.8
18.2
6.6
19.5
8.6
n/a
n/a
11,779
3,963
33,121
24,545
1,846
5,829
1,794
82,877
1,426
13,098
31.3% $
4.0
13.0
17.2
6.0
20.1
8.4
n/a
n/a
8,278
90
45,209
22,054
919
2,912
1,809
81,271
1,594
12,404
28.5% $
4.1
18.6
16.8
5.4
18.6
8.0
n/a
n/a
4,199
87
38,253
16,533
530
752
1,730
62,084
1,108
12,005
25.6%
3.8
25.7
17.2
5.2
15.1
7.4
n/a
n/a
Total allowance for loan losses
$
77,491
100.0% $
82,912
100.0% $
97,401
100.0% $
95,269
100.0% $
75,197
100.0%
(1) We establish specific loss allowances when individual loans are identified that present a possibility of loss (i.e., that full collectability is not reasonably assured). The remainder of the
allocated and unallocated allowance for loan losses is established for the purpose of providing for estimated losses which are inherent in the loan portfolio.
67
Other Operating Income. Other operating income, which includes changes in the valuation of financial instruments carried at fair value as
well as non-interest revenues from core operations, decreased $7.0 million to $26.9 million for the year ended December 31, 2012, compared
to $34.0 million for the year ended December 31, 2011. This decrease was primarily due to a $15.9 million unfavorable variance in net fair
value adjustments compared to the prior year. Excluding fair value and OTTI adjustments and, in the current year, a small gain on sale of
securities, other operating income from core operations increased $12.2 million to $43.8 million for the year ended December 31, 2012 compared
to $31.6 million at December 31, 2011, largely as a result of significantly increased revenues from mortgage banking. Mortgage banking revenues
increased by $7.9 million as increased production and sales of loans were supported by high levels of refinancing in the very low interest rate
environment. Loan sales for the year ended December 31, 2012 totaled $505 million, compared to $282 million for the year ended December 31,
2011. Importantly, and primarily as a result of growth in our customer base, income from deposit fees and other service charges increased by
$2.3 million, or approximately 10%, to $25.3 million for the year ended December 31, 2012, compared to $23.0 million for the prior year. By
contrast, loan servicing fee income decreased $206,000 compared to the prior year, primarily reflecting a $400,000 impairment charge on our
MSRs. Miscellaneous revenues also increased significantly, largely as a result of increased fees associated with interest rate swaps and income
on bank-owned life insurance.
For the year ended December 31, 2012, we recorded a net charge of $16.5 million for changes in the valuation of financial instruments carried
at fair value, compared to a net charge of $624,000 for the year ended December 31, 2011. The adjustments in 2012 primarily reflect changes
in the valuation of the junior subordinated debentures we have issued, which resulted in $23.1 million in charges that were partially offset by
net gains in the value of certain investment securities. The net fair value loss in 2011 was also largely a result of changes in the valuation of the
junior subordinated debentures, which resulted in $1.6 million in charges that were partially offset by net gains in the values of certain investment
securities. Additionally, in 2011, we had a $3.0 million recovery as a result of the full cash repayment of a trust preferred security issued by a
commercial bank that had been written off as an OTTI charge in 2010. As discussed more thoroughly in Note 22 of the Notes to the Consolidated
Financial Statements, the valuation for many of these financial instruments has become very difficult and more subjective in recent periods as
current and reliable observable transaction data does not exist.
Other Operating Expenses. Other operating expenses for the year ended December 31, 2012 totaled $141.5 million compared to $158.1 million
in 2011, a decrease of $16.6 million, or 11%, compared to the prior year, largely as a result of decreased costs related to REO and FDIC deposit
insurance which were partially offset by increased compensation expenses. While lower in 2012 than in 2011, both years’ expenses reflect
significant costs associated with problem loan collection activities including professional services and valuation charges related to REO, which
we expect will decline in future periods as a result of the continuing reduction in non-performing assets. Total REO expenses were $3.4 million,
including only $451,000 of net losses and valuation adjustments, for the year ended December 31, 2012, compared to $22.3 million, including
$16.4 million of losses and valuation adjustments, for the year ended December 31, 2011. Importantly, our total REO was reduced by nearly
$27 million during 2012 to $16 million at December 31, 2012, compared to $43 million a year earlier. The cost of FDIC insurance decreased
by $2.3 million compared to the prior year, largely as a result of the decrease in average deposit balances, leading to a decrease in average assets,
and a reduction in the premium assessment rate. Compensation expense increased $6.2 million to $78.7 million for the year ended December
31, 2012 from $72.5 million for the year ended December 31, 2011, primarily reflecting salary and wage adjustments, increased mortgage
banking activity and higher health insurance costs. The increase in compensation costs was partially offset by an $2.4 million increase in the
amount of the credit for capitalized loan origination costs as a result of increased new loan originations and a $1.6 million reduction in professional
fees largely due to decreased legal expenses associated with problem loan resolution. Payment and card processing expenses increased by
$730,000, reflecting the increased number of transaction accounts and increased customer usage of debit and credit cards. All other expenses
were only modestly changed from the prior year.
Income Taxes: Our normal, expected statutory income tax rate is 36.5%, representing a blend of the statutory federal income tax rate of 35.0%
and apportioned effects of the 7.6% Oregon and Idaho income tax rates. However, during 2010, we evaluated our net deferred tax asset and
determined it was prudent to establish a valuation allowance against the entire asset. While the full valuation allowance remained in effect, we
did not recognize any tax expense or benefit in our Consolidated Statements of Operations. As a result, we did not recognize any tax expense
or benefit for the year ended December 31, 2011, although our pre-tax net income was $5.5 million. During 2012, we determined that maintaining
the full valuation allowance was no longer appropriate and reversed all of the valuation allowance resulting in a substantial tax benefit for the
year. The reversal of the valuation allowance, net of adjustments to tax expense/(benefits), resulted in a net benefit from income taxes for the
year ended December 31, 2012 of $24.8 million. Beginning with the first quarter of 2013, we expect to recognize income tax expense based
upon the statutory rate noted above, although certain tax-exempt income and tax credits likely will result in a slightly lower effective rate in
future periods. For more information on income taxes and deferred taxes, see Note 13 of the Notes to the Consolidated Financial Statements.
Comparison of Results of Operations for the Years Ended December 31, 2011 and 2010
Following three difficult years and despite a still challenging economy, Banner Corporation returned to profitability in 2011. While this return
to profitability largely resulted from a material decrease in credit costs, particularly our provision for loan losses, it also reflected increased
revenue generation from our core operations. The decrease in credit costs reflected a substantially reduced level of non-performing assets, while
the increase in revenues was driven by significant improvement in our net interest income and deposit fees and other service charges fueled by
growth in core deposits. For the year ended December 31, 2011, we had net income of $5.5 million, which, after providing for the preferred
stock dividend of $6.2 million and related discount accretion of $1.7 million, resulted in a net loss to common shareholders of $2.4 million, or
($0.15) per diluted share. This compared to a net loss to common shareholders of $69.7 million, or ($7.21) per diluted share, for the year ended
December 31, 2010. Our provision for loan losses was $35.0 million for the year ended December 31, 2011, compared to $70.0 million for the
prior year. Our results for 2010 also included an $18.0 million provision for income taxes, despite a pre-tax loss, as we recorded a full valuation
allowance for our net deferred tax assets. By contrast, for the year ended December 31, 2011, we had pre-tax net income of $5.5 million, with
the resulting provision for income taxes offset by an adjustment to the deferred tax assets valuation allowance.
68
Aside from credit costs, our operating results depend largely on our net interest income which increased by $6.8 million to $164.6 million,
primarily because of a significant reduction in deposit costs and a reduction in the adverse effect of non-performing assets, and was the most
important component of our growth in revenues from core operations in 2011. Our operating results for the year ended December 31, 2011 also
included an increase in other operating income, which was particularly influenced by a $3.0 million recovery of a previous OTTI charge which
was partially offset by a net loss of $624,000 as a result of changes in the valuation of financial instruments carried at fair value. By comparison,
for the year ended December 31, 2010, we recorded $4.2 million of OTTI charges, which were partially offset by $1.7 million in net fair value
gains. Excluding these fair value and OTTI adjustments, our other operating income was nearly unchanged at $31.6 million for the year ended
December 31, 2011 compared to the preceding year, as increased deposit fees and other service charges were generally offset by decreased gains
on the sale of loans from mortgage banking operations. Other operating expenses decreased to $158.1 million for the year ended December 31,
2011, a decrease of 2% from the prior year, largely as a result of decreased costs related to REO and FDIC deposit insurance.
Net Interest Income. Net interest income before provision for loan losses increased by $6.8 million, or 4%, to $164.6 million for the year ended
December 31, 2011, compared to $157.8 million one year earlier, primarily as a result of an increase in the net interest margin and despite a
modest decrease in average interest-earning assets. The net interest margin of 4.05% for the year ended December 31, 2011 increased 38 basis
points from the prior year, largely as a result of the effect of a much lower cost of deposits which more than offset a further decrease in asset
yields. While less severe than in the preceding year as a result of the significant reduction in problem assets, our net interest margin continued
to be adversely affected by the high level of nonaccrual loans and other non-performing assets. However, nonaccruing loans reduced the margin
by 22 basis points during the year ended December 31, 2011, compared to the 34 basis point reduction for the prior year. In addition, the mix
of earning assets changed to include fewer loans and more securities and interest-bearing deposits. This continued shift in the mix in the low
interest rate environment had a further adverse effect on earning asset yields. Reflecting generally lower market interest rates as well as changes
in asset mix, the yield on earning assets for the year ended December 31, 2011 decreased by 21 basis points compared to the prior year. More
importantly, funding costs were also significantly lower, especially deposit costs, which decreased 64 basis points to 0.75% from 1.39% a year
earlier, more than offsetting the decline in asset yields. As a result, the net interest spread expanded to 3.99% for the year ended December 31,
2011 compared to 3.61% for the prior year and was only partially offset by the 5% decline in average interest-earning assets.
Interest Income. Interest income for the year ended December 31, 2011 was $197.6 million, compared to $218.1 million for the prior year, a
decrease of $20.5 million, or 9%. The decrease in interest income occurred as a result of a $232 million decrease in the average balance of
interest-earning assets, as well as a 21 basis point decrease in the average yield on those assets. The yield on average interest-earning assets
decreased to 4.86% for the year ended December 31, 2011, compared to 5.07% one year earlier, largely as a result of changes in the mix of assets
and the impact of lower market rates on the securities portfolio. The Federal Reserve continued monetary policy actions during 2011 designed
to maintain short-term market interest rates at the extremely low levels of the previous three years and initiated further actions to move intermediate-
and longer-term rates even lower in 2011. Despite the pressure from lower market interest rates, our loan yields were only modestly lower at
5.59% for the year ended December 31, 2011 compared to 5.70% in the preceding year largely because of a decrease in the amount of non-
performing loans. Average loans receivable for the year ended December 31, 2011 decreased $310 million, or 9%, to $3.298 billion, compared
to $3.607 billion for the prior year. Interest income on loans decreased by $21.4 million, or 10%, to $184.4 million for the year from $205.8
million for the year ended December 31, 2010, reflecting the decreased average balance and the lower average yield on loans.
The combined average balance of mortgage-backed securities, investment securities, daily interest-bearing deposits and FHLB stock increased
by $77 million (excluding the effect of fair value adjustments) for the year ended December 31, 2011, and the interest and dividend income from
those investments increased by $908,000 compared to the prior year. The effect of the increased average balance was nearly offset as the average
yield on the securities portfolio and cash equivalents decreased to 1.72% for the year ended December 31, 2011, from 1.78% one year earlier.
The modest decrease in the combined yield on those investments, despite declining market interest rates, reflects a change in the mix to include
lower balances of daily interest-bearing deposits and more investment securities, primarily U.S. Government Agency securities, which helped
to offset the adverse impact of lower market rates.
Interest Expense. Interest expense for the year ended December 31, 2011 was $33.0 million, compared to $60.3 million for the prior year, a
decrease of $27.3 million, or 45%. The sharp decline in interest expense occurred as a result of a 59 basis point decrease in the average cost of
all interest-bearing liabilities to 0.87% for the year ended December 31, 2011, from 1.46% one year earlier, and a $317 million, or 8%, decrease
in average interest-bearing liabilities. The decrease in average interest-bearing balances reflects a substantial decrease in the average balance
of certificates of deposit, as well as a decrease in FHLB advances and other borrowings, which were only partially offset by increases in transaction
and savings accounts.
Deposit interest expense decreased $26.1 million, or 50%, to $26.2 million for the year ended December 31, 2011 compared to $52.3 million
for the prior year as a result of a 64 basis point decrease in the cost of deposits despite a $258 million decrease in the average balance of deposits.
Average deposit balances decreased to $3.510 billion for the year ended December 31, 2011, from $3.769 billion for the year ended December
31, 2010, while the average rate paid on deposit balances decreased to 0.75% in 2011 from 1.39% for the prior year. Deposit costs are significantly
affected by changes in the level of market interest rates; however, changes in the average rate paid for interest-bearing deposits frequently tend
to be less severe and to lag changes in market interest rates. In addition, non-interest-bearing deposits dampen the effect of changes in market
rates on our aggregate cost of deposits. This lower degree of volatility and lag effect for deposit pricing have been evident in the continuing
decrease in deposit costs as the Federal Reserve pursued policies beginning in 2007 first to aggressively lower short-term interest rates and
subsequently to maintain the very low level of interest rates. Furthermore, competitive pricing pressure for interest-bearing deposits was quite
intense for certain periods two to three years earlier, as many financial institutions experienced increased liquidity concerns in the deteriorating
economic conditions. However, as market rates remained low for an extended period, competitors' liquidity strains were generally mitigated
and certificates of deposit issued at those times reached maturity, we experienced significantly declining deposit costs during 2009, 2010 and
69
2011. Further, changes in our deposit mix, reflecting growth in lower cost transaction and savings accounts as a result of our branch network
continuing to mature and the successful execution of targeted marketing strategies, also meaningfully contributed to the decrease in funding
costs.
Average FHLB advances (excluding the effect of fair value adjustments) decreased to $15 million for the year ended December 31, 2011,
compared to $51 million for the prior year. The decline in outstanding FHLB advances was primarily responsible for a $948,000 decrease in
the related interest expense as the average rate paid on FHLB advances remained nearly unchanged for the years ended December 31, 2011 and
2010 at 2.52% and 2.56%, respectively.
The average balance for other borrowings, consisting of customer retail repurchase agreements and senior bank notes, was $154 million for the
year ended December 31, 2011, a decrease of $22 million compared to the prior year, while the related interest expense for other borrowings
decreased by $183,000 to $2.3 million for the year ended December 31, 2011, from $2.4 million one year earlier. All of the decrease in average
balance and interest expense was related to the retail repurchase agreements, as there was no change in the senior bank notes during the year
ended December 31, 2011. As a result, the average rate paid on other borrowings increased eight basis points to 1.47% for the year ended
December 31, 2011, compared to 1.39% one year earlier.
Junior subordinated debentures had an average balance (excluding the effect of fair value adjustments) of $124 million for both the years ended
December 31, 2011 and 2010. The average rate decreased slightly to 3.39% for 2011 compared to 3.42% for 2010. With one exception, these
junior subordinated debentures were adjustable-rate instruments with repricing frequencies of three months based upon the three-month LIBOR
index. The slightly lower average cost of the junior subordinated debentures in 2011 reflects the relatively minor difference in the average three-
month Libor rate for the two-year period.
Provision and Allowance for Loan Losses. During the year ended December 31, 2011, the provision for loan losses was $35.0 million, compared
to $70.0 million for the year ended December 31, 2010. While our provision for loan losses was substantially less in the year ended December
31, 2011 than in 2010, it remained elevated in relation to historical loss rates prior to the economic downturn in response to still high levels of
delinquencies, non-performing assets and net charge-offs as well as declining property values during the year. However, all of our asset quality
indicators improved significantly throughout 2011, allowing us to decrease the level of provisioning as the year progressed and compared to the
prior year. Although the provision for loan losses for the year ended December 31, 2011 continued to largely reflect material levels of delinquencies
and net charge-offs for construction, land and land development loans, our exposure to these types of loans was further reduced during 2011 as
problem asset resolutions occurred. The provision and allowance for loan losses also continued to reflect our concerns that the significant number
of distressed sellers in the market and additional expected lender foreclosures might further disrupt certain housing markets and adversely affect
home prices and the demand for building lots. Aside from housing-related construction and development loans, non-performing loans often
reflect unique operating difficulties for the individual borrower; however, the weak pace of general economic activity and declining commercial
real estate values significantly contributed to defaults in other non-housing-related segments of the portfolio.
We recorded net charge-offs of $49 million for the year ended December 31, 2011, compared to $68 million for the prior year, and non-performing
loans decreased by $76 million during the year to $75 million at December 31, 2011, compared to $151 million at December, 31, 2010. A
comparison of the allowance for loan losses at December 31, 2011 and 2010 reflected a decrease of $14 million, or 15%, to $83 million at
December 31, 2011, from $97 million at December 31, 2010. The allowance for loan losses as a percentage of total loans (loans receivable
excluding allowance for losses) decreased to 2.52% at December 31, 2011, compared to 2.86% at December 31, 2010. However, as a result of
the reduction in problem loans, the allowance as a percentage of non-performing loans increased to 110% at December 31, 2011, compared to
64% a year earlier.
Other Operating Income. Other operating income, which includes changes in the valuation of financial instruments carried at fair value as
well as non-interest revenues from core operations, increased $4.9 million to $34.0 million for the year ended December 31, 2011, compared to
$29.1 million for the year ended December 31, 2010. This increase was primarily due to a $3.0 million recovery of a security that had been
written off as an OTTI charge in the prior year, which was partially offset by a $2.4 million unfavorable variance in net fair value adjustments
compared to the prior year. Excluding fair value and OTTI adjustments, other operating income from core operations remained essentially
unchanged at $31.6 million for the years ended December 31, 2011 and 2010, as increased deposit fees and other service charges were offset by
decreased revenues from mortgage banking activity. Primarily as a result of growth in our customer base, income from deposit fees and other
service charges increased by $953,000, or approximately 4%, to $23.0 million for the year ended December 31, 2011, compared to $22.0 million
for the prior year. While our mortgage banking activity increased in the second half of 2011, gain on sale of loans decreased by $1.2 million to
$5.2 million for the full year ended December 31, 2011, compared to $6.4 million in the prior year. Loan sales for the year ended December
31, 2011 totaled $282 million, compared to $351 million for the year ended December 31, 2010. Loan servicing fee income increased $127,000
compared to the prior year, reflecting an increase in the balance of loans serviced for others. Miscellaneous revenues also increased modestly,
largely as a result of increased fees associated with interest rate swaps which were partially offset by lower returns on bank-owned life insurance.
For the year ended December 31, 2011, we recorded a net charge of $624,000 for changes in the valuation of financial instruments carried at
fair value, compared to a net gain of $1.7 million for the year ended December 31, 2010. The adjustments in 2011 primarily reflect changes in
the valuation of the junior subordinated debentures we have issued, which resulted in $1.6 million in charges that were partially offset by net
gains in the values of certain investment securities. The net fair value gain in 2010 was largely a result of the impact of lower market interest
rates on the valuation of certain fixed-rate securities. Additionally, in 2011, we had a $3.0 million recovery as a result of the full cash repayment
of a trust preferred security issued by a commercial bank that had been written off in 2010. For the year ended December 31, 2010, we had total
OTTI charges of $4.2 million, while in 2011 we did not experience any OTTI charges.
70
Other Operating Expenses. Other operating expenses for the year ended December 31, 2011 totaled $158.1 million compared to $160.8 million
in 2010, a decrease of $2.7 million, or 2%, compared to the prior year, largely as a result of decreased costs related to REO and FDIC deposit
insurance which were partially offset by increased compensation expenses. While lower in 2011 than in 2010, both years' expenses reflect
significant charges related to REO operations, including holding costs, losses on sales and valuation adjustments on foreclosed properties. Total
REO expenses were $22.3 million, including $16.4 million of losses and valuation adjustments, for the year ended December 31, 2011, compared
to $26.0 million, including $17.0 million of losses and valuation adjustments, for the year ended December 31, 2010. Importantly, however,
our total REO was reduced by nearly $58 million during 2011 to $43 million at December 31, 2011, compared to $101 million a year earlier.
The cost of FDIC insurance decreased by $2.6 million in 2011, compared to the prior year, largely because of changes in the assessment formula
mandated in the Dodd-Frank Act. Compensation increased $5.0 million to $72.5 million for the year ended December 31, 2011 from $67.5
million for the year ended December 31, 2010, primarily reflecting changes in salary levels and benefit costs. The increase in compensation
costs was partially offset by an $800,000 increase in the amount of the credit for capitalized loan origination costs as a result of increased new
loan originations and a $671,000 reduction in occupancy and equipment expenses as a result of lower equipment and software depreciation and
charges. Payment and card processing expenses increased by $807,000, primarily reflecting the increased number of transaction accounts and
increased customer usage of debit and credit cards. All other expenses were only modestly changed from the prior year.
Income Taxes. Our normal, expected statutory income tax rate is 36.4%, representing a blend of the statutory federal income tax rate of 35.0%
and apportioned effects of the Oregon and Idaho income tax rates of 6.6% and 7.6%, respectively. However, because of the full valuation
allowance for our net deferred tax asset, there was no net provision for income taxes for the year ended December 31, 2011, although our pre-
tax net income was $5.5 million. For the year ended December 31, 2010, as a result of establishing the deferred tax valuation allowance, we
recorded a net provision for income taxes of $18.0 million despite having a pre-tax loss of $43.9 million, which resulted in an effective tax rate
of negative 41.0%.
During 2010, we determined that it was prudent to provide a full valuation allowance against our net deferred tax asset. Reasons for the
determination included the negative evidence of three years of cumulative losses, the modest pace of economic recovery, and the continued
difficulty in segments of the loan portfolio that put a near-term return to profitability in question. A valuation allowance was established during
2010 against the entire net deferred tax asset, reducing the balance, net of the allowance, to zero. The valuation allowance was subsequently
adjusted going forward for any changes in the net deferred tax asset, and the balance of our deferred tax asset, net of the allowance, continued
to remain at zero on our balance sheet throughout 2011. For more information on deferred taxes, see Note 13 of the Notes to the Consolidated
Financial Statements.
Market Risk and Asset/Liability Management
Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates
as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent to a large extent on our net interest income,
which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing
liabilities.
Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in
market interest rates will have an adverse impact on the institution’s earnings and underlying economic value. Interest rate risk is determined
by the maturity and repricing characteristics of an institution’s assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured
by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market
risk affecting our financial performance.
The greatest source of interest rate risk to us results from the mismatch of maturities or repricing intervals for rate sensitive assets, liabilities
and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing
liabilities than interest-earning assets, although our floating-rate assets tend to be more immediately responsive to changes in market rates than
most funding deposit liabilities. Additional interest rate risk results from mismatched repricing indices and formula (basis risk and yield curve
risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that
are generally more favorable to customers than to us. An exception to this generalization is the beneficial effect of interest rate floors on a
substantial portion of our performing floating-rate loans, which help us maintain higher loan yields in periods when market interest rates decline
significantly. However, in a declining interest rate environment, as loans with floors are repaid they generally are replaced with new loans which
have lower interest rate floors. As of December 31, 2012, our loans with interest rate floors totaled approximately $1.5 billion and had a weighted
average floor rate of 5.08%. An additional source of interest rate risk, which is currently of concern, is a prolonged period of exceptionally low
market interest rates. Because interest-bearing deposit costs have been reduced to nominal levels, there is very little possibility that they will
be significantly further reduced. By contrast, if market rates remain very low, loan and securities yields will likely continue to decline as longer-
term instruments mature or are repaid. Further, non-interest-bearing deposits provide a meaningful portion of our funding. As a result, a prolonged
period of very low interest rates will likely result in compression of our net interest margin. While this pressure on the margin may be mitigated
by further changes in the mix of assets and deposits, particularly increases in non-interest-bearing deposits, a prolonged period of low interest
rates will present a very difficult operating environment for most banks, including us.
The principal objectives of asset/liability management are: to evaluate the interest rate risk exposure; to determine the level of risk appropriate
given our operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability
allocation alternatives; and to manage our interest rate risk consistent with regulatory guidelines and policies approved by the Board of
Directors. Through such management, we seek to reduce the vulnerability of our earnings and capital position to changes in the level of interest
rates. Our actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members
71
of our senior management. The Committee closely monitors our interest sensitivity exposure, asset and liability allocation decisions, liquidity
and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources
to maximize earnings within acceptable risk tolerances.
Sensitivity Analysis
Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of
balance sheet, interest rate and spread movements and to quantify variations in net interest income resulting from those movements under different
rate environments. The sensitivity of net interest income to changes in the modeled interest rate environments provides a measurement of interest
rate risk. We also utilize economic value analysis, which addresses changes in estimated net economic value of equity arising from changes in
the level of interest rates. The net economic value of equity is estimated by separately valuing our assets and liabilities under varying interest
rate environments. The extent to which assets gain or lose value in relation to the gains or losses of liability values under the various interest
rate assumptions determines the sensitivity of net economic value to changes in interest rates and provides an additional measure of interest rate
risk.
The interest rate sensitivity analysis performed by us incorporates beginning-of-the-period rate, balance and maturity data, using various levels
of aggregation of that data, as well as certain assumptions concerning the maturity, repricing, amortization and prepayment characteristics of
loans and other interest-earning assets and the repricing and withdrawal of deposits and other interest-bearing liabilities into an asset/liability
computer simulation model. We update and prepare simulation modeling at least quarterly for review by senior management and the directors.
We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate
scenarios. Nonetheless, the interest rate sensitivity of our net interest income and net economic value of equity could vary substantially if
different assumptions were used or if actual experience differs from the assumptions used.
The following table sets forth as of December 31, 2012 and 2011, the estimated changes in our net interest income over a one-year time horizon
and the estimated changes in economic value of equity based on the indicated interest rate environments (dollars in thousands):
Table 23: Interest Rate Risk Indicators
Change (in Basis Points) in Interest Rates (1)
Net Interest Income
Next 12 Months
Economic Value of Equity
December 31, 2012
Estimated Increase (Decrease) in
+400
+300
+200
+100
0
-25
Change (in Basis Points) in Interest Rates (1)
+400
+300
+200
+100
0
-25
$
$
(608)
(485)
(348)
(888)
—
(27)
(0.4)% $
(0.3)
(0.2)
(0.5)
—
—
(163,443)
(118,067)
(76,879)
(36,029)
—
3,193
(26.9)%
(19.4)
(12.7)
(5.9)
—
0.5
December 31, 2011
Estimated Increase (Decrease) in
Net Interest Income
Next 12 Months
Economic Value of Equity
(227)
537
1,150
1,218
—
(207)
(0.1)% $
0.3
0.7
0.7
—
(0.1)
(153,297)
(106,609)
(64,836)
(23,991)
—
1,400
(25.0)%
(17.4)
(10.6)
(3.9)
—
0.2
(1) Assumes an instantaneous and sustained uniform change in market interest rates at all maturities; however, no rates are allowed to go
below zero. The current federal funds rate is 0.25%.
Another (although less reliable) monitoring tool for assessing interest rate risk is gap analysis. The matching of the repricing characteristics of
assets and liabilities may be analyzed by examining the extent to which assets and liabilities are interest sensitive and by monitoring an institution’s
interest sensitivity gap. An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that
time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon
certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or
reprice, based upon certain assumptions, within that same time period. A gap is considered positive when the amount of interest-sensitive assets
72
exceeds the amount of interest-sensitive liabilities. A gap is considered negative when the amount of interest-sensitive liabilities exceeds the
amount of interest-sensitive assets. Generally, during a period of rising rates, a negative gap would tend to adversely affect net interest income
while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would
tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.
Certain shortcomings are inherent in gap analysis. For example, although certain assets and liabilities may have similar maturities or periods
of repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain
assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the
event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating
the table. Finally, the ability of some borrowers to service their debt may decrease in the event of a severe change in market rates.
Table 24, Interest Sensitivity Gap, presents our interest sensitivity gap between interest-earning assets and interest-bearing liabilities at
December 31, 2012 and 2011. The tables set forth the amounts of interest-earning assets and interest-bearing liabilities which are anticipated
by us, based upon certain assumptions, to reprice or mature in each of the future periods shown. At December 31, 2012, total interest-earning
assets maturing or repricing within one year exceeded total interest-bearing liabilities maturing or repricing in the same time period by $470.5
million, representing a one-year cumulative gap to total assets ratio of 11.03%.
Management is aware of the sources of interest rate risk and in its opinion actively monitors and manages it to the extent possible. The interest
rate risk indicators and interest sensitivity gaps as of December 31, 2012 and 2011 are within our internal policy guidelines and management
considers that our current level of interest rate risk is reasonable.
73
The following tables provide a GAP analysis as of December 31, 2012 and 2011 (dollars in thousands):
Table 24: Interest Sensitivity Gap
Interest-earning assets: (1)
Construction loans
Fixed-rate mortgage loans
Adjustable-rate mortgage loans
Fixed-rate mortgage-backed securities
Adjustable-rate mortgage-backed securities
Fixed-rate commercial/agricultural loans
Adjustable-rate commercial/agricultural loans
Consumer and other loans
Investment securities and interest-earning deposits
Total rate sensitive assets
Interest-bearing liabilities: (2)
Within
6 Months
After 6
Months
Within 1 Year
After 1 Year
Within 3
Years
After 3 Years
Within 5
Years
After 5 Years
Within 10
Years
Over
10 Years
December 31, 2012
$
$
165,905
151,588
424,937
33,360
1,574
48,658
508,340
170,879
240,794
$
10,984
94,294
136,720
29,831
3,376
34,237
12,270
14,357
33,840
$
21,430
241,811
321,554
98,904
—
79,089
37,324
35,701
63,488
$
4,933
135,813
259,410
68,115
—
35,713
15,905
21,450
31,626
$
2,102
155,118
12,622
28,972
—
7,732
24
19,110
62,954
39
60,460
—
25,776
—
126
—
1,181
63,681
$
Total
205,393
839,084
1,155,243
284,958
4,950
205,555
573,863
262,678
496,383
1,746,035
369,909
899,301
572,965
288,634
151,263
4,028,107
Regular savings and interest-bearing checking accounts
Money market deposit accounts
Certificates of deposit
FHLB advances
Trust preferred securities
Retail repurchase agreements
187,258
204,499
453,519
10,000
123,716
76,634
167,884
122,699
299,246
—
—
—
391,730
81,800
216,651
—
—
—
391,730
—
56,352
—
—
—
Total rate sensitive liabilities
1,055,626
589,829
690,181
448,082
—
—
3,490
—
—
—
3,490
—
—
34
—
—
—
34
1,138,602
408,998
1,029,292
10,000
123,716
76,634
2,787,242
Excess (deficiency) of interest-sensitive assets over interest-sensitive
liabilities
Cumulative excess (deficiency) of interest-sensitive assets
$
$
690,409
$ (219,920)
690,409
$
470,489
$
$
209,120
679,609
$
$
124,883
$
285,144
$
151,229
$ 1,240,865
804,492
$ 1,089,636
$ 1,240,865
$ 1,240,865
Cumulative ratio of interest-earning assets to interest-bearing liabilities
165.40%
128.59 %
129.10%
128.90%
139.09%
144.52%
144.52%
Interest sensitivity gap to total assets
16.19%
(5.16)%
4.90%
2.93%
6.68%
3.55%
29.09%
Ratio of cumulative gap to total assets
16.19%
11.03 %
15.93%
18.86%
25.54%
29.09%
29.09%
(footnotes follow)
74
Table 24: Interest Sensitivity Gap (continued)
Interest-earning assets: (1)
Construction loans
Fixed-rate mortgage loans
Adjustable-rate mortgage loans
Fixed-rate mortgage-backed securities
Adjustable-rate mortgage-backed securities
Fixed-rate commercial/agricultural loans
Adjustable-rate commercial/agricultural loans
Consumer and other loans
Investment securities and interest-earning deposits
Total rate sensitive assets
Interest-bearing liabilities: (2)
Regular savings and interest-bearing checking accounts
Money market deposit accounts
Certificates of deposit
FHLB advances
Other borrowings
Trust preferred securities
Retail repurchase agreements
Within
6 Months
After 6
Months
Within 1 Year
After 1 Year
Within 3
Years
December 31, 2011
After 3 Years
Within 5
Years
After 5 Years
Within 10
Years
Over
10 Years
$
167,009
158,622
398,999
19,084
1,409
82,787
483,640
161,976
306,433
$
9,624
95,103
140,517
15,570
573
33,377
18,628
13,388
149,956
$
21,206
309,196
394,604
41,066
4,808
78,773
36,131
39,505
55,225
$
2,728
158,238
183,712
22,042
—
19,826
14,960
18,441
19,773
$
$
1,161
172,391
(1,232)
14,736
—
231
739
19,292
37,881
41
67,471
—
1,803
—
—
—
1,538
64,066
$
Total
201,769
961,021
1,116,600
114,301
6,790
214,994
554,098
254,140
633,334
1,779,959
476,736
980,514
439,720
245,199
134,919
4,057,047
172,355
207,728
534,399
—
50,000
123,716
102,131
151,726
124,637
430,674
—
—
—
—
354,028
83,091
221,332
10,000
—
—
—
354,028
—
60,865
—
—
—
—
—
—
3,208
—
—
—
—
3,208
—
—
18
—
(3)
—
—
15
1,032,137
415,456
1,250,496
10,000
49,997
123,716
102,131
2,983,933
Total rate sensitive liabilities
1,190,329
707,037
668,451
414,893
Excess (deficiency) of interest-sensitive assets over interest-sensitive
liabilities
Cumulative excess (deficiency) of interest-sensitive assets
$
$
589,630
$ (230,301)
589,630
$
359,329
$
$
312,063
671,392
$
$
24,827
696,219
$
$
241,991
$
134,904
$ 1,073,114
938,210
$ 1,073,114
$ 1,073,114
Cumulative ratio of interest-earning assets to interest-bearing liabilities
149.54%
118.94 %
126.17%
123.36%
131.44%
135.96%
135.96%
Interest sensitivity gap to total assets
13.85%
(5.41)%
7.33%
0.58%
5.68%
3.17%
25.21%
Ratio of cumulative gap to total assets
13.85%
8.44 %
15.77%
16.35%
22.04%
25.21%
25.21%
(footnotes follow)
75
(1) Adjustable-rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which
they are due to mature, and fixed-rate assets are included in the period in which they are scheduled to be repaid based upon scheduled
amortization, in each case adjusted to take into account estimated prepayments. Mortgage loans and other loans are not reduced for
allowances for loan losses and non-performing loans. Mortgage loans, mortgage-backed securities, other loans and investment securities
are not adjusted for deferred fees and unamortized acquisition premiums and discounts.
(2) Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are
due to mature. Although regular savings, demand, interest-bearing checking, and money market deposit accounts are subject to immediate
withdrawal, based on historical experience management considers a substantial amount of such accounts to be core deposits having
significantly longer maturities. For the purpose of the gap analysis, these accounts have been assigned decay rates to reflect their longer
effective maturities. If all of these accounts had been assumed to be short-term, the one-year cumulative gap of interest-sensitive assets
would have been $(394.8) million, or (9.3%) of total assets at December 31, 2012, and $(431.8) million, or (10.1%), at December 31,
2011. Interest-bearing liabilities for this table exclude certain non-interest-bearing deposits that are included in the average balance
calculations reflected in Table 19, Analysis of Net Interest Spread.
Liquidity and Capital Resources
Our primary sources of funds are deposits, borrowings, proceeds from loan principal and interest payments and sales of loans, and the maturity
of and interest income on mortgage-backed and investment securities. While maturities and scheduled amortization of loans and mortgage-
backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates,
economic conditions, competition and our pricing strategies.
Our primary investing activity is the origination and purchase of loans and, to a lesser extent, the purchase of securities. During the years ended
December 31, 2012, 2011 and 2010, we purchased loans of $5 million, $5 million and $341,000, respectively, while loan originations, net of
repayments, totaled $460 million, $270 million and $114 million, respectively. This activity was funded primarily by sales of loans. During
the years ended December 31, 2012, 2011 and 2010, we sold $505 million, $282 million, and $351 million, respectively, of loans. During the
year ended December 31, 2012, deposits increased by $82 million, despite a $221 million decline in certificates of deposit, while during the
years ended December 31, 2011 and 2010, deposits decreased by $116 million and $274 million, respectively. The increase in deposits in 2012
was the result of our increased marketing focus on retail deposits and our success in growing the number and dollar volume of core deposit
accounts. The decrease in deposits in the two previous years and in certificates of deposit in 2012 was driven by our pricing decisions designed
to shift our deposit portfolio into lower cost checking, savings and money market accounts, and allow higher rate certificates of deposit to run-
off. Additionally, during 2012 we further reduced brokered deposits by $33 million to just $16 million at December 31, 2012. Brokered deposits
and public funds are generally more price sensitive than retail deposits and our use of those deposits varies significantly based upon our liquidity
management strategies at any point in time. FHLB advances (excluding fair value adjustments) decreased $229,000, $33 million, and $146
million, respectively, for the years ended December 31, 2012, 2011 and 2010. Other borrowings at December 31, 2012 decreased $75 million
to $77 million following a decrease of $24 million in 2011 and a decrease of $1 million in 2010. The decrease in other borrowings in the year
ended December 31, 2012 was due to the $50 million repayment of the senior bank notes issued under the TLGP and a decrease of $25 million
of retail repurchase agreements.
We must maintain an adequate level of liquidity to ensure the availability of sufficient funds to accommodate deposit withdrawals, to support
loan growth, to satisfy financial commitments and to take advantage of investment opportunities. During the years ended December 31, 2012,
2011 and 2010, we used our sources of funds primarily to fund loan commitments, purchase securities, add to our short-term liquidity position
and pay maturing savings certificates and deposit withdrawals. At December 31, 2012, we had outstanding loan commitments totaling $1.014
billion, including undisbursed loans in process and unused credit lines totaling $925 million. While representing potential growth in the loan
portfolio and lending activities, this level of commitments is proportionally consistent with our historical experience and does not represent a
departure from normal operations.
We generally maintain sufficient cash and readily marketable securities to meet short-term liquidity needs; however, our primary liquidity
management practice is to increase or decrease short-term borrowings, including FHLB advances and Federal Reserve Board borrowings. We
maintain credit facilities with the FHLB-Seattle, which at December 31, 2012 provide for advances that in the aggregate may equal the lesser
of 35% of Banner Bank’s assets or adjusted qualifying collateral (subject to a sufficient level of ownership of FHLB stock), up to a total possible
credit line of $889 million, and 25% of Islanders Bank’s assets or adjusted qualifying collateral, up to a total possible credit line of $26
million. Advances under these credit facilities (excluding fair value adjustments) totaled $10 million, or less than 1% of our assets at December 31,
2012. In addition, Banner Bank has been approved for participation in the Federal Reserve Bank’s Borrower-In-Custody (BIC) program. Under
this program Banner Bank can borrow from 57% up to 91% of eligible loans, depending on collateral type and risk rating. We currently estimate
the Federal Reserve’s BIC program would provide additional borrowing capacity of $595 million. We had no funds borrowed from the Federal
Reserve Bank at December 31, 2012 or 2011.
At December 31, 2012, certificates of deposit amounted to $1.029 billion, or 29% of our total deposits, including $760 million which were
scheduled to mature within one year. Certificates of deposit declined from 36% of our total deposits at December 31, 2011, and 43% of total
deposits at December 31, 2010, reflecting our efforts to shift the portfolio mix into lower cost core deposits. While no assurance can be given
as to future periods, historically, we have been able to retain a significant amount of our deposits as they mature, although in 2012 and 2011 we
intentionally encouraged certificates of deposit to decline. Management believes it has adequate resources and funding potential to meet our
foreseeable liquidity requirements.
76
In addition to the trust preferred securities we issued, our capital base is primarily comprised of common stock and paid in capital, which were
reduced by an accumulated deficit largely as a result of goodwill impairment charges recorded in 2008 and net losses in 2009 and 2010. During
2008, we received $124 million when we issued our Series A Preferred Stock and a related warrant to the Treasury through its Capital Purchase
Program. The Series A Preferred Stock was repaid during 2012 and the warrant to purchase up to $18.6 million in Banner Corporation common
stock remains outstanding at December 31, 2012. During 2010, the Company completed a secondary offering of its common stock, resulting
in net proceeds of $162 million. (For additional information see Notes 2 and 17 of the Notes to the Consolidated Financial Statements.) In
addition, during the years ended December 31, 2012, 2011 and 2010, we issued shares of common stock through our DRIP, which resulted in
net proceeds of $36 million, $22 million and $16 million, respectively. Banner Corporation has allocated a significant portion of these net
proceeds to strengthen Banner Bank’s regulatory capital ratios; however, at December 31, 2012, Banner Corporation had retained $37 million
in cash to be used for general corporate purposes.
Capital Requirements
Banner Corporation is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy
requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal
Reserve. Banner Bank and Islanders Bank, as state-chartered, federally insured commercial banks, are subject to the capital requirements
established by the FDIC. The capital adequacy requirements are quantitative measures established by regulation that require Banner Corporation
and the Banks to maintain minimum amounts and ratios of capital. The Federal Reserve requires Banner Corporation to maintain capital adequacy
that generally parallels the FDIC requirements. The FDIC requires the Banks to maintain minimum ratios of Tier 1 total capital to risk-weighted
assets as well as Tier 1 leverage capital to average assets. At December 31, 2012, Banner Corporation and the Banks each exceeded all current
regulatory capital requirements. (See Item 1, “Business–Regulation,” and Note 18 of the Notes to the Consolidated Financial Statements for
additional information regarding Banner Corporation’s and Banner Bank’s regulatory capital requirements.)
The following table shows the regulatory capital ratios of Banner Corporation and its subsidiaries, Banner Bank and Islanders Bank, as of
December 31, 2012, and minimum regulatory requirements for the Banks to be categorized as “well-capitalized.”
Table 25: Regulatory Capital Ratios
Capital Ratios
Banner Corporation
Banner Bank
Islanders Bank
“Well-Capitalized”
Minimum Ratio (1)
Total capital to risk-weighted assets
Tier 1 capital to risk-weighted assets
Tier 1 leverage capital to average assets
16.96%
15.70
12.74
16.38%
15.12
12.29
17.53%
16.28
13.02
10.00%
6.00
5.00
(1) A bank holding company such as Banner Corporation does not have a “Well-capitalized” measurement. “Well-capitalized” only applies
to the Banks.
Effect of Inflation and Changing Prices
The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance with accounting principles
generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical
dollars, without considering the changes in relative purchasing power of money over time due to inflation. The primary effect of inflation on
our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial
institution are monetary in nature. As a result, interest rates generally have a more significant effect on a financial institution’s performance
than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and
services.
The following table shows the obligations of Banner Corporation and its subsidiaries, Banner Bank and Islanders Bank, as of December 31,
2012 by maturity (in thousands):
Table 26: Contractual Obligations
Due In One
Year Or Less
Due In One
to Three
Years
Due In Three
To Five Years
Due In More
Than Five
Years
Advances from Federal Home Loan Bank
Junior subordinated debentures
Retail repurchase agreements
Operating lease obligations
Purchase obligation
$
$
10,000
—
76,633
6,827
5,304
— $
—
—
9,892
8,551
— $
—
—
5,195
2,070
$
210
123,716
—
9,400
—
Total
10,210
123,716
76,633
31,314
15,925
Total
$
98,764
$
18,443
$
7,265
$
133,326
$
257,798
77
At December 31, 2012, we had commitments to extend credit of $1.014 billion. In addition, we have contracts with various vendors to provide
services, including information processing, for periods generally ranging from one to five years, for which our financial obligations are dependent
upon acceptable performance by the vendor. For additional information regarding future financial commitments, this discussion should be read
in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this filing, including Note 27: “Financial
Instruments with Off-Balance-Sheet Risk.”
ITEM 7A – Quantitative and Qualitative Disclosures about Market Risk
See pages 71-76 of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 8 – Financial Statements and Supplementary Data
For financial statements, see index on page 82.
ITEM 9 – Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
ITEM 9A – Controls and Procedures
The management of Banner Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, as
such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (Exchange Act). A control procedure, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Also, because of the inherent limitations in all
control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the
Company have been detected. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply
its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls
and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design
will succeed in achieving its stated goals under all potential future conditions. As a result of these inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Further, projections of any evaluation of effectiveness to future periods are subject
to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures
may deteriorate.
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e)
of the Exchange Act) was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer
and several other members of our senior management as of the end of the period covered by this report. Based on their evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that, as of December 31, 2012, our disclosure controls and procedures were effective
in ensuring that the information required to be disclosed by us in the reports it files or submits under the Exchange Act is (i) accumulated and
communicated to our management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
(b) Changes in Internal Controls Over Financial Reporting: In the quarter ended December 31, 2012, there was no change in our internal
control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Annual Report on Internal Control over Financial Reporting: Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we
included a report of management’s assessment of the design and effectiveness of its internal controls as part of this Annual Report on Form 10-
K for the year ended December 31, 2012.
ITEM 9B – Other Information
None.
78
ITEM 10 – Directors, Executive Officers and Corporate Governance
PART III
The information required by this item contained under the section captioned “Proposal – Election of Directors,” “Meetings and Committees of
the Board of Directors” and “Shareholder Proposals” in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with
the Securities and Exchange Commission no later than 120 days after the end of our fiscal year, is incorporated herein by reference.
Information regarding the executive officers of the Registrant is provided herein in Part I, Item 1 hereof.
The information regarding our Audit Committee and Financial Expert included under the sections captioned “Meetings and Committees of the
Board of Directors” and “Audit Committee Matters” in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with
the Securities and Exchange Commission no later than 120 days after the end of our fiscal year, is incorporated herein by reference.
Reference is made to the cover page of this Annual Report and the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance”
of the Proxy Statement for the Annual Meeting of the Stockholders, which will be filed with the Securities and Exchange Commission no later
than 120 days after the end of our fiscal year, regarding compliance with Section 16(a) of the Securities Exchange Act of 1934.
Code of Ethics
The Board of Directors adopted a Code of Business Conduct and Ethics for our officers (including its senior financial officers), directors, and
employees. The Code of Business Conduct and Ethics requires our officers, directors, and employees to maintain the highest standards of
professional conduct. A copy of the Code of Business Conduct and Ethics was filed as an exhibit to our Annual Report on Form 10-K for the
year ended December 31, 2004 and is available without charge, upon request to Investor Relations, Banner Corporation, P.O. Box 907, Walla
Walla, WA 99362.
Whistleblower Program and Protections
We subscribe to the Ethicspoint reporting system and encourage employees, customers, and vendors to call the Ethicspoint hotline at 1-866-
ETHICSP (384-4277) or visit its website at www.Ethicspoint.com to report any concerns regarding financial statement disclosures, accounting,
internal controls, or auditing matters. We will not retaliate against any of our officers or employees who raise legitimate concerns or questions
about an ethics matter or a suspected accounting, internal control, financial reporting, or auditing discrepancy or otherwise assists in investigations
regarding conduct that the employee reasonably believes to be a violation of Federal Securities Laws or any rule or regulation of the Securities
Exchange Commission, Federal Securities Laws relating to fraud against shareholders or violations of applicable banking laws. Non-retaliation
against employees is fundamental to our Code of Ethics and there are strong legal protections for those who, in good faith, raise an ethical
concern or a complaint about their employer.
ITEM 11 – Executive Compensation
Information required by this item regarding management compensation and employment contracts, director compensation, and Compensation
Committee interlocks and insider participation in compensation decisions is incorporated by reference to the sections captioned “Executive
Compensation,” “Directors’ Compensation,” and “Compensation Committee Matters,” respectively, in the Proxy Statement for the Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal
year.
ITEM 12 – Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item is incorporated herein by reference to the section captioned “Proposal 5 – Approval of an amendment to the
Banner Corporation 2012 Restricted Stock Plan” in the Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the
Securities and Exchange Commission no later than 120 days after the end of our fiscal year.
ITEM 13 – Certain Relationships and Related Transactions, and Director Independence
The information required by this item contained under the sections captioned “Related Party Transactions” and “Director Independence” in the
Proxy Statement for the Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120
days after the end of our fiscal year, is incorporated herein by reference.
ITEM 14 – Principal Accounting Fees and Services
The information required by this item contained under the section captioned “Independent Auditors” in the Proxy Statement for the Annual
Meeting of Stockholders, which will be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal
year, is incorporated herein by reference.
79
ITEM 15 – Exhibits and Financial Statement Schedules
PART IV
(a)
(1)
(2)
(3)
Financial Statements
See Index to Consolidated Financial Statements on page 82.
Financial Statement Schedules
All financial statement schedules are omitted because they are not applicable or not required, or because
the required information is included in the Consolidated Financial Statements or the Notes thereto or
in Part 1, Item 1.
Exhibits
See Index of Exhibits on page 152.
(b)
Exhibits
See Index of Exhibits on page 152.
80
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 14, 2013
Banner Corporation
/s/ Mark J. Grescovich
Mark J. Grescovich
President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
/s/ Mark J. Grescovich
Mark J. Grescovich
President and Chief Executive Officer; Director
(Principal Executive Officer)
/s/ Lloyd W. Baker
Lloyd W. Baker
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: March 14, 2013
/s/ Robert J. Lane
Robert J. Lane
Director
Date: March 14, 2013
/s/ Edward L. Epstein
Edward L. Epstein
Director
Date: March 14, 2013
/s/ Gary Sirmon
Gary Sirmon
Chairman of the Board
Date: March 14, 2013
/s/ Brent A. Orrico
Brent A. Orrico
Director
Date: March 14, 2013
/s/ Michael M. Smith
Michael M. Smith
Director
Date: March 14, 2013
/s/ Constance H. Kravas
Constance H. Kravas
Director
Date: March 14, 2013
Date: March 14, 2013
/s/ Robert D. Adams
Robert D. Adams
Director
Date: March 14, 2013
/s/ Jesse G. Foster
Jesse G. Foster
Director
Date: March 14, 2013
/s/ D. Michael Jones
D. Michael Jones
Former President and Chief Executive Officer; Director
Date: March 14, 2013
/s/ Gordon E. Budke
Gordon E. Budke
Director
Date: March 14, 2013
/s/ David A. Klaue
David A. Klaue
Director
Date: March 14, 2013
/s/ John R. Layman
John R. Layman
Director
Date: March 14, 2013
81
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
BANNER CORPORATION AND SUBSIDIARIES
(Item 8 and Item 15(a)(1))
Report of Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management Report on Internal Control Over Financial Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Financial Condition as of December 31, 2012 and 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011 and 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2012, 2011 and 2010. . . . . . . . . . . . . . . .
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2012, 2011 and 2010 . . . . . . . . . . . . . .
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Page
83
83
84
85
86
87
88
92
94
82
March 14, 2013
Report of Management
To the Shareholders:
The management of Banner Corporation (the Company) is responsible for the preparation, integrity, and fair presentation of its published financial
statements and all other information presented in this annual report. The financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America and, as such, include amounts based on informed judgments and estimates made
by management. In the opinion of management, the financial statements and other information herein present fairly the financial condition and
operations of the Company at the dates indicated in conformity with accounting principles generally accepted in the United States of America.
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting. The internal control
system is augmented by written policies and procedures and by audits performed by an internal audit staff (assisted in certain instances by
contracted external audit resources other than the independent registered public accounting firm), which reports to the Audit Committee of the
Board of Directors. Internal auditors monitor the operation of the internal and external control system and report findings to management and
the Audit Committee. When appropriate, corrective actions are taken to address identified control deficiencies and other opportunities for
improving the system. The Audit Committee provides oversight to the financial reporting process. There are inherent limitations in the
effectiveness of any system of internal control, including the possibility of human error and circumvention or overriding of controls. Accordingly,
even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because
of changes in conditions, the effectiveness of an internal control system may vary over time.
The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of the Company’s management. The
Audit Committee is responsible for the selection of the independent auditors. It meets periodically with management, the independent auditors
and the internal auditors to ensure that they are carrying out their responsibilities. The Committee is also responsible for performing an oversight
role by reviewing and monitoring the financial, accounting, and auditing procedures of the Company in addition to reviewing the Company’s
financial reports. The independent auditors and the internal auditors have full and free access to the Audit Committee, with or without the
presence of management, to discuss the adequacy of the internal control structure for financial reporting and any other matters which they believe
should be brought to the attention of the Committee.
Mark J. Grescovich, Chief Executive Officer
Lloyd W. Baker, Chief Financial Officer
Management Report on Internal Control over Financial Reporting
March 14, 2013
The management of Banner Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, as
such term is defined in Exchange Act Rule 13a-15(f).
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems,
no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding
controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial
statement preparation. Also, projection of any evaluation of effectiveness to future periods is subject to risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management with the participation of the Chief Executive Officer and Chief Financial Officer assessed the effectiveness of Banner Corporation’s
internal control over financial reporting as of December 31, 2012. In making this assessment, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework.
Based on its assessment, Management concluded that Banner Corporation maintained effective internal control over financial reporting as of
December 31, 2012.
The Company’s registered public accounting firm has audited the Company’s consolidated financial statements and the effectiveness of our
internal control over financial reporting as of and for the year ended December 31, 2012 that are included in this annual report and issued their
Report of Independent Registered Public Accounting Firm, appearing under Item 8. The attestation report expresses an unqualified opinion on
the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2012.
83
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Banner Corporation and Subsidiaries
Walla Walla, Washington
We have audited the accompanying consolidated statements of financial condition of Banner Corporation and subsidiaries, (the "Company") as
of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’
equity, and cash flows for each of the three years in the period ended December 31, 2012. We also have audited the Company’s internal control
over financial reporting as of December 31, 2012, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal Control - Integrated Framework. The Company's management is responsible for these consolidated financial
statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over
financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on these consolidated financial statements and an opinion on the Company's internal control over financial reporting based
on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated
financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements,
assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that
our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A
company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors
of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition
of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position
of Banner Corporation and subsidiaries, as of December 31, 2012 and 2011, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 2012, in conformity with generally accepted accounting principles. Also in our
opinion, Banner Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December
31, 2012, based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control
- Integrated Framework.
/s/Moss Adams LLP
Moss Adams LLP
Portland, Oregon
March 14, 2013
84
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except shares)
December 31, 2012 and 2011
ASSETS
Cash and due from banks
Securities—trading, amortized cost $90,339 and $112,663, respectively
Securities—available-for-sale, amortized cost $469,650 and $462,579, respectively
Securities—held-to-maturity, fair value $92,458 and $80,107, respectively
Federal Home Loan Bank stock
Loans receivable:
Held for sale
Held for portfolio
Allowance for loan losses
Accrued interest receivable
Real estate owned, held for sale, net
Property and equipment, net
Intangible assets, net
Bank-owned life insurance (BOLI)
Deferred tax assets, net
Other assets
LIABILITIES
Deposits:
Non-interest-bearing
Interest-bearing transactions and savings accounts
Interest-bearing certificates
Advances from FHLB at fair value
Other borrowings
Junior subordinated debentures at fair value (issued in connection with Trust Preferred Securities)
Accrued expenses and other liabilities
Deferred compensation
COMMITMENTS AND CONTINGENCIES (Notes 19 and 27)
STOCKHOLDERS’ EQUITY
Preferred stock - $0.01 par value, 500,000 shares authorized;
Series A – liquidation preference $1,000 per share, no shares outstanding at December 31, 2012 and
124,000 outstanding at December 31, 2011
Common stock and paid in capital - $0.01 par value per share, 50,000,000 shares authorized, 19,454,965
shares issued: 19,420,625 shares and 17,519,132 shares outstanding at December 31, 2012 and 2011,
respectively
Accumulated deficit
Accumulated other comprehensive income
Unearned shares of common stock issued to Employee Stock Ownership Plan (ESOP) trust at cost:
34,340 restricted shares outstanding at December 31, 2012 and 2011
Carrying value of shares held in trust for stock related compensation plans
Liability for common stock issued to deferred, stock related, compensation plans
See notes to consolidated financial statements
85
2012
2011
$
181,298
$
132,436
71,232
472,920
86,452
36,705
11,920
3,223,794
(77,491)
3,158,223
13,930
15,778
89,117
4,230
59,891
35,007
40,781
80,727
465,795
75,438
37,371
3,007
3,293,331
(82,912)
3,213,426
15,570
42,965
91,435
6,331
58,563
—
37,255
$
$
4,265,564
$
4,257,312
$
981,240
1,547,271
1,029,293
3,557,804
10,304
76,633
73,063
26,389
14,452
3,758,645
777,563
1,447,594
1,250,497
3,475,654
10,533
152,128
49,988
23,253
13,306
3,724,862
—
120,702
567,907
(61,102)
2,101
(1,987)
(7,242)
7,242
506,919
531,149
(119,465)
2,051
(1,987)
(7,715)
7,715
532,450
$
4,265,564
$
4,257,312
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except for per share data)
For the Years Ended December 31, 2012, 2011 and 2010
2012
2011
2010
INTEREST INCOME:
Loans receivable
Mortgage-backed securities
Securities and cash equivalents
INTEREST EXPENSE:
Deposits
FHLB advances
Other borrowings
Junior subordinated debentures
Net interest income before provision for loan losses
PROVISION FOR LOAN LOSSES
Net interest income
OTHER OPERATING INCOME:
Deposit fees and other service charges
Mortgage banking operations
Loan servicing fees, net of amortization and impairment
Miscellaneous
Gain on sale of securities
Other-than-temporary impairment recovery (loss)
Net change in valuation of financial instruments carried at fair value
Total other operating income
OTHER OPERATING EXPENSES:
Salary and employee benefits
Less capitalized loan origination costs
Occupancy and equipment
Information/computer data services
Payment and card processing expenses
Professional services
Advertising and marketing
Deposit Insurance
State/municipal business and use taxes
REO operations
Amortization of core deposit intangibles
Miscellaneous
Total other operating expenses
Income (loss) before provision for (benefit from) income taxes
PROVISION FOR (BENEFIT FROM) INCOME TAXES
NET INCOME (LOSS)
PREFERRED STOCK DIVIDEND AND DISCOUNT ACCRETION
Preferred stock dividend
Preferred stock discount accretion
Gain on repurchase of preferred stock
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
Earnings (loss) per common share
Basic
Diluted
Cumulative dividends declared per common share
$
$
$
$
$
174,322
4,176
8,664
187,162
15,107
254
758
3,395
19,514
167,648
13,000
154,648
25,266
12,940
872
4,697
43,775
51
(409)
(16,515)
26,902
78,696
(10,404)
21,812
6,904
8,604
4,411
7,215
3,685
2,289
3,354
2,092
12,795
141,453
40,097
(24,785)
64,882
4,938
3,298
(2,471)
59,117
3.17
3.16
0.04
$
$
184,357
3,455
9,751
197,563
26,164
370
2,265
4,193
32,992
164,571
35,000
129,571
22,962
5,068
1,078
2,506
31,614
—
3,000
(624)
33,990
72,499
(8,001)
21,561
6,023
7,874
6,017
7,281
6,024
2,153
22,262
2,276
12,135
158,104
5,457
—
5,457
6,200
1,701
—
205,784
4,045
8,253
218,082
52,320
1,318
2,448
4,226
60,312
157,770
70,000
87,770
22,009
6,370
951
2,302
31,632
—
(4,231)
1,747
29,148
67,490
(7,199)
22,232
6,132
7,067
6,401
7,457
8,622
2,259
26,025
2,459
11,856
160,801
(43,883)
18,013
(61,896)
6,200
1,593
—
$
$
$
$
(2,444) $
(69,689)
(0.15) $
(0.15) $
$
0.10
(7.21)
(7.21)
0.28
See notes to the consolidated financial statements
86
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
For the Years Ended December 31, 2012, 2011 and 2010
2012
2011
2010
NET INCOME (LOSS)
$
64,882
$
5,457
$
(61,896)
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES:
Unrealized holding gain on AFS securities arising during the period
Income tax expense related to AFS unrealized holding gains
Reclassification for net (gains) losses on AFS securities realized in earnings
Income tax benefit (expense) related to AFS realized gains (losses)
Amortization of unrealized gain on tax exempt securities transferred from available-
for-sale to held-to-maturity
Other comprehensive income
28
(10)
38
(14)
8
50
2,638
(950)
(5)
2
16
1,701
56
(20)
36
(13)
42
101
COMPREHENSIVE INCOME (LOSS)
$
64,932
$
7,158
$
(61,795)
See notes to the consolidated financial statements
87
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands)
For the Years Ended December 31, 2012, 2011 and 2010
Preferred
Stock
Common
Stock and
Paid in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income (Loss)
Unearned
Restricted ESOP
Shares
Carrying Value, Net
of Liability, Of
Shares Held in Trust
for Stock-Related
Compensation Plans
Stockholders’
Equity
Balance, January 1, 2012
$
120,702
$
531,149
$
(119,465) $
2,051
$
(1,987) $
— $
532,450
Net income (loss)
Change in valuation of securities—available-for-sale, net
of income tax
Amortization of unrealized loss on tax exempt securities
transferred from available-for-sale to held-to-maturity,
net of income tax
Accretion of preferred stock discount
Repurchase of preferred stock
Gain on repurchase of preferred stock
Accrual of dividends on preferred stock
Accrual of dividends on common stock ($.04/share-
cumulative)
Proceeds from issuance of common stock for stockholder
reinvestment program, net of registration expenses
Amortization of compensation related to restricted stock
grant
Amortization of compensation related to stock options
3,298
(124,000)
36,317
434
7
42
8
64,882
(3,298)
2,471
(4,938)
(754)
64,882
42
8
—
(124,000)
2,471
(4,938)
(754)
36,317
434
7
BALANCE, December 31, 2012
$
— $
567,907
$
(61,102) $
2,101
$
(1,987) $
— $
506,919
Continued
88
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands)
For the Years Ended December 31, 2012, 2011 and 2010
Balance, January 1, 2011
$
119,000
$
509,457
$
(115,348) $
350
$
(1,987) $
— $
511,472
Preferred
Stock
Common
Stock and
Paid in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income (Loss)
Unearned
Restricted ESOP
Shares
Carrying Value, Net
of Liability, Of
Shares Held in Trust
for Stock-Related
Compensation Plans
Stockholders’
Equity
Net income (loss)
Change in valuation of securities-available-for-sale, net of
income tax
Amortization of unrealized loss on tax exempt securities
transferred from available-for-sale to held-to-maturity,
net of income tax
Accretion of preferred stock discount
1,701
Accrual of dividends on preferred stock
Accrual of dividends on common stock ($.10/share
cumulative)
Proceeds from issuance of common stock for stockholder
reinvestment program, net of registration expenses
Amortization of compensation related to restricted stock
grant
Amortization of compensation related to stock options
Other
1
21,556
111
25
1,685
16
5,457
(1,701)
(6,200)
(1,673)
5,457
1,685
16
—
(6,200)
(1,673)
21,556
111
25
1
BALANCE, December 31, 2011
$
120,702
$
531,149
$
(119,465) $
2,051
$
(1,987) $
— $
532,450
Continued
89
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands)
For the Years Ended December 31, 2012, 2011 and 2010
Balance, January 1, 2010
$
117,407
$
331,538
$
(42,077) $
249
$
(1,987) $
(2) $
405,128
Preferred
Stock
Common
Stock and
Paid in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income (Loss)
Unearned
Restricted ESOP
Shares
Carrying Value, Net
of Liability, Of
Shares Held in Trust
for Stock-Related
Compensation Plans
Stockholders’
Equity
Net income (loss)
(61,896)
59
42
(1,593)
(6,200)
(3,582)
Change in valuation of securities—available-for-sale, net of
income tax
Amortization of unrealized loss on tax exempt securities
transferred from available-for-sale to held-to-maturity,
net of income tax
Accretion of preferred stock discount
1,593
Accrual of dividends on preferred stock
Accrual of dividends on common stock ($.28/share
cumulative)
Proceeds from issuance of common stock for stockholder
reinvestment program, net of registration expenses
Proceeds from issuance of common stock, net of offering
costs
Amortization of compensation related to MRP
Amortization of compensation related to restricted stock
grant
Amortization of compensation related to stock options
16,201
161,637
28
53
(61,896)
59
42
—
(6,200)
(3,582)
16,201
161,637
2
28
53
2
BALANCE, December 31, 2010
$
119,000
$
509,457
$
(115,348) $
350
$
(1,987) $
— $
511,472
90
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(continued) (in thousands)
For the Years Ended December 31, 2012, 2011 and 2010
2012
2011
2010
COMMON STOCK—SHARES ISSUED
Common stock, shares issued, beginning of period
17,553
16,165
Issuance of unvested restricted common stock or exercise of stock options
Issuance of common stock for stockholder reinvestment program
Issuance of common stock through public offering
Net number of shares issued during the period
87
1,815
—
1,902
16
1,372
—
1,388
COMMON SHARES ISSUED, END OF PERIOD
19,455
17,553
3,077
17
837
12,234
13,088
16,165
UNEARNED, RESTRICTED ESOP SHARES
(34)
(34)
(34)
NET COMMON STOCK—SHARES OUTSTANDING
19,421
17,519
16,131
See notes to consolidated financial statements
91
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Years Ended December 31, 2012, 2011 and 2010
2012
2011
2010
$
64,882
$
5,457
$
(61,896)
OPERATING ACTIVITIES:
Net income (loss)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation
Deferred income and expense, net of amortization
Amortization of core deposit intangibles
Other-than-temporary impairment losses (recovery)
Net change in valuation of financial instruments carried at fair value
Purchases of securities—trading
Proceeds from sales of securities—trading
Principal repayments and maturities of securities—trading
Deferred taxes
Increase in current taxes payable
Equity-based compensation
Increase in cash surrender value of bank-owned life insurance
Gain on sale of loans, net of capitalized servicing rights
(Gain) Loss on disposal of real estate held for sale and property and equipment
Provision for losses on loans and real estate held for sale
Origination of loans held for sale
Proceeds from sales of loans held for sale
Net change in:
Other assets
Other liabilities
Net cash provided from operating activities
INVESTING ACTIVITIES:
Purchases of available-for-sale securities
Principal repayments and maturities of available-for-sale securities
Proceeds from sales of securities available-for-sale
Purchases of securities held-to-maturity
Principal repayments and maturities of securities held-to-maturity
Principal repayments of loans, net of originations
Purchases of loans and participating interest in loans
Purchases of property and equipment, net of sales
Proceeds from sale of real estate held for sale, net
Other
Net cash provided from (used by) investing activities
FINANCING ACTIVITIES
Increase (decrease) in deposits, net
Repayment of FHLB advances
Decrease in other borrowings, net
Cash dividends paid
Cash proceeds from issuance of stock for stockholder reinvestment plan
Cash proceeds from issuance of stock in secondary offering, net of costs
Redemption of preferred stock
Net cash used by financing activities
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS
CASH AND DUE FROM BANKS, BEGINNING OF YEAR
CASH AND DUE FROM BANKS, END OF YEAR
$
(Continued on next page)
92
7,788
2,864
2,092
409
16,515
(5,408)
5,073
15,880
(35,007)
1,089
440
(2,554)
(10,154)
(4,614)
18,178
(503,492)
504,734
(869)
3,569
81,415
(413,482)
389,414
13,282
(23,007)
11,806
55,763
(18,410)
(5,613)
40,834
1,892
52,479
82,150
(6)
(75,495)
(6,470)
36,317
—
(121,528)
(85,032)
48,862
132,436
181,298
$
8,593
1,645
2,276
(3,000)
624
—
—
15,409
—
—
136
(1,910)
(3,226)
1,465
50,064
(278,733)
282,444
17,965
2,104
101,313
(622,192)
328,037
28,179
(12,480)
12,074
9,125
(5,092)
(3,587)
94,957
(234)
(171,213)
(115,544)
(32,806)
(23,695)
(8,827)
21,556
—
—
(159,316)
(229,216)
361,652
132,436
$
9,208
103
2,459
4,231
(1,747)
(3,266)
—
55,427
14,988
—
83
(2,057)
(4,634)
1,917
85,096
(349,975)
350,980
15,622
(2,020)
114,519
(238,499)
131,900
1,965
(8,727)
8,416
235,847
(341)
(2,167)
47,809
(149)
176,054
(274,352)
(145,506)
(1,039)
(8,867)
16,201
161,637
—
(251,926)
38,647
323,005
361,652
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2012, 2011 and 2010
(in thousands)
(continued from prior page)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid in cash
Taxes paid (received) in cash
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
2012
2011
2010
$
20,712
$
35,114
$
9,631
(13,048)
64,112
(592)
Loans, net of discounts, specific loss allowances and unearned income transferred to
real estate owned and other repossessed assets
14,070
53,518
87,967
See notes to consolidated financial statements
93
BANNER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business: Banner Corporation (Banner or the Company) is a bank holding company incorporated in the State of Washington. The
Company is primarily engaged in the business of planning, directing and coordinating the business activities of two wholly-owned subsidiaries,
Banner Bank and, subsequent to May 1, 2007, Islanders Bank. Banner Bank is a Washington-chartered commercial bank that conducts business
from its main office in Walla Walla, Washington and, as of December 31, 2012, its 85 branch offices and seven loan production offices located
in Washington, Oregon and Idaho. Islanders Bank is also a Washington-chartered commercial bank that conducts business from three locations
in San Juan County, Washington. Banner Corporation is subject to regulation by the Board of Governors of the Federal Reserve System. Banner
Bank and Islanders Bank (the Banks) are subject to regulation by the Washington State Department of Financial Institutions, Division of Banks
(DFI) and the Federal Deposit Insurance Corporation (the FDIC).
The Company’s operating results depend primarily on its net interest income, which is the difference between interest income on interest-earning
assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of customer deposits,
Federal Home Loan Bank (FHLB) advances, other borrowings and junior subordinated debentures. Net income also is affected by the level of
the Company’s other operating income, including deposit fees and service charges, loan origination and servicing fees, and gains and losses on
the sale of loans and securities, as well as non-interest operating expenses, provisions for loan losses and income tax provisions. In addition,
net income is affected by the net change in the value of certain financial instruments carried at fair value. During the three-year period ended
December 31, 2012, the Company’s net income was significantly impacted by high levels of provisions for loan losses, expenses related to real
estate owned, net changes in the value of financial instruments carried at fair value, and the provision for, and benefit from, income taxes as a
result of establishing and eliminated a valuation allowance for its net deferred tax assets.
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All
material intercompany transactions, profits and balances have been eliminated.
Subsequent events: The Company has evaluated events and transactions subsequent to December 31, 2012 for potential recognition or
disclosure.
Use of Estimates: In the opinion of management, the accompanying consolidated statements of financial condition and related consolidated
statements of operations, comprehensive income (loss), changes in stockholders’ equity and cash flows reflect all adjustments (which include
reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with U.S. Generally Accepted
Accounting Principles (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and
assumptions that affect amounts reported in the financial statements. Various elements of the Company’s accounting policies, by their nature,
are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified
several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of
Banner’s financial statements. These policies relate to (i) the methodology for the recognition of interest income, (ii) determination of the
provision and allowance for loan and lease losses, (iii) the valuation of financial assets and liabilities recorded at fair value, including other-
than-temporary impairment (OTTI) losses, (iv) the valuation of intangibles, such as core deposit intangibles and mortgage servicing rights, (v)
the valuation of real estate held for sale and (vi) the valuation of or recognition of deferred tax assets and liabilities. These policies and judgments,
estimates and assumptions are described in greater detail in subsequent notes to the consolidated financial statements and Management’s
Discussion and Analysis of Financial Condition and Results of Operations (Critical Accounting Policies) in this Annual Report on Form 10-K
for the year ended December 31, 2012 filed with the Securities and Exchange Commission (SEC). Management believes that the judgments,
estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the
time. However, given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and
assumptions could result in material differences in the Company’s results of operations or financial condition. Further, subsequent changes in
economic or market conditions could have a material impact on these estimates and the Company’s financial condition and operating results in
future periods.
Securities: Securities are classified as held-to-maturity when the Company has the ability and positive intent to hold them to maturity. Securities
classified as available-for-sale are available for future liquidity requirements and may be sold prior to maturity. Securities classified as trading
are also available for future liquidity requirements and may be sold prior to maturity. Purchase premiums and discounts are recognized in interest
income using the interest method over the terms of the securities. Securities classified as held-to-maturity are carried at cost, adjusted for
amortization of premiums and accretion of discounts to maturity and, if appropriate, any other-than-temporary impairment losses. Securities
classified as available-for-sale are recorded at fair value. Unrealized gains and losses on securities classified as available-for-sale are excluded
from earnings and are reported net of tax as accumulated other comprehensive income, a component of stockholders’ equity, until
realized. Securities classified as trading are also recorded at fair value. Unrealized holding gains and losses on securities classified as trading
are included in earnings. (See Note 22 for a more complete discussion of accounting for the fair value of financial instruments.) Declines in
the fair value of securities below their cost that are deemed to be other-than-temporary are recognized in earnings as realized losses. Realized
gains and losses on sale are computed on the specific identification method and are included in earnings on the trade date sold.
We review investment securities on an ongoing basis for the presence of OTTI or permanent impairment, taking into consideration current market
conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether we intend
94
to sell a security or if it is likely that we will be required to sell the security before recovery of our amortized cost basis of the investment, which
may be maturity, and other factors.
For debt securities, if the Company intends to sell the security or it is likely that the Company will be required to sell the security before recovering
its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and
it is not likely that the Company will be required to sell the security but the Company does not expect to recover the entire amortized cost basis
of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security
is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash
flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI.
The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and
fair value, is recognized as a charge to other comprehensive income (OCI). Impairment losses related to all other factors are presented as separate
categories within OCI. For investment securities transferred from held-to-maturity to available-for-sale, this amount is accreted from the time
of transfer over the remaining life of the debt security based on the amount and timing of future estimated cash flows. The accretion of the
amount recorded in OCI increases the carrying value of the investment and does not affect earnings. If there is an indication of additional credit
losses, the security is re-evaluated according to the procedures described above.
Investment in FHLB Stock: At December 31, 2012, the Company had recorded $36.7 million in FHLB stock, compared to $37.4 million at
December 31, 2011. The Banks' investments in FHLB stock are generally viewed as a long-term investment and are carried at par value ($100
per share), which reasonably approximates its fair value. It does not have a readily determinable fair value. Ownership of FHLB stock is restricted
to the FHLB and member institutions and can only be purchased and redeemed at par. As members of the FHLB system, the Banks are required
to maintain a minimum level of investment in FHLB stock based on specific percentages of their outstanding FHLB advances. For the years
ended December 31, 2012, 2011 and 2010, the Banks did not receive any dividend income on FHLB stock.
Management periodically evaluates FHLB stock for impairment. Management's determination of whether these investments are impaired is
based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of
whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of
the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the
FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB,
(3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position
of the FHLB.
The Seattle FHLB announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (the FHFA),
its primary regulator, as of December 31, 2008, and that it would suspend future dividends and the repurchase and redemption of outstanding
common stock. The FHLB of Seattle announced September 7, 2012 that the FHFA now considers the FHLB of Seattle to be adequately capitalized.
Dividends on, or repurchases of, the FHLB of Seattle stock continue to require consent of the FHFA. The FHFA subsequently approved the
repurchase of portions of FHLB of Seattle stock, and as of December 31, 2012, the FHLB had repurchased $665,900 of the Banks' stock. The
Company will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of Banner's
investment. Based on the above, the Company has determined there is not any impairment on the FHLB stock investment as of December 31,
2012.
Loans Receivable: The Banks originate residential mortgage loans for both portfolio investment and sale in the secondary market. At the time
of origination, mortgage loans are designated as held for sale or held for investment. Loans held for sale are stated at lower of cost or estimated
market value determined on an aggregate basis. Net unrealized losses on loans held for sale are recognized through a valuation allowance by
charges to income. The Banks also originate construction and land development, commercial and multifamily real estate, commercial business,
agricultural and consumer loans for portfolio investment. Loans receivable not designated as held for sale are recorded at the principal amount
outstanding, net of allowance for loan losses, deferred fees, discounts and premiums. Premiums, discounts and deferred loan fees are amortized
to maturity using the level-yield methodology.
Some of the Company’s loans are reported as troubled debt restructures (TDRs). Loans are reported as restructured when the Bank grants a
concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include
forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available
for a transaction of similar risk. As a result of these concessions, loans identified as TDRs are impaired as the Bank will not collect all amounts
due, both principal and interest, in accordance with the terms of the original loan agreement. TDRs are accounted for in accordance with the
Banks’ impaired loan accounting policies.
Income Recognition on Nonaccrual and Impaired Loans: Interest on loans and securities is accrued as earned unless management doubts the
collectability of the asset or the unpaid interest. Interest accruals on loans are generally discontinued when loans become 90 days past due for
payment of interest and the loans are then placed on nonaccrual status. All previously accrued but uncollected interest is deducted from interest
income upon transfer to nonaccrual status. For any future payments collected, interest income is recognized only upon management’s assessment
that there is a strong likelihood that the full amount of a loan will be repaid or recovered. A loan may be put on nonaccrual status sooner than
this policy would dictate if, in management’s judgment, the interest may be uncollectable. While less common, similar interest reversal and
nonaccrual treatment is applied to investment securities if their ultimate collectability becomes questionable.
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Provision and Allowance for Loan Losses: The provision for loan losses reflects the amount required to maintain the allowance for losses at an
appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves. The Company maintains an
allowance for loan losses consistent in all material respects with generally accepted accounting principles. The Company has established
systematic methodologies for the determination of the adequacy of the Company’s allowance for loan losses. The methodologies are set forth
in a formal policy and take into consideration the need for a general valuation allowance as well as specific allowances that are tied to individual
problem loans. The Company increases its allowance for loan losses by charging provisions for probable loan losses against its income and
values impaired loans consistent with accounting guidelines.
The allowance for losses on loans is maintained at a level sufficient to provide for estimated losses based on evaluating known and inherent
risks in the loan portfolio and upon the Company’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors
include, among others, changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience, current and
anticipated economic conditions, detailed analysis of individual loans for which full collectability may not be assured, and determination of the
existence and realizable value of the collateral and guarantees securing the loans. Realized losses related to specific assets are applied as a
reduction of the carrying value of the assets and charged immediately against the allowance for loan loss reserve. Recoveries on previously
charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by Banner at the time financial statements
are prepared. Although the Company uses the best information available, future adjustments to the allowance may be necessary due to economic,
operating, regulatory and other conditions beyond the Company’s control. The adequacy of general and specific reserves is based on a continuing
evaluation of the pertinent factors underlying the quality of the loan portfolio as well as individual review of certain large balance loans. Large
groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment
include residential real estate and consumer loans and, as appropriate, smaller balance non-homogeneous loans. Larger balance non-homogeneous
residential construction and land, commercial real estate, commercial business loans and unsecured loans are individually evaluated for
impairment. Loans are considered impaired when, based on current information and events, the Company determines that it is probable that it
will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment
include, but are not limited to, the financial condition of the borrower, the value of the underlying collateral and the current status of the
economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate
or, as a practical expedient, at the loan’s observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent
changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was
recognized or as a reduction in the provision that would otherwise be reported.
The Company’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific
allowances, an allocated formula allowance and an unallocated allowance. Losses on specific loans are provided for when the losses are probable
and estimable. General loan loss reserves are established to provide for inherent loan portfolio risks not specifically provided for. The level of
general reserves is based on analysis of potential exposures existing in Banner’s loan portfolio including evaluation of historical trends, current
market conditions and other relevant factors identified by us at the time the financial statements are prepared. The formula allowance is calculated
by applying loss factors to outstanding loans, excluding those loans that are subject to individual analysis for specific allowances. Loss factors
are based on the Company’s historical loss experience adjusted for significant environmental considerations, including the experience of other
banking organizations, which in the judgment of management affects the collectability of the portfolio as of the evaluation date. The unallocated
allowance is based upon the Company’s evaluation of various factors that are not directly measured in the determination of the formula and
specific allowances.
While the Company believes the estimates and assumptions used in Banner’s determination of the adequacy of the allowance are reasonable,
there can be no assurance that such estimates and assumptions will not be proved incorrect in the future, or that the actual amount of future
provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact the
financial condition and results of operations of the Company. In addition, the determination of the amount of the Banks’ allowance for loan
losses is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based
upon their judgment of information available to them at the time of their examination.
Loan Origination and Commitment Fees: Loan origination fees, net of certain specifically defined direct loan origination costs, are deferred
and recognized as an adjustment of the loans’ interest yield using the level-yield method over the contractual term of each loan adjusted for
actual loan prepayment experience. Net deferred fees or costs related to loans held for sale are recognized in income at the time the loans are
sold. Loan commitment fees are deferred until the expiration of the commitment period unless management believes there is a remote likelihood
that the underlying commitment will be exercised, in which case the fees are amortized to fee income using the straight-line method over the
commitment period. If a loan commitment is exercised, the deferred commitment fee is accounted for in the same manner as a loan origination
fee. Deferred commitment fees associated with expired commitments are recognized as fee income.
Real Estate Held for Sale: Property acquired by foreclosure or deed in lieu of foreclosure is recorded at the lower of the estimated fair value of
the property, less expected selling costs, or the carrying value of the defaulted loan. Development and improvement costs relating to the property
are capitalized while direct holding costs are expensed. The carrying value of the property is periodically evaluated by management and, if
necessary, allowances are established to reduce the carrying value to net realizable value. Gains or losses at the time the property is sold are
charged or credited to operations in the period in which they are realized. The amounts the Banks will ultimately recover from real estate held
for sale may differ substantially from the carrying value of the assets because of market factors beyond the Banks’ control or because of changes
in the Banks’ strategies for recovering the investment.
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Property and Equipment: The provision for depreciation is based upon the straight-line method applied to individual assets and groups of assets
acquired in the same year at rates adequate to charge off the related costs over their estimated useful lives:
Buildings and leased improvements
Furniture and equipment
10-30 years
3-10 years
Routine maintenance, repairs and replacement costs are expensed as incurred. Expenditures which significantly increase values or extend useful
lives are capitalized. The Company reviews buildings, leasehold improvements and equipment for impairment whenever events or changes in
circumstances indicate that the undiscounted cash flows for the property are less than its carrying value. If identified, an impairment loss is
recognized through a charge to earnings based on the fair value of the property.
Other Intangible Assets: Other intangible assets consist primarily of core deposit intangibles (CDI), which are amounts recorded in business
combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the customer relationships
associated with the deposits. Core deposit intangibles are being amortized on an accelerated basis over a weighted average estimated useful life
of eight years. These assets are reviewed at least annually for events or circumstances that could impact their recoverability. These events could
include loss of the underlying core deposits, increased competition or adverse changes in the economy. To the extent other identifiable intangible
assets are deemed unrecoverable, impairment losses are recorded in other non-interest expense to reduce the carrying amount of the assets.
Mortgage Servicing Rights: Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of
loans. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage loans, the value of the servicing
right is estimated and capitalized. Fair value is based on market prices for comparable mortgage servicing contracts. Capitalized servicing rights
are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing
income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined
by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, balance outstanding, loan type, age and remaining
term, and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less
than the capitalized amount for the tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular
tranche, a reduction of the allowance may be recorded as an increase to income.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal
or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing
fee income.
Bank-Owned Life Insurance (BOLI): The Banks have purchased, or acquired through mergers, life insurance policies in connection with the
implementation of certain executive supplemental income, salary continuation and deferred compensation retirement plans. These policies
provide protection against the adverse financial effects that could result from the death of a key employee and provide tax-exempt income to
offset expenses associated with the plans. It is the Banks’ intent to hold these policies as a long-term investment; however, there may be an
income tax impact if the Bank chooses to surrender certain policies. Although the lives of individual current or former management-level
employees are insured, the Banks are the respective owners and sole or partial beneficiaries. At December 31, 2012 and 2011, the cash surrender
value of these policies was $59.9 million and $58.6 million, respectively.
Derivative Instruments: Derivatives include “off-balance-sheet” financial products, the value of which is dependent on the value of underlying
financial assets, such as stock, bonds, foreign currency, or a reference rate or index. Such derivatives include “forwards,” “futures,” “options”
or “swaps.” As a result of the 2007 acquisition of F&M Bank, we became a party to approximately $23 million ($16 million as of December 31,
2012) in notional amounts of interest rate swaps. These swaps serve as hedges to an equal amount of fixed rate loans which include market
value prepayment penalties that mirror the provision of the specifically matched interest rate swaps. In addition, in 2011 we began actively
marketing interest rate swaps to certain loan customers in connection with longer-term floating rate loans, allowing them to effectively fix their
loan interest rates. These customer swaps are matched with third party swaps with qualified broker/dealer or banks to offset the risk. As of
December 31, 2012, we had $95 million in notional amounts of these customer interest rate swaps outstanding, with an equal amount of offsetting
third party swaps also in place. The fair value adjustments for these swaps and the related loans are reflected in other assets or other liabilities
as appropriate, and in the carrying value of the hedged loans.
Further, as a part of mortgage banking activities, we issue “rate lock” commitments to borrowers and obtain offsetting “best efforts” delivery
commitments from purchasers of loans. We also use forward contracts for the sale of mortgage-backed securities and mandatory delivery
commitments for the sale of loans to hedge "rate lock" commitments. We enter into forward delivery contracts to sell residential mortgage loans
to secondary market investors (i.e., Freddie Mac or Fannie Mae or others) at specific prices and dates in order to hedge the interest rate risk in
their portfolios of mortgage loans held for sale and their residential mortgage loan commitments. The commitments to originate mortgage loans
held for sale and the related delivery contracts are considered derivatives. The Company recognizes all derivatives as either assets or liabilities
in the balance sheet and requires measurement of those instruments at fair value through adjustments to accumulated other comprehensive income
and/or current earnings, as appropriate. None of these residential mortgage loan related derivatives are designated as hedging instruments for
accounting purposes. Rather, they are accounted for as free-standing derivatives, or economic hedges, and the Company reports changes in fair
values of its derivatives in current period net income. The fair value of the derivative loan commitments is estimated using the present value of
expected future cash flows. Assumptions used include rate assumptions based on historical information, current mortgage interest rates, the
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stage of completion of the underlying application and underwriting process, the time remaining until the expiration of the derivative loan
commitment, and the expected net future cash flows related to the associated servicing of the loan.
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control
over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Banks, (2) the transferee obtains the right
(free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Banks do not
maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Advertising Expenses: Advertising costs are expensed as incurred. Costs related to production of advertising are considered incurred when the
advertising is first used.
Income Taxes: The Company files a consolidated income tax return including all of its wholly-owned subsidiaries on a calendar year
basis. Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined
based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax bases of
existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax
rates is recognized in income in the period of change. A valuation allowance is recognized as a reduction to deferred tax assets when management
determines it is more likely than not that deferred tax assets will not be available to offset future income tax liabilities.
Accounting standards for income taxes prescribe a recognition threshold and measurement process for financial statement recognition and
measurement of uncertain tax positions taken or expected to be taken in a tax return, and also provides guidance on the de-recognition of
previously recorded benefits and their classification, as well as the proper recording of interest and penalties, accounting in interim periods,
disclosures and transition. The Company periodically reviews its income tax positions based on tax laws and regulations and financial reporting
considerations, and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations
of the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment.
As of December 31, 2012, the Company had an insignificant amount of unrecognized tax benefits for uncertain tax positions, none of which
would materially affect the effective tax rate if recognized. The Company does not anticipate that the amount of unrecognized tax benefits will
significantly increase or decrease in the next twelve months. The Company’s policy is to recognize interest and penalties on unrecognized tax
benefits in the income tax expense. The amount of interest and penalties accrued for the years ended December 31, 2012 and 2011 is
immaterial. The Company files consolidated income tax returns in Oregon and Idaho and for federal purposes. The tax years which remain
subject to examination by the taxing authorities are the years ended December 31, 2011, 2010, 2009 and 2008.
Employee Stock Ownership Plan: The Company loaned the Employee Stock Ownership Plan (ESOP) the funds necessary to fund the purchase
of 8% of the common stock sold in the Company’s initial public offering of common stock. The loan to the ESOP is repaid principally from the
Company’s contribution to the ESOP, and the collateral for the loan is the Company’s common stock purchased by the ESOP. However, the
Company has not made a contribution since 2007. Annually, in consultation with the Company’s directors, the ESOP’s trustees determine if a
contribution will be made and whether it will be used to make a payment on the loan or purchase shares in the open market. When the contribution
is used to repay debt, shares are released from collateral based on the proportion of debt service paid in the year and allocated to participants’
accounts. When shares are released from collateral, compensation expense is recorded equal to the average current market price of the shares,
and the shares become outstanding for earnings-per-share calculations. When the contribution is used to purchase shares in the open market,
compensation expense is recorded in the amount of the contribution. Stock and cash dividends on allocated shares are recorded as a reduction
of retained earnings and paid or distributed directly to participants’ accounts. Dividends on unallocated shares are used to fund a portion of the
Company’s contribution to the ESOP (see additional discussion in Note 15).
Share-Based Compensation: At December 31, 2012, the Company had the following stock-based employee/director compensation plans: three
stock option plans (the 1996 Stock Option Plan, the 1998 Stock Option Plan and the 2001 Stock Option Plan), the 2012 Restricted Stock Plan
and the Banner Corporation Long-Term Incentive Plan. In addition, in 2011 and 2010, the Company made restricted stock grants to Mark
Grescovich, President and CEO of Banner Bank and Banner Corporation, in accordance with his employment agreement. The restricted grants
value shares awarded at their fair value, which is their intrinsic value on the date of the award grant. The expense of the award grants are accrued
ratably over the vesting period from the date of each award. These plans are described more fully in Note 16.
The Company has adopted the fair value recognition for recognizing stock compensation exposure, using the modified-prospective-transition
method. Under that method, compensation costs are recognized based upon grant date fair value. This method requires the cash flows resulting
from the tax benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as
financing cash flows (see Note 16).
The Banner Corporation Long-Term Incentive Plan (the Plan) was initiated in June 2006. The Plan is an account-based type of benefit, the value
of which is directly related to changes in the value of the Company’s common stock (the excess of the fair market value of a share of the
Company’s common stock on the date of vesting over the fair market value of such share on the date granted) plus, for certain awards, dividends
declared on the Company’s common stock and changes in Banner Bank’s average earnings rate. Awards granted through the Plan are considered
stock appreciation rights (SARs) and are included in deferred compensation. The Company remeasures the fair value of a SAR each reporting
period until the award is settled and compensation expense is recognized each reporting period for changes in the SAR’s fair value and vesting.
Comprehensive Income: Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net
income. In addition, certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as
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a separate component of the equity section of the Consolidated Statements of Financial Condition, and such items, along with net income, are
components of comprehensive income which is reported in the Consolidated Statements of Comprehensive Income (Loss).
Business Segments: The Company is managed by legal entity and not by lines of business. Each of the Banks is a community oriented commercial
bank chartered in the State of Washington. The Banks’ primary business is that of a traditional banking institution, gathering deposits and
originating loans for portfolio in its respective primary market areas. The Banks offer a wide variety of deposit products to their consumer and
commercial customers. Lending activities include the origination of real estate, commercial/agriculture business and consumer loans. Banner
Bank is also an active participant in the secondary market, originating residential loans for sale on both a servicing released and servicing retained
basis. In addition to interest income on loans and investment securities, the Banks receive other income from deposit service charges, loan
servicing fees and from the sale of loans and investments. The performance of the Banks is reviewed by the Company’s executive management
and Board of Directors on a monthly basis. All of the executive officers of the Company are members of Banner Bank’s management team.
Generally Accepted Accounting Principles establish standards to report information about operating segments in annual financial statements and
require reporting of selected information about operating segments in interim reports to stockholders. The Company has determined that its
current business and operations consist of a single business segment.
Reclassification: Certain reclassifications have been made to the prior years’ consolidated financial statements and/or schedules to conform to
the current year’s presentation. These reclassifications may have affected certain reported amounts and ratios for the prior periods. These
reclassifications had no effect on retained earnings (accumulated deficit) or net income (loss) as previously presented and the effect of these
reclassifications is considered immaterial.
Note 2: RECENT DEVELOPMENTS AND SIGNIFICANT EVENTS
Regulatory Actions: On March 23, 2010, Banner Bank entered into a Memorandum of Understanding (Bank MOU) with the FDIC and Washington
DFI. The Company also entered into a similar MOU with the Federal Reserve Bank of San Francisco on March 29, 2010 (FRB MOU). On
March 19, 2012, the Bank MOU was terminated. On April 10, 2012, the FRB MOU was also terminated.
Income Tax Reporting and Accounting:
Amended Federal Income Tax Returns: On October 25, 2011, the Company filed amended federal income tax returns for tax years 2005, 2006,
2008 and 2009. The amended tax returns, which are under review by the Internal Revenue Service (IRS), would significantly affect the timing
for recognition of credit losses within previously filed income tax returns and, if approved, would result in the refund of up to $13.6 million of
previously paid taxes from the utilization of net operating loss carryback claims into prior tax years. The outcome of the anticipated IRS review
is inherently uncertain and since there can be no assurance of approval of some or all of the tax carryback claims, no asset has been recognized
to reflect the possible results of these amendments as of December 31, 2012, because of this uncertainty. Accordingly, the Company does not
anticipate recognizing any tax benefit until the results of the IRS review have been determined.
Deferred Tax Asset Valuation Allowance: The Company and the Banks file consolidated U.S. federal income tax returns, as well as state income
tax returns in Oregon and Idaho. Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset
or liability is determined based on the enacted tax rates which are expected to be in effect when the differences between the financial statement
carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on
deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Under GAAP, a valuation allowance
is required to be recognized if it is “more likely than not” that all or a portion of our deferred tax assets will not be realized. While realization
of the deferred tax asset is ultimately dependent on sustained profitability, the guidance reflected in the accounting standard is significantly
influenced by consideration of recent historical operating results. During 2010, the Company evaluated its net deferred tax asset and determined
it was prudent to establish a valuation allowance against the entire asset. As a result, we recorded an $18.0 million income tax expense for the
year ended December 31, 2010. No tax benefit or expense was recognized during 2011. During the year ended December 31, 2012, management
analyzed the Company's performance and trends, focusing on trends in asset quality, loan loss provisioning, capital position, net interest margin,
core operating income and net income and the likelihood of continued profitability. Based on this analysis, management determined that a full
valuation allowance was no longer appropriate and reversed all of the valuation allowance during the year ended December 31, 2012. See Note
13 of the Notes to the Consolidated Financial Statements for more information.
Stockholder Equity Transactions:
Reverse stock split: On May 26, 2011, Banner Corporation filed with the Secretary of State of the State of Washington Articles of Amendment
to the Amended and Restated Articles of Incorporation of the Company, which effected a 1-for-7 reverse stock split. The amendment to the
Company's Amended and Restated Articles of Incorporation was effective June 1, 2011. As a result of the reverse stock split, every seven shares
of the Company's common stock issued and outstanding immediately prior to the effective date automatically consolidated into one share of
common stock. No fractional shares of common stock were issued by the Company in connection with the reverse stock split. Approximately
$50,000 in cash was paid for fractional shares based on the closing price of the common stock on May 31, 2011. All prior shares outstanding
and per share information have been retroactively adjusted for the reverse stock split.
Participation in the U.S. Treasury’s Capital Purchase Program: On November 21, 2008, Banner received $124 million from the Treasury
Department ("Treasury") as part of the Treasury’s Capital Purchase Program. Banner issued $124 million of Series A Preferred Stock of the
Company's Fixed Rate Cumulative Perpetual Preferred Stock, (the Series A Preferred Stock) having a liquidation value of $1,000 per share, with
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a related warrant to purchase up to $18.6 million in common stock, to the U.S. Treasury. The warrant provides the Treasury the option to purchase
up to 243,998 shares (post reverse-split) of the Company's common stock at a price of $76.23 per share (post reverse-split) at any time during
the next 10 years. On March 29, 2012, the Company's $124 million of Series A Preferred Stock was sold by the Treasury as part of its efforts
to manage and recover its investments under the Troubled Asset Relief Program (TARP). While the sale of these preferred shares to new owners
did not result in any proceeds to the Company and did not change the Company's capital position or accounting for these securities, it did eliminate
restrictions put in place by the Treasury on TARP recipients. The Treasury retained its related warrants to purchase up to $18.6 million in Banner
common stock.
Redemption of senior preferred shares: Subsequent to March 29, 2012, the Company repurchased or redeemed all of its Series A Preferred
Stock, realizing gains aggregating $2.5 million, which was partially offset by accelerated amortization of a portion of the initial discount recorded
at the issuance of the Series A Preferred Stock. In addition, the accrual for the quarterly dividend was reduced by the retirement of the repurchased
shares.
Restricted Stock Grants: On April 24, 2012, shareholders approved the Banner Corporation 2012 Restricted Stock Plan (the Plan). Under the
Plan, the Company was authorized to issue up to 300,000 shares of its common stock to provide a means for attracting and retaining highly
skilled officers of Banner and its affiliates. Shares granted under the Plan have a minimum vesting period of three years. The Plan has a ten-
year term after which no further awards may be granted. Concurrent with the approval of the Plan was the approval of a grant of $300,000 of
restricted stock (14,535 restricted shares) that vests in one-third increments over a three-year period to Mark J. Grescovich, President and Chief
Executive Officer of Banner Corporation and Banner Bank. Subsequent to that initial issuance from this new plan was the issuance of 78,500
additional shares to certain other officers of the Company.
Note 3: ACCOUNTING STANDARDS RECENTLY ADOPTED OR ISSUED
Accounting Standards Recently Adopted
In April 2011, FASB issued Accounting Standards Update (ASU) No. 2011-03, Reconsideration of Effective Control for Repurchase
Agreements. This guidance is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance has been
applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. The amendments remove
the transferor’s ability criterion from the consideration of effective control for repurchase and other agreements that both entitle and obligate
the transferor to repurchase or redeem financial assets before their maturity. The adoption of this guidance did not have a material effect on the
Company’s Consolidated Financial Statements.
In May 2011, FASB issued ASU No. 2011-04, Fair Value Measurement - Amendments to Achieve Common Fair Value Measurements and
Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 amends Topic 820, Fair Value Measurements and Disclosures, to converge
the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU
2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional
fair value disclosures. ASU 2011-04 became effective for the first interim or annual period beginning on or after December 15, 2011 and did
not have a significant impact on the Company's Consolidated Financial Statements.
In June 2011, FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. The amendments in this Update are required to be applied
retrospectively. The amendments are effective for fiscal years and interim periods within those years, beginning after December 15, 2011. Early
adoption is permitted. The FASB decided to eliminate the option to present components of other comprehensive income as part of the statement
of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single
continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, the amendments require the
consecutive presentation of the statement of net income and other comprehensive income and require the presentation of reclassification
adjustments on the face of the financial statements from other comprehensive income to net income. See also ASU No. 2011-12. The adoption
of this guidance did not have a material effect on the Company’s Consolidated Financial Statements.
In December 2011, FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of
Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-05. This ASU was made to allow the Board time to redeliberate
whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the
components of net income and other comprehensive income for all periods presented. The amendments in this Update are effective at the same
time as the amendments in Update 2011-05 so that entities were not required to comply with the presentation requirements in Update 2011-05
until this ASU becomes effective. The adoption of this guidance has not had a material effect on the Company's Consolidated Financial Statements.
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Note 4: CASH AND SECURITIES
Cash, due from bank and cash equivalents consisted of the following at the dates indicated (in thousands):
Cash on hand and due from banks
Cash equivalents:
Short-term cash investments
December 31
2012
2011
181,100
$
132,189
198
247
181,298
$
132,436
$
$
Federal regulations require depository institutions to maintain certain minimum reserve balances. Included in cash and demand deposits were
required reserves of $25.4 million and $20.4 million at December 31, 2012 and 2011, respectively.
The following table sets forth a summary of Banner’s interest-bearing deposits and securities at the dates indicated (includes securities—trading,
available-for-sale and held-to-maturity, all at carrying value) (in thousands):
December 31
2012
2011
Interest-bearing deposits included in cash and due from banks
$
114,928
$
69,758
U.S. Government and agency obligations
98,617
341,606
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Mortgage-backed or related securities:
1-4 residential agency guaranteed
1-4 residential other
Multifamily agency guaranteed
Multifamily other
Total mortgage-backed securities
Asset-backed securities:
Equity securities (excludes FHLB stock)
Total securities
FHLB stock
31,480
103,545
135,025
48,519
115,966
1,299
177,940
10,659
305,864
42,516
63
18,497
88,963
107,460
42,565
107,173
1,835
20,919
—
129,927
—
402
630,604
621,960
36,705
37,371
$
782,237
$
729,089
101
Securities—Trading: The amortized cost and estimated fair value of securities—trading at December 31, 2012 and 2011 are summarized as
follows (dollars in thousands):
December 31, 2012
December 31, 2011
Amortized
Cost
Fair Value
Percent of
Total
Amortized
Cost
Fair Value
Percent of
Total
U.S. Government and agency obligations
$
1,380
$
1,637
2.3% $
2,401
$
2,635
3.3%
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
—
5,590
5,590
—
5,684
5,684
—
8.0
8.0
391
5,431
5,822
420
5,542
5,962
0.5
6.9
7.4
Corporate bonds
57,807
35,741
50.2
63,502
35,055
43.4
Mortgage-backed and related securities:
1-4 residential agency guaranteed
25,548
28,107
Total mortgage-backed and related
securities
Equity securities
25,548
28,107
14
63
39.4
39.4
0.1
34,024
36,673
34,024
36,673
6,914
402
45.4
45.4
0.5
$
90,339
$
71,232
100.0% $
112,663
$
80,727
100.0%
There were eight sales of securities—trading for the year ended December 31, 2012 with proceeds of $5.1 million and related gains of $13,000.
There were no sales of securities—trading for the years ended December 31, 2011, and 2010. The Company recognized $409,000 in OTTI
charges on securities—trading for the year ended December 31, 2012 compared to no OTTI charges in 2011 and OTTI charges of $1.2 million
for the year ended December 31, 2010. Additionally, at December 31, 2012 and 2011, there were no securities—trading in a nonaccrual
status. Net unrealized holding gains of $6.3 million were recognized in 2012 compared to $754,000 and $497,000 of net unrealized holding
gains on securities—trading for the years ended December 31, 2011 and 2010, respectively.
The amortized cost and estimated fair value of securities—trading at December 31, 2012 and 2011, by contractual maturity, are shown below
(in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or without
call or prepayment penalties.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years through twenty years
Due after twenty years
Mortgage-backed securities
Equity securities
December 31, 2012
December 31, 2011
Amortized Cost
Fair Value
Amortized Cost
Fair Value
$
— $
— $
1,679
3,743
7,626
51,729
64,777
25,548
14
1,767
3,750
6,492
31,053
43,062
28,107
63
$
1,000
1,545
4,087
6,544
58,549
71,725
34,024
6,914
1,009
1,626
4,123
6,184
30,710
43,652
36,673
402
$
90,339
$
71,232
$
112,663
$
80,727
102
Securities—Available-for-Sale: The amortized cost, gross unrealized losses and gains and estimated fair value of securities— available-for-
sale at December 31, 2012 and 2011 are summarized as follows (dollars in thousands):
December 31, 2012
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Percent of Total
U.S. Government and agency obligations
$
96,666
$
367
$
(53) $
96,980
20.5%
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Mortgage-backed or related securities:
1-4 residential agency guaranteed
1-4 residential other
Multifamily agency guaranteed
Multifamily other
Total mortgage-backed or related
securities
Asset-backed securities:
SLMA
20,987
23,575
44,562
10,701
87,392
1,223
176,026
10,700
275,341
233
221
454
37
1,051
76
2,140
4
3,271
(67)
(11)
(78)
(9)
(584)
—
(226)
(45)
(855)
21,153
23,785
44,938
10,729
87,859
1,299
177,940
10,659
277,757
42,380
210
(74)
42,516
4.5
5.0
9.5
2.3
18.6
0.3
37.6
2.2
58.7
9.0
$
469,650
$
4,339
$
(1,069) $
472,920
100.0%
December 31, 2011
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Amortized Cost
Fair Value
Percent of Total
U.S. Government and agency obligations
$
338,165
$
862
$
(56) $
338,971
72.8%
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Mortgage-backed or related securities:
1-4 residential agency guaranteed
1-4 residential other
Multifamily agency guaranteed
Total mortgage-backed or related
securities
Asset-backed securities:
SLMA
10,358
16,535
26,893
6,240
68,922
1,735
20,624
91,281
225
210
435
20
1,711
100
310
2,121
(2)
(16)
(18)
—
(133)
—
(15)
(148)
10,581
16,729
27,310
6,260
70,500
1,835
20,919
93,254
—
—
—
—
2.3
3.6
5.9
1.3
15.1
0.4
4.5
20.0
—
$
462,579
$
3,438
$
(222) $
465,795
100.0%
103
At December 31, 2012 and 2011, an aging of unrealized losses and fair value of related securities—available-for-sale was as follows (in thousands):
December 31, 2012
Less Than 12 Months
12 Months or More
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
U.S. Government and agency obligations
$
22,955
$
(53) $
— $
— $
22,955
$
(53)
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Mortgage-backed or related securities:
1-4 residential agency guaranteed
Multifamily agency guaranteed
Multifamily other
Total mortgage-backed or related
securities
Asset-backed securities:
SLMA
11,009
4,619
15,628
6,670
32,459
32,170
7,279
71,908
(67)
(11)
(78)
(9)
(503)
(226)
(45)
(774)
—
—
—
—
5,746
—
—
5,746
—
—
—
—
(81)
—
—
(81)
11,009
4,619
15,628
6,670
38,205
32,170
7,279
77,654
(67)
(11)
(78)
(9)
(584)
(226)
(45)
(855)
19,716
(74)
—
—
19,716
(74)
$
136,877
$
(988) $
5,746
$
(81) $
142,623
$
(1,069)
December 31, 2011
Less Than 12 Months
12 Months or More
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
U.S. Government and agency obligations
$
74,326
$
(56) $
— $
— $
74,326
$
(56)
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Mortgage-backed or related securities:
1-4 residential agency guaranteed
Multifamily agency guaranteed
Total mortgage-backed or related
securities
3,599
4,075
7,674
26,730
7,158
33,888
(2)
(16)
(18)
(133)
(15)
(148)
—
—
—
—
—
—
—
—
—
—
—
—
3,599
4,075
7,674
26,730
7,158
33,888
(2)
(16)
(18)
(133)
(15)
(148)
$
115,888
$
(222) $
— $
— $
115,888
$
(222)
Proceeds from the sale of three available-for-sale securities were $13 million for the year ended December 31, 2012 and the Company recognized
a gain of $38,000 on those sales. There were four sales of securities—available-for-sale during the year ended December 31, 2011 with proceeds
of $28 million and resulting losses of $5,000. There was one sale of securities—available-for-sale of $2 million with a resulting gain of $36,000
during the year ended December 31, 2010. There were no OTTI impairment charges on securities—available-for-sale for the years ended
December 31, 2012, 2011 and 2010. At December 31, 2012, there were 52 securities— available-for-sale with unrealized losses, compared to
26 at December 31, 2011 and 24 at December 31, 2010. Management does not believe that any individual unrealized loss as of December 31,
2012, 2011 or 2010 represented OTTI. The decline in fair market value of these securities was generally due to changes in interest rates and
changes in market-desired spreads subsequent to their purchase.
104
The amortized cost and estimated fair value of securities—available-for-sale at December 31, 2012 and 2011, by contractual maturity, are shown
below (in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or
without call or prepayment penalties.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years through twenty years
Mortgage-backed securities
December 31, 2012
December 31, 2011
Amortized Cost
Fair Value
Amortized Cost
Fair Value
$
$
16,369
104,917
51,654
21,369
194,309
275,341
$
16,393
105,579
51,637
21,554
195,163
277,757
$
19,520
312,862
38,916
—
371,298
91,281
19,602
313,930
39,009
—
372,541
93,254
$
469,650
$
472,920
$
462,579
$
465,795
Securities—Held-to-Maturity: The amortized cost, gross gains and losses and estimated fair value of securities—held-to-maturity at
December 31, 2012 and 2011 are summarized as follows (dollars in thousands):
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Amortized Cost
$
$
10,326
74,076
84,402
2,050
December 31, 2012
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Percent of Total
$
436
5,757
6,193
—
(157) $
(30)
(187)
—
10,605
79,803
90,408
2,050
11.5%
86.3
97.8
2.2
$
86,452
$
6,193
$
(187) $
92,458
100.0%
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Corporate bonds
Amortized Cost
$
$
7,496
66,692
74,188
1,250
December 31, 2011
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Percent of Total
$
390
4,281
4,671
—
— $
—
—
(2)
7,886
70,973
78,859
1,248
9.8%
88.6
98.4
1.6
$
75,438
$
4,671
$
(2) $
80,107
100.0%
At December 31, 2012 and 2011, an age analysis of unrealized losses and fair value of related securities—held-to-maturity was as follows (in
thousands):
Municipal bonds:
Taxable
Tax exempt
Total municipal bonds
Less Than 12 Months
Fair Value
Unrealized
Losses
December 31, 2012
12 Months or More
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$
$
$
4,137
910
5,047
(157) $
(30)
(187)
5,047
$
(187) $
— $
—
—
— $
— $
—
—
$
4,137
910
5,047
— $
5,047
$
(157)
(30)
(187)
(187)
105
Less Than 12 Months
Fair Value
Unrealized
Losses
December 31, 2011
12 Months or More
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Corporate bonds
$
$
— $
— $
— $
— $
498
498
$
$
(2) $
(2) $
498
498
$
$
(2)
(2)
There were no sales of securities—held-to-maturity during the years ended December 31, 2012, 2011 or 2010. The Company recognized no
OTTI charges on securities—held-to-maturity for the year ended December 31, 2012 compared to a $3 million OTTI recovery for the year ended
December 31, 2011 and a $3 million charge for the year ended December 31, 2010. As of December 31, 2012, there were no securities—held-
to-maturity in a nonaccrual status. There were two held-to-maturity non-rated corporate bonds issued by a housing authority in nonaccrual status
as of December 31, 2011. There were five securities—held-to-maturity with unrealized losses at December 31, 2012 compared to two at
December 31, 2011 and 13 at December 31, 2010. Management does not believe that any individual unrealized losses as of December 31, 2012
or 2011 represented OTTI. The decline in fair market value of these securities was generally due to changes in interest rates and changes in
market-desired spreads subsequent to their purchase.
The amortized cost and estimated fair value of securities—held-to-maturity at December 31, 2012 and 2011, by contractual maturity, are shown
below (in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or
without call or prepayment penalties.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years through twenty years
Due after twenty years
December 31, 2012
December 31, 2011
Amortized Cost
Fair Value
Amortized Cost
Fair Value
$
$
3,323
13,641
13,295
53,031
3,162
$
3,410
14,335
13,452
57,868
3,393
$
2,707
14,420
9,726
46,741
1,844
2,768
15,150
10,254
49,936
1,999
$
86,452
$
92,458
$
75,438
$
80,107
Pledged Securities: The following table presents, as of December 31, 2012, investment securities which were pledged to secure borrowings,
public deposits or other obligations as permitted or required by law (in thousands):
Purpose or beneficiary:
State and local governments public deposits
Interest rate swap counterparties
Retail repurchase transaction accounts
Other
Total pledged securities
Amortized Cost
Fair Value
$
$
$
119,426
12,149
107,225
2,176
125,433
12,480
109,479
2,205
240,976
$
249,597
The carrying value of investment securities pledged to secure borrowings as of December 31, 2012 was $244.1 million.
Note 5: ADDITIONAL INFORMATION REGARDING INTEREST INCOME FROM SECURITIES AND CASH EQUIVALENTS
The following table sets forth the composition of income from securities for the periods indicated (in thousands):
Mortgage-backed securities interest
Taxable interest income
Tax-exempt interest income
Total income from securities
Years Ended December 31
2012
2011
2010
$
$
$
4,176
5,087
3,577
$
3,455
6,247
3,504
4,045
5,091
3,162
12,840
$
13,206
$
12,298
106
Note 6: LOANS RECEIVABLE AND THE ALLOWANCE FOR LOAN LOSSES
Loans receivable, including loans held for sale, at December 31, 2012 and 2011 are summarized as follows (dollars in thousands):
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including secured by farmland
One- to four-family real estate
Consumer:
Consumer secured by one- to four-family
Consumer—other
December 31, 2012
December 31, 2011
Amount
Percent
Amount
Percent
$
489,581
583,641
137,504
30,229
22,581
160,815
77,010
13,982
618,049
230,031
581,670
170,123
120,498
15.1% $
18.0
4.3
0.9
0.7
5.0
2.4
0.4
19.1
7.1
18.0
5.3
3.7
469,806
621,622
139,710
42,391
19,436
144,177
97,491
15,197
601,440
218,171
642,501
181,049
103,347
14.2%
18.9
4.2
1.3
0.6
4.4
3.0
0.5
18.2
6.6
19.5
5.5
3.1
Total loans outstanding
3,235,714
100.0%
3,296,338
100.0%
Less allowance for loan losses
(77,491)
(82,912)
Net loans
$
3,158,223
$
3,213,426
Loan amounts are net of unearned, unamortized loan fees (and costs) of approximately $9.0 million at December 31, 2012 and $10.0 million at
December 31, 2011.
The Company’s loans by geographic concentration at December 31, 2012 were as follows (dollars in thousands):
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including secured by
farmland
One- to four-family real estate
Consumer:
Consumer secured by one- to four-family
Consumer—other
Total loans
Percent of total loans
Washington
Oregon
Idaho
Other
Total
$
$
$
366,422
450,142
117,654
20,839
12,383
88,090
41,680
8,979
396,935
108,671
360,625
114,405
80,209
57,903
85,416
11,309
6,107
10,198
71,663
33,478
3,092
72,594
51,286
195,364
42,395
34,668
$
61,379
42,774
8,249
934
—
1,062
1,852
1,911
58,416
70,074
23,596
12,644
5,621
$
3,877
5,309
292
2,349
—
—
—
—
90,104
—
2,085
679
—
489,581
583,641
137,504
30,229
22,581
160,815
77,010
13,982
618,049
230,031
581,670
170,123
120,498
$
2,167,034
$
675,473
$
288,512
$
104,695
$
3,235,714
67.0%
20.9%
8.9%
3.2%
100.0%
107
The geographic concentrations of Banner’s land and land development loans by state at December 31, 2012 were as follows (dollars in thousands):
Residential:
Acquisition and development
Improved land and lots
Unimproved land
Commercial and industrial:
Acquisition and development
Improved land and lots
Unimproved land
Washington
Oregon
Idaho
Total
$
$
10,182
23,418
8,080
1,273
4,204
3,502
$
13,454
18,823
1,201
—
136
2,956
$
1,612
240
—
482
552
877
25,248
42,481
9,281
1,755
4,892
7,335
Total land and land development loans
$
50,659
$
36,570
$
3,763
$
90,992
Percent of land and land development loans
55.7%
40.2%
4.1%
100.0%
The Company originates both adjustable- and fixed-rate loans. At December 31, 2012 and 2011, the maturity and repricing composition of all
those loans, less undisbursed amounts and deferred fees, were as follows (in thousands):
Fixed-rate (term to maturity):
Due in one year or less
Due after one year through three years
Due after three years through five years
Due after five years through ten years
Due after ten years
Total fixed-rate loans
Adjustable-rate (term to rate adjustment):
Due in one year or less
Due after one year through three years
Due after three years through five years
Due after five years through ten years
Due after ten years
Total adjustable-rate loans
Total loans
December 31
2012
2011
$
$
183,004
171,724
173,251
167,858
473,927
216,782
250,715
182,647
157,559
502,196
1,169,764
1,309,899
1,260,472
275,223
467,895
60,316
2,044
1,200,182
425,309
336,382
23,618
948
2,065,950
1,986,439
$
3,235,714
$
3,296,338
The adjustable-rate loans have interest rate adjustment limitations and are generally indexed to various prime (The Wall Street Journal) or LIBOR
rates, FHLB advance rates or One-to-Five-Year Constant Maturity Treasury Indices. Future market factors may affect the correlation of the
interest rate adjustment with the rates the Banks pay on the short-term deposits that primarily have been utilized to fund these loans.
The Company’s loans to directors, executive officers and related entities are on substantially the same terms and underwriting as those prevailing
at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. Such loans had the
following balances and activity during the years ended December 31, 2012 and 2011 (in thousands):
Balance at beginning of year
New loans or advances
Repayments and adjustments
Balance at end of period
108
Years Ended December 31
2012
2011
$
$
$
10,239
31,394
(29,170)
5,428
19,742
(14,931)
12,463
$
10,239
Impaired Loans and the Allowance for Loan Losses. A loan is considered impaired when, based on current information and circumstances, the
Company determines it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement,
including scheduled interest payments. Impaired loans are comprised of loans on nonaccrual, TDRs that are performing under their restructured
terms, and loans that are 90 days or more past due, but are still on accrual.
The amount of impaired loans and the related allocated reserve for loan losses at the dates indicated were as follows (in thousands):
Impaired loans:
Nonaccrual loans
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including secured by farmland
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
Total nonaccrual loans
Past due and still accruing
Troubled debt restructuring on accrual status
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Land and land development-residential:
Commercial business
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
Total troubled debt restructurings on accrual status
December 31, 2012
December 31, 2011
Loan Amount
Allocated
Reserves
Loan Amount
Allocated
Reserves
$
$
4,105
2,474
—
—
1,565
2,061
46
4,750
—
12,964
2,073
1,323
31,361
3,029
188
7,034
7,131
6,726
4,842
2,975
27,540
538
488
57,462
$
618
56
—
—
326
323
12
344
—
520
41
16
2,256
62
4
664
1,665
1,115
667
610
1,228
29
38
6,020
$
4,306
4,920
362
949
6,622
19,060
1,100
13,460
1,896
17,408
1,790
1,115
72,988
2,324
189
8,406
2,088
8,362
5,334
4,598
24,851
334
371
54,533
281
626
11
—
1,921
1,485
45
1,871
629
243
23
62
7,197
19
3
1,119
6
514
306
468
675
6
3
3,100
Total impaired loans
$
91,852
$
8,338
$
129,845
$
10,316
As of December 31, 2012, the Company had additional commitments to advance funds up to an amount of $1.8 million related to TDRs.
109
The following tables provide additional information on impaired loans with and without specific allowance reserves as of December 31, 2012
and December 31, 2011. Recorded investment includes the unpaid principal balance or the carrying amount of loans less charge-offs and net
deferred loan fees (in thousands):
Without a specific allowance reserve (1)
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
With a specific allowance reserve (2)
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
Total
Commercial real estate:
Owner occupied
Investment properties
Multifamily real estate
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
December 31, 2012
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$
$
1,300
624
2,131
4,460
2,122
46
4,352
10,886
1,641
1,167
28,729
2,993
8,884
5,000
3,831
4,782
—
3,373
32,494
1,042
724
63,123
4,293
9,508
7,131
8,291
6,904
46
7,725
43,380
2,683
1,891
$
1,551
861
2,131
4,460
2,587
46
4,970
12,004
2,335
1,275
32,220
2,993
10,120
5,000
3,831
4,782
—
3,734
33,672
1,140
740
66,012
4,544
10,981
7,131
8,291
7,369
46
8,704
45,676
3,475
2,015
$
103
90
392
571
404
12
821
150
54
16
2,613
518
630
1,273
870
586
—
134
1,656
26
32
5,725
621
720
1,665
1,441
990
12
955
1,806
80
48
$
1,470
735
2,136
3,335
2,948
46
2,121
11,458
1,966
1,297
27,512
3,113
9,449
5,000
3,611
5,039
—
3,931
33,100
1,074
754
65,071
4,583
10,184
7,136
6,946
7,987
46
6,052
44,558
3,040
2,051
—
17
113
145
73
—
154
44
14
5
565
—
229
295
194
185
—
6
1,259
15
—
2,183
—
246
408
339
258
—
160
1,303
29
5
$
91,852
$
98,232
$
8,338
$
92,583
$
2,748
110
December 31, 2011
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$
Without a specific allowance reserve (1)
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including secured by farmland
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
With a specific allowance reserve (2)
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including secured by farmland
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
Total
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including secured by farmland
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
$
852
1,576
452
5,429
4,064
645
5,173
412
27,529
1,707
559
48,398
3,643
11,750
1,997
949
9,556
20,331
454
12,889
1,483
16,877
603
915
81,447
4,495
13,326
2,449
949
14,985
24,395
1,099
18,062
1,895
44,406
2,310
1,474
$
853
1,618
452
5,488
4,679
645
5,535
632
28,121
2,162
666
50,851
4,013
14,200
1,997
1,493
9,821
34,068
454
13,333
1,671
18,301
630
915
100,896
4,866
15,818
2,449
1,493
15,309
38,747
1,099
18,868
2,303
46,422
2,792
1,581
$
78
261
6
437
1,176
45
932
37
277
29
5
3,283
207
1,485
11
—
1,998
616
—
1,404
592
658
—
62
7,033
285
1,746
17
—
2,435
1,792
45
2,336
629
935
29
67
$
874
1,728
456
5,580
4,524
616
5,587
529
27,933
2,042
624
50,493
3,901
13,471
1,967
1,465
9,185
36,747
454
13,721
1,855
17,555
585
881
101,787
4,775
15,199
2,423
1,465
14,765
41,271
1,070
19,308
2,384
45,488
2,627
1,505
—
9
32
242
99
—
81
—
919
22
7
1,411
13
424
82
—
277
220
—
144
—
469
—
18
1,647
13
433
114
—
519
319
—
225
—
1,388
22
25
$
129,845
$
151,747
$
10,316
$
152,280
$
3,058
(1) Loans without a specific allowance reserve have not been individually evaluated for impairment, but have been included in pools of
homogeneous loans for evaluation of related allowance reserves.
111
(2) Loans with a specific allowance reserve have been individually evaluated for impairment using either a discounted cash flow analysis
or, for collateral dependent loans, current appraisals to establish realizable value. These analyses may identify a specific impairment
amount needed or may conclude that no reserve is needed. Any specific impairment that is identified is included in the category’s Related
Allowance column.
The following tables present TDRs at December 31, 2012 and 2011 (in thousands):
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Land and land development:
Residential
Commercial business
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
December 31, 2012
Accrual
Status
Nonaccrual
Status
Total
Modifications
$
$
188
7,034
7,131
6,726
4,842
2,975
27,540
538
488
$
1,551
1,514
—
1,044
15
247
2,703
496
396
1,739
8,548
7,131
7,770
4,857
3,222
30,243
1,034
884
$
57,462
$
7,966
$
65,428
December 31, 2011
Accrual
Status
Nonaccrual
Status
Total
Modifications
$
— $
7,751
2,088
8,362
5,334
—
4,401
23,291
371
2,935
$
142
1,822
—
271
557
949
—
3,086
549
3,974
142
9,573
2,088
8,633
5,891
949
4,401
26,377
920
6,909
$
54,533
$
11,350
$
65,883
112
The following tables present new TDRs that occurred during the twelve months ended December 31, 2012 and 2011 (dollars in thousands):
Recorded Investment (1) (2)
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Residential land and land development
Commercial business
One- to four-family residential
Consumer:
Consumer secured by one- to four-family
Consumer—other
Recorded Investment (1) (2)
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
One- to four-family construction
Residential land and land development
Commercial business
One- to four-family residential
Consumer
Twelve Months Ended December 31, 2012
Number of
Loans
Pre-modification
Outstanding
Recorded
Investment
Post-modification
Outstanding
Recorded
Investment
$
1
6
2
23
6
9
29
3
2
$
943
3,891
5,054
5,454
3,341
1,886
10,914
206
368
943
3,891
5,054
5,454
3,341
1,886
10,914
206
368
81
$
32,057
$
32,057
Twelve Months Ended December 31, 2011
Number of
Loans
Pre-modification
Outstanding
Recorded
Investment
Post-modification
Outstanding
Recorded
Investment
1
4
3
6
6
8
5
21
142
6,753
2,450
3,134
1,908
3,767
1,379
3,150
142
6,753
2,450
3,064
1,908
3,767
1,284
3,150
54
$
22,683
$
22,518
(1) Since most loans were already considered classified and/or on non-accrual status prior to restructuring, the modifications did not have
a material effect on the Company’s determination of the allowance for loan losses.
(2) The majority of these modifications do not fit into one separate type, such as: rate, term, amount, interest-only or payment; but instead
are a combination of multiple types of modifications, therefore they are disclosed in aggregate.
113
The following table presents TDRs which incurred a payment default within the twelve-month periods ended December 31, 2012 and 2011, for
which the payment default occurred within twelve months of the restructure date. A default on a restructured loan results in a transfer to nonaccrual
status, a charge-off or a combination of both (in thousands):
Commercial real estate
Construction and land
One- to four-family residential
Consumer
Balance, end of period
Twelve Months Ended December 31
2012
2011
Number of
Loans
Amount
Number of
Loans
Amount
$
2
6
4
—
2,346
1,044
492
—
$
2
2
1
11
1,964
578
598
1,732
12
$
3,882
16
$
4,872
Credit Quality Indicators: To appropriately and effectively manage the ongoing credit quality of the Company’s loan portfolio, management
has implemented a risk-rating or loan grading system for its loans. The system is a tool to evaluate portfolio asset quality throughout each
applicable loan’s life as an asset of the Company. Generally, loans and leases are risk rated on an aggregate borrower/relationship basis with
individual loans sharing similar ratings. There are some instances when specific situations relating to individual loans will provide the basis for
different risk ratings within the aggregate relationship. Loans are graded on a scale of 1 to 9. A description of the general characteristics of
these categories is shown below:
Overall Risk Rating Definitions: Risk-ratings contain both qualitative and quantitative measurements and take into account the financial strength
of a borrower and the structure of the loan or lease. Consequently, the definitions are to be applied in the context of each lending transaction
and judgment must also be used to determine the appropriate risk rating, as it is not unusual for a loan or lease to exhibit characteristics of more
than one risk-rating category. Consideration for the final rating is centered in the borrower’s ability to repay, in a timely fashion, both principal
and interest. There were no material changes in the risk-rating or loan grading system in 2012.
Risk Rating 1: Exceptional
A credit supported by exceptional financial strength, stability, and liquidity. The risk rating of 1 is reserved for the Company’s top quality loans,
generally reserved for investment grade credits underwritten to the standards of institutional credit providers.
Risk Rating 2: Excellent
A credit supported by excellent financial strength, stability and liquidity. The risk rating of 2 is reserved for very strong and highly stable
customers with ready access to alternative financing sources.
Risk Rating 3: Strong
A credit supported by good overall financial strength and stability. Collateral margins are strong, cash flow is stable although susceptible to
cyclical market changes.
Risk Rating 4: Acceptable
A credit supported by the borrower’s adequate financial strength and stability. Assets and cash flow are reasonably sound and provide for orderly
debt reduction. Access to alternative financing sources will be more difficult to obtain.
Risk Rating 5: Watch
A credit with the characteristics of an acceptable credit but one which requires more than the normal level of supervision and warrants formal
quarterly management reporting. Credits in this category are not yet criticized or classified, but due to adverse events or aspects of underwriting
require closer than normal supervision. Generally, credits should be watch credits in most cases for six months or less as the impact of stress
factors are analyzed.
Risk Rating 6: Special Mention
A credit with potential weaknesses that deserves management’s close attention is risk rated a 6. If left uncorrected, these potential weaknesses
will result in deterioration in the capacity to repay debt. A key distinction between Special Mention and Substandard is that in a Special Mention
credit, there are identified weaknesses that pose potential risk(s) to the repayment sources, versus well defined weaknesses that pose risk(s) to
the repayment sources. Assets in this category are expected to be in this category no more than 9-12 months as the potential weaknesses in the
credit are resolved.
Risk Rating 7: Substandard
A credit with well defined weaknesses that jeopardize the ability to repay in full is risk rated a 7. These credits are inadequately protected by
either the sound net worth and payment capacity of the borrower or the value of pledged collateral. These are credits with a distinct possibility
of loss. Loans headed for foreclosure and/or legal action due to deterioration are rated 7 or worse.
114
Risk Rating 8: Doubtful
A credit with an extremely high probability of loss is risk rated 8. These credits have all the same critical weaknesses that are found in a
substandard loan; however, the weaknesses are elevated to the point that based upon current information, collection or liquidation in full is
improbable. While some loss on doubtful credits is expected, pending events may strengthen a credit making the amount and timing of any loss
indeterminate. In these situations taking the loss is inappropriate until it is clear that the pending event has failed to strengthen the credit and
improve the capacity to repay debt.
Risk Rating 9: Loss
A credit that is considered to be currently uncollectible or of such little value that it is no longer a viable Bank asset is risk rated 9. Losses are
taken in the accounting period in which the credit is determined to be uncollectible. Taking a loss does not mean that a credit has absolutely no
recovery or salvage value but, rather, it is not practical or desirable to defer writing off the credit, even though partial recovery may occur in the
future.
The following table shows Banner’s portfolio of risk-rated loans and non-risk-rated loans by grade or other characteristic as of December 31,
2012 (in thousands):
Commercial
Real Estate Multifamily
Construction
and Land
Commercial
Business
Agricultural
Business
One- to
Four-Family
Residential
Consumer (1)
Total Loans
December 31, 2012
Risk-rated
loans:
Pass (Risk
Ratings 1-5)
Special
mention
Substandard
Doubtful
$ 1,016,964
$
130,815
$
274,407
$
581,846
$
228,304
$
560,781
$
284,816
$ 3,077,933
14,332
41,382
544
—
6,689
—
3,146
27,064
—
7,905
28,287
11
713
1,014
—
438
20,451
—
148
5,657
—
26,682
130,544
555
Total loans
$ 1,073,222
$
137,504
$
304,617
$
618,049
$
230,031
$
581,670
$
290,621
$ 3,235,714
Performing
loans
Non-performing
loans (2)
$ 1,066,643
$
137,504
$
300,945
$
613,299
$
230,031
$
565,829
$
287,073
$ 3,201,324
6,579
—
3,672
4,750
—
15,841
3,548
34,390
Total loans
$ 1,073,222
$
137,504
$
304,617
$
618,049
$
230,031
$
581,670
$
290,621
$ 3,235,714
(1) Most consumer loans are not individually risk-rated. For consumer loans that are not risk-rated, those that are performing consumer
loans are reflected above as “Pass,” while non-performing consumer loans are reflected above as “Substandard.”
(2) Non-performing loans include loans on non-accrual status and loans more than 90 days delinquent, but still accruing interest.
115
The following table shows Banner’s portfolio of risk-rated loans and non-risk-rated loans by grade or other characteristic as of December 31,
2011 (in thousands):
Commercial
Real Estate Multifamily
Construction
and Land
Commercial
Business
Agricultural
Business
One- to
Four-Family
Residential
Consumer (1)
Total Loans
December 31, 2011
Risk-rated
loans:
Pass (Risk
Ratings 1-5)
Special
mention
Substandard
Doubtful
$ 1,003,990
$
132,108
$
257,685
$
542,625
$
213,512
$
607,793
$
276,642
$ 3,034,355
29,751
57,687
—
5,000
2,602
—
3,359
57,648
—
13,447
45,032
336
923
3,736
—
772
33,936
—
402
7,352
—
53,654
207,993
336
Total loans
$ 1,091,428
$
139,710
$
318,692
$
601,440
$
218,171
$
642,501
$
284,396
$ 3,296,338
Performing
loans
Non-performing
loans (2)
$ 1,082,202
$
139,348
$
290,961
$
587,976
$
216,275
$
622,946
$
281,318
$ 3,221,026
9,226
362
27,731
13,464
1,896
19,555
3,078
75,312
Total loans
$ 1,091,428
$
139,710
$
318,692
$
601,440
$
218,171
$
642,501
$
284,396
$ 3,296,338
(1) Most consumer loans are not individually risk-rated. For consumer loans that are not risk-rated, those that are performing consumer
loans are reflected above as “Pass,” while non-performing consumer loans are reflected above as “Substandard.”
(2) Non-performing loans include loans on non-accrual status and loans more than 90 days delinquent, but still accruing interest.
The following tables provide additional detail on the age analysis of Banner’s past due loans as of December 31, 2012 and 2011 (in thousands):
December 31, 2012
30-59
Days Past
Due
60-89
Days Past
Due
Greater
Than 90
Days Past
Due
Total Past
Due
Current
Total Loans
Loans 90
Days or
More Past
Due and
Accruing
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including
secured by farmland
One- to four-family residential
Consumer:
Consumer secured by one- to
four-family
Consumer—other
$
$
1,693
743
—
—
—
611
—
2,083
1,849
—
1,376
699
816
— $
—
—
—
—
—
—
—
49
$
1,371
1,431
—
—
—
—
2,047
45
842
$
3,064
2,174
—
—
—
611
2,047
2,128
2,740
—
3,468
—
11,488
—
16,332
$
486,517
581,467
137,504
30,229
22,581
160,204
74,963
11,854
615,309
230,031
565,338
$
489,581
583,641
137,504
30,229
22,581
160,815
77,010
13,982
618,049
230,031
581,670
74
673
1,204
839
1,977
2,328
168,146
118,170
170,123
120,498
—
—
—
—
—
—
—
—
—
—
2,877
—
152
Total
$
9,870
$
4,264
$
19,267
$
33,401
$ 3,202,313
$ 3,235,714
$
3,029
116
December 31, 2011
30-59
Days Past
Due
60-89
Days Past
Due
Greater
Than 90
Days Past
Due
Total Past
Due
Current
Total Loans
Loans 90
Days or
More Past
Due and
Accruing
Commercial real estate:
Owner-occupied
Investment properties
Multifamily real estate
Commercial construction
Multifamily construction
One- to four-family construction
Land and land development:
Residential
Commercial
Commercial business
Agricultural business, including
secured by farmland
One- to four-family residential
Consumer:
Consumer secured by one- to
four-family
Consumer—other
$
$
1,251
—
—
—
—
643
638
308
2,411
99
794
1,072
670
2,703
—
—
—
—
—
—
—
4,170
—
585
109
363
$
$
3,462
3,087
—
949
—
3,819
15,919
791
5,612
1,849
15,770
$
7,416
3,087
—
949
—
4,462
16,557
1,099
12,193
1,948
17,149
$
462,390
618,535
139,710
41,442
19,436
139,715
80,934
14,098
589,247
216,223
625,352
$
469,806
621,622
139,710
42,391
19,436
144,177
97,491
15,197
601,440
218,171
642,501
1,374
769
2,555
1,802
178,494
101,545
181,049
103,347
—
—
—
—
—
—
—
—
4
—
2,147
148
25
Total
$
7,886
$
7,930
$
53,401
$
69,217
$ 3,227,121
$ 3,296,338
$
2,324
117
The following tables provide additional information on the allowance for loan losses and loan balances individually and collectively evaluated for impairment as of December 31, 2012 (in
thousands):
Commercial
Real Estate
Multifamily
Construction
and Land
Commercial
Business
Agricultural
Business
One- to Four-
Family
Consumer
Commitments
and
Unallocated
Total
December 31, 2012
Allowance for loan losses:
Beginning balance
Provision for loan losses
Recoveries
Charge-offs
Ending balance
Allowance individually evaluated
for impairment
Allowance collectively evaluated
for impairment
$
$
$
$
16,457
2,009
921
(4,065)
$
3,952
554
—
—
$
18,184
399
2,954
(6,546)
$
15,159
(1,142)
2,425
(6,485)
$
1,548
1,154
49
(456)
$
12,299
8,918
586
(5,328)
$
1,253
2,571
531
(3,007)
$
14,060
(1,463)
—
—
82,912
13,000
7,466
(25,887)
15,322
$
4,506
$
14,991
$
9,957
$
2,295
$
16,475
$
1,348
$
12,597
$
77,491
1,149
$
1,273
$
1,456
$
133
$
— $
1,656
$
58
$
— $
5,725
14,173
3,233
13,535
9,824
2,295
14,819
1,290
12,597
71,766
Total allowance for loan losses
$
15,322
$
4,506
$
14,991
$
9,957
$
2,295
$
16,475
$
1,348
$
12,597
$
77,491
Commercial
Real Estate
Multifamily
Construction
and Land
Commercial
Business
Agricultural
Business
One- to Four-
Family
Consumer
Commitments
and
Unallocated
Total
Loan balances:
Loans individually evaluated for
impairment
Loans collectively evaluated for
impairment
Total loans
$
11,877
$
5,000
$
8,613
$
3,373
$
— $
32,494
$
1,766
$
— $
63,123
1,061,345
132,504
296,004
614,676
230,031
549,176
288,855
—
3,172,591
$
1,073,222
$
137,504
$
304,617
$
618,049
$
230,031
$
581,670
$
290,621
$
— $
3,235,714
118
The following tables provide additional information on the allowance for loan losses and loan balances individually and collectively evaluated for impairment as of December 31, 2011 (in
thousands):
Commercial
Real Estate
Multifamily
Construction
and Land
Commercial
Business
Agricultural
Business
One- to Four-
Family
Consumer
Commitments
and
Unallocated
Total
December 31, 2011
Allowance for loan losses:
Beginning balance
Provision for loan losses
Recoveries
Charge-offs
Ending balance
Allowance individually evaluated
for impairment
Allowance collectively evaluated
for impairment
$
$
$
$
11,779
10,704
53
(6,079)
$
3,963
671
—
(682)
$
33,121
9,789
1,602
(26,328)
$
24,545
(2,072)
1,082
(8,396)
$
1,846
159
20
(477)
$
5,829
16,024
356
(9,910)
$
1,794
189
304
(1,034)
$
14,524
(464)
—
—
97,401
35,000
3,417
(52,906)
16,457
$
3,952
$
18,184
$
15,159
$
1,548
$
12,299
$
1,253
$
14,060
$
82,912
1,693
$
11
$
2,614
$
1,404
$
592
$
658
$
62
$
— $
7,034
14,764
3,941
15,570
13,755
956
11,641
1,191
14,060
75,878
Total allowance for loan losses
$
16,457
$
3,952
$
18,184
$
15,159
$
1,548
$
12,299
$
1,253
$
14,060
$
82,912
Commercial
Real Estate
Multifamily
Construction
and Land
Commercial
Business
Agricultural
Business
One- to Four-
Family
Consumer
Commitments
and
Unallocated
Total
Loan balances:
Loans individually evaluated for
impairment
Loans collectively evaluated
for impairment
$
15,393
$
1,997
$
31,290
$
12,889
$
1,483
$
16,877
$
1,518
$
— $
81,447
1,076,035
137,713
287,402
588,551
216,688
625,624
282,878
—
3,214,891
Total loans
$
1,091,428
$
139,710
$
318,692
$
601,440
$
218,171
$
642,501
$
284,396
$
— $
3,296,338
119
Note 7: REAL ESTATE OWNED, NET
The following table presents the changes in real estate owned (REO), net of valuation allowance, for the years ended December 31, 2012, 2011
and 2010 (in thousands):
Years Ended December 31
2012
2011
2010
Balance, beginning of period
$
42,965
$
100,872
$
77,743
Additions from loan foreclosures
Additions from capitalized costs
Dispositions of REO
Gain (loss) on sale of REO
Valuation adjustments in the period
13,930
300
(40,965)
4,725
(5,177)
53,197
4,404
(99,070)
(1,374)
(15,064)
87,761
4,006
(51,651)
(1,891)
(15,096)
Balance, end of period
$
15,778
$
42,965
$
100,872
The following table shows REO by type and geographic location by state as of December 31, 2012 (dollars in thousands):
Commercial real estate
Land development—commercial
Land development—residential
Agricultural land
One- to four-family real estate
Total REO
Percent of total REO
Washington
Oregon
Idaho
Total
$
$
390
—
3,174
365
1,866
— $
—
6,438
—
3,099
$
199
177
70
—
—
589
177
9,682
365
4,965
$
5,795
$
9,537
$
446
$
15,778
36.7%
60.5%
2.8%
100.0%
REO properties are recorded at the lower of the estimated fair value of the property, less expected selling costs, or the carrying value of the
defaulted loan, establishing a new cost basis. Subsequently, REO properties are carried at the lower of the new cost basis or updated fair market
values, based on updated appraisals of the underlying properties, as received. Valuation allowances on the carrying value of REO may be
recognized based on updated appraisals or on management’s authorization to reduce the selling price of a property.
Note 8: PROPERTY AND EQUIPMENT
Land, buildings and equipment owned by the Company and its subsidiaries at December 31, 2012 and 2011 are summarized as follows (in
thousands):
Buildings and leasehold improvements
Furniture and equipment
Less accumulated depreciation
Subtotal
Land
December 31
2012
$
$
95,270
61,519
2011
95,374
56,387
(87,646)
(80,949)
69,143
19,974
70,812
20,623
Property and equipment, net
$
89,117
$
91,435
The Company’s depreciation expense related to property and equipment was $7.8 million, $8.6 million, and $9.2 million for the years ended
December 31, 2012, 2011 and 2010, respectively. The Company’s rental expense was $7.1 million, $6.7 million, and $6.8 million for the years
ended December 31, 2012, 2011 and 2010, respectively.
120
The Company’s obligations under long-term property leases over the next five years is as follows:
Year
2013
2014
2015
2016
2017
Thereafter
Amount
$ 6.8 million
6.0 million
3.9 million
3.0 million
2.2 million
9.4 million
Note 9: DEPOSITS
Deposits consist of the following at December 31, 2012 and 2011 (dollars in thousands):
Non-interest-bearing checking
Interest-bearing checking
Regular savings accounts
Money market accounts
Total transaction and savings accounts
Certificates of deposit:
Up to 1.00%
1.01% to 2.00%
2.01% to 3.00%
3.01% to 4.00%
4.01% and greater
Total certificates of deposit
Total deposits
Included in total deposits:
Public transaction accounts
Public interest-bearing certificates
Total public deposits
Total brokered deposits
December 31
2012
2011
Amount
Percent of
Total
Amount
Percent of
Total
$
$
$
$
$
981,240
410,316
727,957
408,998
27.6% $
11.5
20.5
11.5
777,563
362,542
669,596
415,456
2,528,511
71.1
2,225,157
792,674
155,144
59,094
12,881
9,500
1,029,293
22.3
4.3
1.6
0.4
0.3
28.9
701,593
394,285
96,334
19,495
38,790
1,250,497
22.4%
10.4
19.3
11.9
64.0
20.2
11.3
2.8
0.6
1.1
36.0
3,557,804
100.0% $
3,475,654
100.0%
79,955
60,518
140,473
15,702
2.2% $
1.7
72,064
67,112
3.9% $
139,176
0.4% $
49,194
2.1%
1.9
4.0%
1.4%
Deposits at December 31, 2012 and 2011 included deposits from the Company’s directors, executive officers and related entities totaling $8.9
million and $11.1 million, respectively.
121
Scheduled maturities and weighted average interest rates of certificate accounts at December 31, 2012 and 2011 are as follows (dollars in
thousands):
December 31
2012
2011
Amount
Weighted
Average Rate
Amount
Weighted
Average Rate
Due in one year or less
Due after one year through two years
Due after two years through three years
Due after three years through four years
Due after four years through five years
Due after five years
$
759,626
153,371
56,419
29,571
26,782
3,524
0.64% $
1.05
1.72
1.78
1.59
2.66
972,315
169,353
44,738
34,841
26,024
3,226
Total certificates of deposit
$
1,029,293
0.82% $
1,250,497
1.05%
1.37
2.22
2.20
1.92
3.60
1.19%
Included in total deposits are certificate of deposit accounts in excess of $100,000 totaling $571 million and $734 million at December 31, 2012
and 2011, respectively. Interest expense on certificate of deposit accounts in excess of $100,000 totaled $6.7 million for the year ended
December 31, 2012 and $11.1 million for the year ended December 31, 2011.
The following table sets forth the deposit activities for the years ended December 31, 2012, 2011 and 2010 (in thousands):
Years Ended December 31
2012
2011
2010
Balance at beginning of year
$
3,475,654
$
3,591,198
$
3,865,550
Net increase (decrease) before interest credited
Interest credited
Net increase (decrease) in deposits
67,043
15,107
82,150
(141,708)
26,164
(326,672)
52,320
(115,544)
(274,352)
Balance at end of year
$
3,557,804
$
3,475,654
$
3,591,198
Deposit interest expense by type for the years ended December 31, 2012, 2011 and 2010 was as follows (in thousands):
Certificates of deposit
Demand, interest-bearing-checking and money market accounts
Regular savings
Years Ended December 31
2012
11,458
1,824
1,825
$
2011
19,752
3,293
3,119
$
2010
40,569
6,598
5,153
15,107
$
26,164
$
52,320
$
$
122
Note 10: ADVANCES FROM FEDERAL HOME LOAN BANK OF SEATTLE
Utilizing a blanket pledge, qualifying loans receivable at December 31, 2012 were pledged as security for FHLB borrowings and there were no
securities pledged as collateral as of December 31, 2012 or 2011. At December 31, 2012 and 2011, FHLB advances were scheduled to mature
as follows (dollars in thousands):
Due in one year or less
Due after one year through three years
Due after three years through five years
Due after five years
Total FHLB advances, at par
Fair value adjustment
December 31
2012
2011
Amount
Weighted
Average Rate
Amount
Weighted
Average Rate
$
10,000
—
—
210
10,210
94
2.38% $
—
—
5.94
2.45
—
10,000
—
217
10,217
316
—%
2.38
—
5.94
2.45
Total FHLB advances, carried at fair value
$
10,304
$
10,533
The maximum, average outstanding and year-end balances (excluding fair value adjustments) and average interest rates on advances from the
FHLB were as follows for the years ended December 31, 2012, 2011 and 2010 (dollars in thousands):
Maximum outstanding at any month end, at par
Average outstanding, at par
Year-end outstanding, at par
Weighted average interest rates:
Annual
End of period
Years Ended December 31
2012
2011
2010
$
$
10,216
10,215
10,210
$
36,522
14,699
10,217
66,028
51,411
43,023
2.49%
2.45%
2.52%
2.45%
2.56%
2.67%
Interest expense during the period
$
254
$
370
$
1,318
As of December 31, 2012, Banner Bank has established a borrowing line with the FHLB to borrow up to 35% of its total assets, contingent on
having sufficient qualifying collateral and ownership of FHLB stock. Islanders Bank has a similar line of credit, although it may borrow up to
25% of its total assets, also contingent on collateral and FHLB stock. At December 31, 2012, the maximum total FHLB credit line was $889
million and $26 million for Banner Bank and Islanders Bank, respectively.
Note 11: OTHER BORROWINGS
Other borrowings consist of retail repurchase agreements, other term borrowings and Federal Reserve Bank borrowings.
Retail Repurchase Agreements: At December 31, 2012, retail repurchase agreements carry interest rates ranging from 0.20% to 0.70%, payable
at maturity, and are secured by the pledge of certain mortgage-backed and agency securities with a carrying value of $109 million. Banner Bank
has the right to pledge or sell these securities, but they must replace them with substantially the same security. There were no wholesale repurchase
agreements and other term borrowings, such as Fed Funds, outstanding as of December 31, 2012 and 2011.
Federal Reserve Bank of San Francisco and Other Borrowings: Banner Bank periodically borrows funds on an overnight basis from the Federal
Reserve Bank through the Borrower-In-Custody (BIC) program. Such borrowings are secured by a pledge of eligible loans. At December 31,
2012, based upon available unencumbered collateral, Banner Bank was eligible to borrow $595 million from the Federal Reserve Bank, although,
at that date, as well as at December 31, 2011, the Bank had no funds borrowed under this arrangement. There were no other borrowings at
December 31, 2012.
123
A summary of all other borrowings at December 31, 2012 and 2011 by the period remaining to maturity is as follows (dollars in thousands):
Retail repurchase agreements:
Due in one year or less
Total year-end outstanding
Average outstanding
Maximum outstanding at any month-end
Temporary liquidity guarantee program notes: (1)
Due in one year or less
Total year-end outstanding
Average outstanding
Maximum outstanding at any month-end
At or for the Years Ended December 31
2012
2011
Amount
Weighted
Average Rate
Amount
Weighted
Average Rate
$
$
$
$
$
$
76,633
76,633
90,017
100,949
—
—
12,158
49,999
0.30% $
102,131
0.29%
$
$
0.30
0.31
n/a
102,131
103,704
125,136
0.29
0.34
n/a
—% $
49,997
3.82%
— $
49,997
$
3.92
n/a
49,993
49,997
3.82
3.82
n/a
(1) These notes matured and were repaid on March 31, 2012. Weighted average rate includes FDIC guarantee fee and amortization of
origination costs.
The table below summarizes interest expense for other borrowings for the years ended December 31, 2012, 2011 and 2010 (in thousands):
Retail repurchase agreements
FDIC guaranteed debt
Total expense
Years Ended December 31
2012
2011
$
281
477
$
356
1,909
758
$
2,265
$
2010
539
1,909
2,448
$
$
124
NOTE 12: JUNIOR SUBORDINATED DEBENTURES AND MANDATORILY REDEEMABLE TRUST PREFERRED SECURITIES
At December 31, 2012, six wholly-owned subsidiary grantor trusts, Banner Capital Trust II, III, IV, V, VI and VII (BCT II, BCT III, BCT IV, BCT V, BCT VI and BCT VII (collectively, the
Trusts)), established by the Company had issued $120 million of trust preferred securities to third parties, as well as $3.7 million of common capital securities, carried among other assets, which
were issued to the Company. Trust preferred securities and common capital securities accrue and pay distributions periodically at specified annual rates as provided in the indentures. The Trusts
used the proceeds from the offerings to purchase a like amount of junior subordinated debentures (the Debentures) of the Company. The Debentures are the sole assets of the Trusts. The Company’s
obligations under the debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the Trusts. The trust preferred securities
are mandatorily redeemable upon the maturity of the Debentures, or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole on or
after specific dates, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. All of the trust preferred securities issued by the Trusts qualified
as Tier 1 capital as of December 31, 2012, under guidance issued by the Board of Governors of the Federal Reserve System. At December 31, 2012, the Trusts comprised $69.3 million, or 11.9%
of the Company’s total risk-based capital.
The following table is a summary of trust preferred securities at December 31, 2012 (dollars in thousands):
Aggregate
Liquidation
Amount of
Trust
Preferred
Securities
Aggregate
Liquidation
Amount of
Common
Capital
Securities
Aggregate
Principal
Amount of
Junior
Subordinated
Debentures
Stated
Maturity
Current
Interest
Rate
Name of Trust
Reset
Period
Interest Rate
Spread
Interest Deferral
Period
Redemption Option
Banner Capital Trust II
$
15,000
$
464
$
15,464
2033
3.69% Quarterly
Three-month
LIBOR + 3.35%
20 Consecutive
Quarters
On or after
January 7, 2008
Banner Capital Trust III
15,000
Banner Capital Trust IV
15,000
Banner Capital Trust V
25,000
Banner Capital Trust VI
25,000
Banner Capital Trust VII
25,000
465
465
774
774
774
15,465
2033
3.24
Quarterly
Three-month
LIBOR + 2.90%
20 Consecutive
Quarters
On or after
October 8, 2008
15,465
2034
3.19
Quarterly
Three-month
LIBOR + 2.85%
20 Consecutive
Quarters
On or after
April 7, 2009
25,774
2035
1.88
Quarterly
Three-month
LIBOR + 1.57%
20 Consecutive
Quarters
On or after
November 23, 2010
25,774
2037
1.93
Quarterly
Three-month
LIBOR + 1.62%
20 Consecutive
Quarters
On or after
March 1, 2012
25,774
2037
1.74
Quarterly
Three-month
LIBOR + 1.38%
20 Consecutive
Quarters
On or after
July 31, 2012
Total TPS liability at par
$
120,000
$
3,716
123,716
2.42
Fair value adjustment
Total TPS liability at fair value
(50,653)
$
73,063
125
Note 13: INCOME TAXES
The following table presents the components of the provision for income tax (benefit) expense included in the Consolidated Statement of
Operations for the years ended December 31, 2012, 2011 and 2010 (in thousands):
Current
Deferred
Increase (decrease) in valuation allowance
Provision for (benefit from) income taxes
Years Ended December 31
2012
2011
2010
$
$
$
10,759
841
(36,385)
— $
(3,322)
3,322
3,025
(21,183)
36,171
(24,785) $
— $
18,013
The following tables present the reconciliation of the provision for income taxes computed at the federal statutory rate to the actual effective
rate for the years ended December 31, 2012, 2011 and 2010 (dollars in thousands):
Years Ended December 31
2012
2011
2010
Provision for (benefit from) income taxes computed at federal statutory rate
$
14,034
$
1,910
$
(15,359)
Increase (decrease) in taxes due to:
Tax-exempt interest
Investment in life insurance
State income taxes (benefit), net of federal tax offset
Tax credits
Valuation allowance
Other
(1,710)
(894)
539
(788)
(36,385)
419
(1,616)
(663)
(2,260)
(840)
3,322
147
(1,471)
(683)
(495)
(816)
36,171
666
Provision for (benefit from) income taxes
$
(24,785) $
— $
18,013
Federal income tax statutory rate
Increase (decrease) in tax rate due to:
Tax-exempt interest
Investment in life insurance
State income taxes (benefit), net of federal tax offset
Tax credits
Valuation allowance
Other
Years Ended December 31
2012
35.0 %
(4.3)
(2.2)
1.3
(2.0)
(90.7)
1.1
2011
35.0%
(29.6)
(12.1)
(41.5)
(15.4)
60.9
2.7
2010
35.0 %
3.4
1.6
1.1
1.9
(82.4)
(1.6)
Effective income tax rate
(61.8)%
—%
(41.0)%
126
The following table reflects the effect of temporary differences that gave rise to the components of the net deferred tax asset as of December 31,
2012 and 2011 (in thousands):
Deferred tax assets:
REO and loan loss reserves
Deferred compensation
Net operating loss carryforward
Low income housing tax credits
State net operating losses
Other
Total deferred tax assets
Deferred tax liabilities:
FHLB stock dividends
Depreciation
Deferred loan fees, servicing rights and loan origination costs
Intangibles
Financial instruments accounted for under fair value accounting
Total deferred tax liabilities
Deferred income tax asset
Unrealized gain on securities available-for-sale
Valuation allowance
Deferred tax asset, net
$
December 31
2012
2011
$
24,615
6,122
26,959
4,767
1,081
689
64,233
(6,187)
(4,061)
(5,608)
(1,544)
(10,632)
(28,032)
31,156
6,032
27,992
7,202
—
309
72,691
(6,137)
(3,570)
(4,863)
(2,243)
(16,499)
(33,312)
36,201
39,379
(1,194)
(1,151)
—
(38,228)
$
35,007
$
—
During the quarter ended September 30, 2010, the Company evaluated its net deferred tax asset and determined it was prudent to establish a full
valuation allowance against the net asset. At each subsequent quarter-end, the Company has re-analyzed that position. During the quarter ended
June 30, 2012, management analyzed the Company's performance and trends over the prior five quarters, focusing strongly on trends in asset
quality, loan loss provisioning, capital position, net interest margin, core operating income and net income. Based on this analysis, management
determined that a full valuation allowance was no longer appropriate and the full amount has been reversed to a zero balance as of December 31,
2012. The ultimate realization of deferred tax assets is dependent upon the existence, or generation, of taxable income in the periods when those
temporary differences and net operating loss and credit carryforwards are deductible. Management considered the scheduled reversal of deferred
tax assets and liabilities, taxes paid in carryback years, projected future taxable income, available tax planning strategies, and other factors in
making its assessment to reverse the deferred tax valuation allowance.
At December 31, 2012, the Company has federal and state net operating loss carryforwards of approximately $77.0 million and $22.8 million,
respectively, which will expire, if unused, by the end of 2031. The Company has federal general business credits and state tax credit carryforwards
of $3.3 million and $600,000, respectively, which will expire, if unused, by the end of 2031 and 2025, respectively. The Company also has
alternative minimum tax credit carryforwards of approximately $1.5 million, which are available to reduce future federal regular income taxes,
if any, over an indefinite period.
As a consequence of our capital raise in June 2010, the Company experienced a change in control within the meaning of Section 382 of the
Internal Revenue code of 1986, as amended. Section 382 limits the ability of a corporate taxpayer to use net operating loss carryforwards,
general business credit, and recognized built-in-losses incurred prior to the change in control against income earned after the change in control.
As a result of the Section 382 limitation, the Company expects it will be able to utilize approximately $6.9 million of net operating loss
carryforwards on an annual basis. Based on its analysis, the Company does not believe the change in control will impact its ability to utilize all
of the available net operating loss carryforwards, general business credit, and recognized built-in-losses.
As of December 31, 2012, the Company has an insignificant amount of unrecognized tax benefits for uncertain tax positions, none of which
would materially affect the effective tax rate if recognized. The Company does not anticipate that the amount of unrecognized tax benefits will
significantly increase or decrease in the next twelve months. The Company’s policy is to recognize interest and penalties on unrecognized tax
benefits in the income tax expense. The amount of interest and penalties accrued for the years ended December 31, 2012 and 2011 is immaterial.
The Company files consolidated income tax returns in Oregon and Idaho and for federal purposes. The tax years which remain subject to
examination by the taxing authorities are the years ending December 31, 2006 through 2011.
127
Retained earnings (accumulated deficits) at December 31, 2012 and 2011 include approximately $5.4 million in tax basis bad debt reserves for
which no income tax liability has been booked. In the future, if this tax bad debt reserve is used for purposes other than to absorb bad debts or
the Company no longer qualifies as a bank or is completely liquidated, the Company will incur a federal tax liability at the then-prevailing
corporate tax rate, established as $1.9 million at December 31, 2012.
On October 25, 2011, the Company filed amended federal income tax returns for tax years 2005, 2006, 2008 and 2009. The amended tax returns,
which are under review by the Internal Revenue Service (IRS), significantly affect the timing for recognition of credit losses within previously
filed income tax returns and, if approved, would result in the refund of up to $13.6 million of previously paid taxes from the utilization of net
operating loss carryback claims into prior tax years. The outcome of the anticipated IRS review is inherently uncertain and since there can be
no assurance of approval of some or all of the tax carryback claims, no asset has been recognized to reflect the possible results of these amendments
as of December 31, 2012. Accordingly, the Company does not anticipate recognizing any tax benefit until the results of the IRS review have
been determined. We expect this review to be completed and the issue resolved during 2013.
Note 14: EMPLOYEE BENEFIT PLANS
Employee Retirement Plans. Substantially all of the Company’s employees are eligible to participate in its 401(k)/Profit Sharing Plan, a defined
contribution and profit sharing plan sponsored by the Company. Employees may elect to have a portion of their salary contributed to the plan
in conformity with Section 401(k) of the Internal Revenue Code. At the discretion of the Company’s Board of Directors, the Company may
elect to make matching and/or profit sharing contributions for the employees’ benefit. For the year ended December 31, 2012, $43,000 was
expensed for 401(k) contributions. There were no contributions under the plan for the years ended December 31, 2011 and 2010. The Board
of Directors has elected to make a 2% of eligible compensation matching contribution for 2013.
Supplemental Retirement and Salary Continuation Plans. Through the Banks, the Company is obligated under various non-qualified deferred
compensation plans to help supplement the retirement income of certain executives, including certain retired executives, selected by resolution
of the Banks’ Boards of Directors or in certain cases by the former directors of acquired banks. These plans are unfunded, include both defined
benefit and defined contribution plans, and provide for payments after the executive’s retirement. In the event of a participant employee’s death
prior to or during retirement, the Bank is obligated to pay to the designated beneficiary the benefits set forth under the plan. For the years ended
December 31, 2012, 2011 and 2010, expense recorded for supplemental retirement and salary continuation plan benefits totaled $879,000,
$848,000, and $1.4 million, respectively. At December 31, 2012 and 2011, liabilities recorded for the various supplemental retirement and salary
continuation plan benefits totaled $12.6 million and $12.3 million, respectively, and are recorded in a deferred compensation liability account.
Deferred Compensation Plans and Rabbi Trusts. The Company and the Banks also offer non-qualified deferred compensation plans to members
of their Boards of Directors and certain employees. The plans permit each participant to defer a portion of director fees, non-qualified retirement
contributions, salary or bonuses for future receipt. Compensation is charged to expense in the period earned. In connection with its acquisitions,
the Company also assumed liability for certain deferred compensation plans for key employees, retired employees and directors.
In order to fund the plans’ future obligations, the Company has purchased life insurance policies or other investments, including Banner
Corporation common stock, which in certain instances are held in irrevocable trusts commonly referred to as “Rabbi Trusts.” As the Company
is the owner of the investments and the beneficiary of the insurance policies, and in order to reflect the Company’s policy to pay benefits equal
to the accumulations, the assets and liabilities are reflected in the Consolidated Statements of Financial Condition. Banner Corporation common
stock held for such plans is reported as a contra-equity account and was recorded at an original cost of $7.2 million at December 31, 2012 and
$7.7 million at December 31, 2011. At December 31, 2012 and 2011, liabilities recorded in connection with deferred compensation plan benefits
totaled $8.5 million ($7.2 million in contra-equity) and $8.3 million ($7.7 million in contra-equity), respectively, and are recorded in deferred
compensation or equity as appropriate.
The Banks have purchased, or acquired through mergers, life insurance policies in connection with the implementation of certain executive
supplemental retirement, salary continuation and deferred compensation retirement plans, as well as additional policies not related to any specific
plan. These policies provide protection against the adverse financial effects that could result from the death of a key employee and provide tax-
exempt income to offset expenses associated with the plans. It is the Banks’ intent to hold these policies as a long-term investment. However,
there will be an income tax impact if the Banks choose to surrender certain policies. Although the lives of individual current or former management-
level employees are insured, the Banks are the owners and sole or partial beneficiaries. At December 31, 2012 and 2011, the cash surrender
value of these policies was $59.9 million and $58.6 million, respectively. The Banks are exposed to credit risk to the extent an insurance company
is unable to fulfill its financial obligations under a policy. In order to mitigate this risk, the Banks use a variety of insurance companies and
regularly monitor their financial condition.
Note 15: EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST
The Company established for eligible employees an ESOP and related trust that became effective upon the former mutual holding company’s
conversion to a stock-based holding company. Eligible employees of Banner Bank as of January 1, 1995 and eligible employees of the Banks
or Company employed after such date who have been credited with at least 1,000 hours during a twelve-month period are participants.
In 1995, the ESOP borrowed $8.7 million from the Company in order to purchase the common stock. The loan is repaid principally from the
Company’s contributions to the ESOP over a period not to exceed 25 years , and the collateral for the loan is the unreleased, restricted common
stock purchased by the ESOP. Contributions to the ESOP are discretionary. The interest rate for the loan is 8.75%. Shares are released to
participants for allocation based on the cumulative debt service paid to the Company by the ESOP divided by cumulative debt service paid to
128
date plus the scheduled debt service remaining. Dividends on allocated shares are distributed to the participants as additional earnings. Dividends
on unallocated shares are used to reduce the Company’s contribution to the ESOP or offset administrative expenses of the ESOP.
Participants generally become 100% vested in their ESOP account after seven years of credited service or if their service was terminated due to
death, early retirement, permanent disability or a change in control of the Company. Prior to the completion of one year of credited service, a
participant who terminates employment for reasons other than death, retirement, disability or change in control of the Company will not receive
any benefit. Forfeitures will be reallocated among remaining participating employees in the same proportion as contributions. Benefits are
payable upon death, retirement, early retirement, disability or separation from service. The contributions to the ESOP are not fixed, so benefits
payable under the ESOP cannot be estimated.
No ESOP contributions were made for the years ended December 31, 2012, 2011 or 2010 and no payments were made on the loan in those years.
Dividends on unallocated ESOP shares for the year ended December 31, 2012, 2011 and 2010 were $1,374, $3,434 and $9,615, respectively. As
of December 31, 2012, the Company had 34,340 unearned, restricted shares remaining to be released to the ESOP. The fair value of unearned,
restricted shares held by the ESOP trust was $1.1 million at December 31, 2012. The ESOP held 129,271 allocated, earned shares at December 31,
2012. No payments were made on the loan for the years ended December 31, 2012, 2011 and 2010. The balance of the ESOP loan was $2.5
million at December 31, 2012, with accrued interest of $1.3 million.
Note 16: STOCK-BASED COMPENSATION PLANS
The Company operates the following stock-based compensation plans as approved by the shareholders: the 1996 Stock Option Plan, the 1998
Stock Option Plan and the 2001 Stock Option Plan (collectively, SOPs) and the Banner Corporation 2012 Restricted Stock Plan. In addition,
during 2006 the Board of Directors approved the Banner Corporation Long-Term Incentive Plan, an account-based benefit plan which for
reporting purposes is considered a stock appreciation rights plan.
Restricted Stock Grants. The Company granted shares of restricted common stock to Mark J. Grescovich, President and Chief Executive Officer
of Banner Bank and Banner Corporation on August 22, 2010 and on August 23, 2011. The restricted shares were granted to Mr. Grescovich in
accordance with his employment agreement, which, as an inducement material to his joining the Company and the Bank, provided for the granting
of restricted shares on the six-month and the 18-month anniversaries of the effective date of the agreement. The shares vest in one-third annual
increments over the subsequent three-year periods following the grants. Under the 2012 Restricted Stock Plan, which was approved by
shareholders on April 24, 2012, the Company is authorized to issue up to 300,000 shares of its common stock to provide a means for attracting
and retaining highly skilled officers of Banner Corporation and its affiliates. Shares granted under the Plan have a minimum vesting period of
three years. The Plan will continue in effect for a term of ten years, after which no further awards may be granted. Concurrent with the approval
of the Plan was the approval of a grant of $300,000 of restricted stock (14,535 restricted shares) to Mr. Grescovich. Subsequent to that initial
issuance from this new plan was the issuance of 78,500 additional shares to certain other officers of the Company. All of these shares also vest
in one-third annual increments over the subsequent three-year period following the grant.
The expense associated with restricted stock was $434,000 and $111,000 and 28,000 respectively, for the years ended December 31, 2012, 2011
2010. Unrecognized compensation expense for these awards as of December 31, 2012 was $1.8 million and will be amortized over the next 33
months.
A summary of the Company's unvested Restricted Stock activity during the years ended December 31, 2010, 2011 and 2012 follows:
Unvested at December 31, 2009
Granted
Vested
Forfeited
Unvested at December 31, 2010
Granted
Vested
Forfeited
Unvested at December 31, 2011
Granted
Vested
Forfeited
Unvested at December 31, 2012
129
Weighted
Average
Grant-Date
Fair Value
—
15.09
—
—
15.09
14.13
15.09
—
14.50
21.77
14.60
21.94
20.59
Shares
— $
16,565
—
—
16,565
17,692
(5,522)
—
28,735
92,035
(11,419)
(1,500)
107,851
Stock Options. Under the SOPs, Banner reserved 2,284,186 shares for issuance pursuant to the exercise of stock options to be granted to directors
and employees. Authority to grant additional options under the 1996 Stock Option Plan terminated on July 26, 2006. Authority to grant additional
options under the 1998 Stock Option Plan terminated on July 24, 2008 with all options having been granted. Authority to grant additional options
under the 2001 Stock Option Plan terminated on April 20, 2011. The exercise price of the stock options is set at 100% of the fair market value
of the stock price on the date of grant. Options granted vest at a rate of 20% per year from the date of grant and any unexercised incentive stock
options will expire ten years after date of grant or 90 days after employment or service ends.
During the years ended December 31, 2012, 2011 and 2010, the Company did not grant any stock options. Additionally, there were no significant
modifications made to any stock option grants during the period. The fair values of stock options granted are amortized as compensation expense
on a straight-line basis over the vesting period of the grant.
For the years ended December 31, 2012, 2011 and 2010, stock-based compensation costs related to the SOPs were $7,000, $25,000 and $53,000,
respectively. The SOPs' stock option grant compensation costs are generally based on the fair value calculated from the Black-Scholes option
pricing on the date of the grant award. The Black-Scholes model assumes an expected stock price volatility based on the historical volatility at
the date of the grant and an expected term based on the remaining contractual life of the vesting period. The Company bases the estimate of
risk-free interest rate on the Treasury's Constant Maturities Indices in effect at the time of the grant. The dividend yield is based on the current
quarterly dividend in effect at the time of the grant.
The Company is required to estimate potential forfeitures of stock option grants and adjust compensation cost recorded accordingly. The estimate
of forfeitures is adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such
estimates. Changes in estimated forfeitures are recognized through a cumulative catch-up adjustment in the period of change and also impact
the amount of stock compensation expense to be recognized in future periods.
A summary of the Company’s stock option award activity (post reverse split) for the years ended December 31, 2010, 2011 and 2012 follows:
Weighted
Average
Exercise Price
Shares
Weighted
Average
Remaining
Contractual
Term, In Years
Aggregate
Intrinsic Value
Outstanding at December 31, 2009
70,769
$
156.38
3.8
n/a
Granted
Exercised
Forfeited
Outstanding at December 31, 2010
Granted
Exercised
Forfeited
Outstanding at December 31, 2011
Granted
Exercised
Forfeited
Outstanding at December 31, 2012
Outstanding at December 31, 2012, net of expected forfeitures
Exercisable at December 31, 2012
—
—
(9,044)
61,725
—
—
(9,996)
51,729
—
—
(9,208)
42,521
—
42,521
—
—
117.39
162.12
—
—
127.54
168.98
—
—
145.97
173.98
—
—
3.1
n/a
2.4
n/a
1.75
n/a
1.75
n/a
n/a
The intrinsic value of stock options is calculated as the amount by which the market price of Banner's common stock exceeds the exercise price
at the time of exercise or the end of the period as applicable.
130
A summary of the Company’s unvested stock option activity for the years ended December 31, 2010, 2011 and 2012 follows:
Shares
Weighted Average
Grant-Date
Fair Value
Unvested at December 31, 2009
5,247
$
Granted
Vested
Forfeited
Unvested at December 31, 2010
Granted
Vested
Forfeited
Unvested at December 31, 2011
Granted
Vested
Forfeited
Unvested at December 31, 2012
—
(2,247)
—
3,000
—
(1,500)
—
1,500
—
(1,500)
—
—
54.74
—
57.47
—
52.78
—
57.12
—
48.37
—
48.37
—
—
At December 31, 2012, financial data pertaining to outstanding stock options was as follows:
Exercise Price
Weighted Average
Exercise Price of
Option Shares
Granted
Number of Option
Shares Granted
Weighted Average
Option Shares
Vested and
Exercisable
Weighted Average
Exercise Price of
Option Shares
Exercisable
Remaining
Contractual Life
$
$0.00 to $110.00
$110.01 to $184.00
$184.01 to $220.00
greater than $220.00
109.69
156.52
203.76
221.97
173.98
11,193
11,657
9,643
10,028
42,521
$
11,193
11,657
9,643
10,028
42,521
0.6 years
0.3 years
0.9 years
0.5 years
109.69
156.52
203.76
221.97
173.98
During the year ended December 31, 2012, there were no exercises of stock options. Cash was not used to settle any equity instruments previously
granted. The Company issues shares from authorized but unissued shares upon the exercise of stock options. The Company does not currently
expect to repurchase shares from any source to satisfy such obligations under the SOPs.
The following are the stock-based compensation costs recognized in the Company’s consolidated statements of operations for the years ended
December 31, 2012, 2011 and 2010 (in thousands):
Salary and employee benefits
Decrease in provision for income taxes
Decrease in equity, net
Years Ended December 31
2012
2011
2010
$
$
$
11
(4)
7
$
$
39
(14)
25
$
83
(30)
53
Banner Corporation Long-Term Incentive Plan: In June 2006, the Board of Directors adopted the Banner Corporation Long-Term Incentive
Plan effective July 1, 2006. The Plan is an account-based type of benefit, the value of which is directly related to changes in the value of Company
common stock, dividends declared on Company common stock and changes in Banner Bank’s average earnings rate, and is considered a stock
appreciation right (SAR). Each SAR entitles the holder to receive cash, upon vesting, equal to the excess of the fair market value of a share of
the Company’s common stock on the date of exercise over the fair market value of such share on the date granted plus, for some grants, the
dividends declared on the stock from the date of grant to the date of vesting. On April 27, 2008, the Board of Directors amended the Plan and
also authorized the repricing of certain awards to non-executive officers based upon the price of Banner common stock three business days
131
following the public announcement of the Company’s earnings for the quarter ended March 31, 2008. The primary objective of the Plan is to
create a retention incentive by allowing officers who remain with the Company or the Banks for a sufficient period of time to share in the increases
in the value of Company stock. Detailed information with respect to the Plan and the amendments to the Plan were disclosed on Forms 8-K
filed with SEC on July 19, 2006 and May 6, 2008. The Company re-measures the fair value of SARs each reporting period until the award is
settled and compensation expense is recognized each reporting period for changes in fair value and vesting. The Company recognized
compensation expense of $314,000, $148,000, and $228,000, respectively, for the years ended December 31, 2012, 2011 and 2010 related to
the increase in the fair value of SARs and additional vesting during the period. At December 31, 2012, the aggregate liability related to SARs
was $591,000 and is included in deferred compensation.
Note 17: PREFERRED STOCK AND RELATED WARRANT
On November 21, 2008, as part of the Capital Purchase Program established by the Treasury under the Emergency Economic Stabilization Act
of 2008 (the EESA), the Company entered into a Purchase Agreement with Treasury pursuant to which the Company issued and sold to Treasury
124,000 shares of Series A Preferred Stock, having a liquidation preference of $1,000 per share ($124 million liquidation preference in the
aggregate), and as more fully explained below, a ten-year warrant to purchase up to 243,998 shares (post reverse-split) of the Company’s common
stock, par value $0.01 per share, at an initial exercise price of $76.23 per share (post reverse-split), for an aggregate purchase price of $18.6
million in cash. The warrant issued is immediately exercisable, in whole or in part, has a ten-year term and the number of shares is subject to
certain customary anti-dilution and other adjustments. The warrant is not subject to any contractual restrictions on transfer. The Company has
granted the warrant holder piggyback registration rights for the warrant and the common stock underlying the warrant and has agreed to take
such other steps as may be reasonably requested to facilitate the transfer of the warrant and the common stock underlying the warrant. The
holder of the warrant is not entitled to any common stockholder rights. The Treasury agreed not to exercise voting power with respect to any
shares of common stock of the Company issued to it upon exercise of the warrant.
On March 29, 2012, the Company's $124 million of Series A Preferred Stock was sold by the Treasury as part of its efforts to manage and recover
its investments under the TARP. While the sale of these preferred shares to new owners did not result in any proceeds to the Company and did
not change the Company's capital position or accounting for these securities, it did eliminate restrictions put in place by the Treasury on TARP
recipients. The Treasury retained its related warrant to purchase up to $18.6 million in Banner common stock.
Subsequent to March 29, 2012, the Company repurchased or redeemed all of its Series A Preferred Stock, realizing gains aggregating $2.5
million, which was partially offset by accelerated amortization of a portion of the initial discount recorded at the issuance of the Series A Preferred
Stock. As a result, the accrual for the quarterly dividend was reduced by the retirement of these shares. As of December 31, 2012, all of the
Series A Preferred Stock had been retired.
Note 18: REGULATORY CAPITAL REQUIREMENTS
Banner Corporation is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy
requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (BHCA), and the regulations of the Federal
Reserve. Banner Bank and Islanders Bank, as state-chartered federally insured commercial banks, are subject to the capital requirements
established by the FDIC. The Federal Reserve requires Banner to maintain capital adequacy that generally parallels the FDIC requirements.
Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. An institution’s category depends upon where its capital levels are in relation to
relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure and certain other factors. The federal
banking agencies have adopted regulations that implement this statutory framework. Under these regulations, an institution is treated as well
capitalized if its ratio of total capital to risk-weighted assets is 10% or more, its ratio of core capital to risk-weighted assets is 6% or more, its
ratio of core capital to adjusted total assets (leverage ratio) is 5% or more, and it is not subject to any federal supervisory order or directive to
meet a specific capital level. In order to be adequately capitalized, an institution must have a total risk-based capital ratio of not less than 8%,
a core capital to risk-weighted assets ratio of not less than 4%, and a leverage ratio of not less than 4%. Any institution which is neither well
capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions which become
more extensive as an institution becomes more severely undercapitalized. Failure by either Banner Bank and Islanders Bank to comply with
applicable capital requirements would, if unremedied, result in progressively more severe restrictions on their respective activities and lead to
enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and,
ultimately, the appointment of the FDIC as receiver or conservator. Banking regulators will take prompt corrective action with respect to
depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review
may be dependent on compliance with capital requirements.
FDIC regulations recognize two types, or tiers, of capital: core (Tier 1) capital and supplementary (Tier 2) capital. Tier 1 capital generally
includes common stockholders’ equity and qualifying noncumulative perpetual preferred stock, less most intangible assets. Tier 2 capital, which
is recognized up to 100% of Tier 1 capital for risk-based capital purposes (after any deductions for disallowed intangibles and disallowed deferred
tax assets), includes such items as qualifying general loan loss reserves (up to 1.25% of risk-weighted assets), cumulative perpetual preferred
stock, long-term preferred stock, certain perpetual preferred stock, hybrid capital instruments including mandatory convertible debt, term
subordinated debt, intermediate-term preferred stock (original average maturity of at least five years), and net unrealized holding gains on equity
132
securities (subject to certain limitations); provided, however, the amount of term subordinated debt and intermediate term preferred stock that
may be included in Tier 2 capital for risk-based capital purposes is limited to 50% of Tier 1 capital.
The FDIC currently measures an institution’s capital using a leverage limit together with certain risk-based ratios. The FDIC’s minimum leverage
capital requirement specifies a minimum ratio of Tier 1 capital to average total assets. Most banks are required to maintain a minimum leverage
ratio of at least 3% to 4% of total assets. The FDIC retains the right to require a particular institution to maintain a higher capital level based
on an institution’s particular risk profile.
FDIC regulations also establish a measure of capital adequacy based on ratios of qualifying capital to risk-weighted assets. Assets are placed
in one of four categories and given a percentage weight—0%, 20%, 50% or 100%—based on the relative risk of the category. In addition, certain
off-balance-sheet items are converted to balance-sheet credit equivalent amounts, and each amount is then assigned to one of the four
categories. Under the guidelines, the ratio of total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8%, and the
ratio of Tier 1 capital to risk-weighted assets must be at least 4%. In evaluating the adequacy of a bank’s capital, the FDIC may also consider
other factors that may affect the bank’s financial condition. Such factors may include interest rate risk exposure, liquidity, funding and market
risks, the quality and level of earnings, concentration of credit risk, risks arising from nontraditional activities, loan and investment quality, the
effectiveness of loan and investment policies, and management’s ability to monitor and control financial operating risks.
FDIC capital requirements are designated as the minimum acceptable standards for banks whose overall financial condition is fundamentally
sound, which are well-managed and have no material or significant financial weaknesses. The FDIC capital regulations state that, where the
FDIC determines that the financial history or condition, including off-balance-sheet risk, managerial resources and/or the future earnings prospects
of a bank are not adequate and/or a bank has a significant volume of assets classified substandard, doubtful or loss or otherwise criticized, the
FDIC may determine that the minimum adequate amount of capital for the bank is greater than the minimum standards established in the
regulation.
133
The following table shows the regulatory capital ratios of the Company and the Banks and the minimum regulatory requirements (dollars in
thousands):
Actual
Minimum for Capital
Adequacy Purposes
Minimum to be
Categorized as “Well-
Capitalized” Under
Prompt Corrective Action
Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2012:
The Company—consolidated:
Total capital to risk-weighted assets
Tier 1 capital to risk-weighted assets
Tier 1 leverage capital to average assets
$
581,796
538,485
538,485
16.96% $
15.70
12.74
274,460
137,230
169,035
8.00%
4.00
4.00
n/a
n/a
n/a
n/a
n/a
n/a
Banner Bank:
Total capital to risk- weighted assets
Tier 1 capital to risk- weighted assets
Tier 1 leverage capital to average assets
Islanders Bank:
Total capital to risk- weighted assets
Tier 1 capital to risk- weighted assets
Tier 1 leverage capital to average assets
December 31, 2011:
The Company—consolidated:
533,128
492,025
492,025
32,913
30,558
30,558
16.38
15.12
12.29
17.53
16.28
13.02
260,390
130,195
160,104
15,019
7,509
9,388
8.00
4.00
4.00
8.00
4.00
4.00
$
325,488
195,293
200,130
10.00%
6.00
5.00
18,773
11,264
11,735
10.00
6.00
5.00
Total capital to risk-weighted assets
Tier 1 capital to risk-weighted assets
Tier 1 leverage capital to average assets
$
615,092
572,036
572,036
18.07% $
16.80
13.44
272,344
136,172
170,242
8.00%
4.00
4.00
n/a
n/a
n/a
n/a
n/a
n/a
Banner Bank:
Total capital to risk- weighted assets
Tier 1 capital to risk- weighted assets
Tier 1 leverage capital to average assets
Islanders Bank:
Total capital to risk- weighted assets
Tier 1 capital to risk- weighted assets
Tier 1 leverage capital to average assets
511,594
470,668
470,668
30,627
28,237
28,237
15.81
14.54
11.71
16.06
14.81
12.08
258,900
129,450
160,721
15,255
7,627
9,351
8.00
4.00
4.00
8.00
4.00
4.00
$
323,625
194,175
200,902
10.00%
6.00
5.00
19,068
11,441
11,689
10.00
6.00
5.00
At December 31, 2012, Banner Corporation and the Banks each exceeded all regulatory capital adequacy requirements. There have been no
conditions or events since December 31, 2012 that have materially adversely changed the Tier 1 or Tier 2 capital of the Company or the
Banks. However, events beyond the control of the Banks, such as weak or depressed economic conditions in areas where the Banks have most
of their loans, could adversely affect future earnings and, consequently, the ability of the Banks to meet their respective capital requirements. The
Company may not declare or pay cash dividends on, or repurchase, any of its shares of common stock if the effect thereof would cause equity
to be reduced below applicable regulatory capital maintenance requirements or if such declaration and payment would otherwise violate regulatory
requirements.
Note 19: CONTINGENCIES
In the normal course of business, the Company and/or its subsidiaries have various legal proceedings and other contingent matters
outstanding. These proceedings and the associated legal claims are often contested and the outcome of individual matters is not always
predictable. These claims and counter-claims typically arise during the course of collection efforts on problem loans or with respect to action
to enforce liens on properties in which the Banks hold a security interest. Based upon the information known to management at this time, the
Company and the Banks are not a party to any legal proceedings that management believes would have a material adverse effect on the results
of operations or consolidated financial position at December 31, 2012.
In connection with certain asset sales, the Banks typically make representations and warranties about the underlying assets conforming to specified
guidelines. If the underlying assets do not conform to the specifications, the Bank may have an obligation to repurchase the assets or indemnify
134
the purchaser against any loss. The Banks believe that the potential for material loss under these arrangements is remote. Accordingly, the fair
value of such obligations is not material.
In February 2009, for the first time in its history, the State of Washington’s Public Deposit Protection Commission assessed all Qualified Public
Depositories participating in the State’s public deposit program an amount that, in aggregate, covered the uninsured portion of the public funds
on deposit at a failed Washington bank. Generally, the maximum liability should any member(s) of the State’s public deposit program default
on its uninsured public funds is limited to 10% of the public funds held by the Banks. A similar program is also in place in Oregon, where
Banner Bank also holds public deposits. Should other bank failures occur in either state, the Banks could be subject to additional assessments;
however, the rules for participation have been revised to require 100% collateralization of these deposits, which serves to significantly limit the
contingent liability that currently exists for Qualified Public Depositories. As a result of these collateralization requirements, the Banks have
generally sought to reduce their reliance on public funds since February 2009; however, public funds increased by $1 million in 2012 after
decreasing $7 million and $20 million in the years ended December 31, 2011 and 2010, respectively. Public funds totaled $140 million at
December 31, 2012.
Note 20: INTEREST RATE RISK
The financial condition and operation of the Company are influenced significantly by general economic conditions, including the absolute level
of interest rates as well as changes in interest rates and the slope of the yield curve. The Company’s profitability is dependent to a large extent
on its net interest income, which is the difference between the interest received from its interest-earning assets and the interest expense incurred
on its interest-bearing liabilities.
The activities of the Company, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk
that changes in market interest rates will have an adverse effect on the institution’s earnings and underlying economic value. Interest rate risk
is determined by the maturity and repricing characteristics of an institution’s assets, liabilities and off-balance-sheet contracts. Interest rate risk
is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the
primary market risk impacting the Company’s financial performance.
The greatest source of interest rate risk to the Company results from the mismatch of maturities or repricing intervals for rate-sensitive assets,
liabilities and off-balance-sheet contracts. Additional interest rate risk results from mismatched repricing indices and formula (basis risk and
yield curve risk), product caps and floors, and early repayment or withdrawal provisions (option risk), which may be contractual or market
driven, that are generally more favorable to customers than to the Company.
The Company’s primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the
dynamics of balance sheet, interest rate and spread movements, and to quantify variations in net interest income and economic value of equity
resulting from those movements under different rate environments. Another monitoring tool used by the Company to assess interest rate risk is
gap analysis. The matching of repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets
and liabilities are interest sensitive and by monitoring the Company’s interest sensitivity gap. Management is aware of the sources of interest
rate risk and in its opinion actively monitors and manages it to the extent possible, and considers that the Company’s current level of interest
rate risk is reasonable.
Note 21: OTHER INTANGIBLE ASSETS AND MORTGAGE SERVICING RIGHTS
At December 31, 2012, intangible assets consisted primarily of CDI, which are amounts recorded in business combinations or deposit purchase
transactions related to the value of transaction-related deposits and the value of the customer relationships associated with the deposits.
The Company amortizes CDI over their estimated useful life and reviews them at least annually for events or circumstances that could impact
their recoverability. The CDI assets shown in the table below represent the value ascribed to the long-term deposit relationships acquired in
three separate bank acquisitions during 2007. These intangible assets are being amortized using an accelerated method over estimated useful
lives of eight years. The CDI assets are not estimated to have a significant residual value. Other intangible assets are amortized over their useful
lives and are also reviewed for impairment.
135
The following table summarizes the changes in the Company’s other intangibles for the years ended December 31, 2010, 2011 and 2012 (in
thousands):
Balance, December 31, 2009
Amortization
Balance, December 31, 2010
Amortization
Balance, December 31, 2011
Amortization
Balance, December 31, 2012
Core Deposit
Intangibles
Other
Total
$
11,057
$
13
$
(2,459)
8,598
(2,276)
6,322
(2,092)
(2)
11
(2)
9
(9)
$
4,230
$
— $
11,070
(2,461)
8,609
(2,278)
6,331
(2,101)
4,230
Estimated amortization expense in future years with respect to existing intangibles as of December 31, 2012 (in thousands):
Year Ended
December 31, 2013
December 31, 2014
December 31, 2015
Net carrying amount
Core Deposit
Intangibles
Other
Total
$
$
$
1,908
1,724
598
4,230
$
— $
—
—
— $
1,908
1,724
598
4,230
Mortgage servicing rights are reported in other assets. Mortgage servicing rights are initially reported at fair value and are amortized in proportion
to, and over the period of, the estimated future net servicing income of the underlying financial assets. Mortgage servicing rights are subsequently
evaluated for impairment based upon the fair value of the rights compared to the amortized cost (remaining unamortized initial fair value). If
the fair value is less than the amortized cost, a valuation allowance is created through an impairment charge to servicing fee income. However,
if the fair value is greater than the amortized cost, the amount above the amortized cost is not recognized in the carrying value. In 2012, the
Company recorded $400,000 in impairment charges against mortgage servicing rights. In 2011 and in 2010, the Company did not record an
impairment charge. Loans serviced for others totaled $1.031 billion and $773 million at December 31, 2012 and 2011, respectively. Custodial
accounts maintained in connection with this servicing totaled $5.0 million and $3.4 million at December 31, 2012 and 2011, respectively.
An analysis of the mortgage servicing rights for the years ended December 31, 2012, 2011 and 2010 is presented below (in thousands):
Balance, beginning of the year
Amounts capitalized
Amortization (1)
Valuation adjustments in the period
Balance, end of the year
Years Ended December 31
2012
2011
2010
$
$
5,584
$
5,441
$
3,662
(2,602)
(400)
1,928
(1,785)
—
6,244
$
5,584
$
5,703
1,736
(1,998)
—
5,441
(1) Amortization of mortgage servicing rights is recorded as a reduction of loan servicing income and any unamortized balance is fully
written off if the loan repays in full.
Note 22: FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has elected to record certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (that is, not a forced liquidation
or distressed sale). The GAAP standard (ASC 820, Fair Value Measurements) establishes a consistent framework for measuring fair value and
disclosure requirements about fair value measurements. Among other things, the standard requires us to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent
sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair
value hierarchy:
136
• Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with
sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the
most reliable evidence of fair value and shall be used to measure fair value whenever available.
• Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less
active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data. Our
use of Level 2 measurements is generally based upon a matrix pricing model from an investment reporting and valuation service. Matrix
pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific
securities, but rather by relying on the securities’ relationship to other benchmark quoted securities.
• Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing
models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value
requires significant management judgment or estimation; also includes observable inputs from non-binding single dealer quotes not
corroborated by observable market data. In developing Level 3 measurements, management incorporates whatever market data might
be available and uses discounted cash flow models where appropriate. These calculations include projections of future cash flows,
including appropriate default and loss assumptions, and market based discount rates.
The estimated fair value amounts of financial instruments have been determined by the Company using available market information and
appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value
amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation
techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This
lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Transfers between levels
of the fair value hierarchy are deemed to occur at the end of the reporting period.
Items Measured at Fair Value on a Recurring Basis:
Banner records trading account securities, securities available-for-sale, FHLB debt, junior subordinated debentures and certain derivative
transactions at fair value on a recurring basis.
• The securities assets primarily consist of U.S. Government and agency obligations, municipal bonds, corporate bonds, single issue trust
preferred securities (TPS), pooled trust preferred collateralized debt obligation securities (TRUP CDO), mortgage-backed securities,
asset-backed securities, equity securities and certain other financial instruments.
From mid-2008 through the current year, the lack of active markets and market participants for certain securities resulted in an increase
in Level 3 measurements. This has been particularly true for our TRUP CDO securities. As of December 31, 2012, Banner owned $32
million in current par value of these securities. The market for TRUP CDO securities is inactive, which was evidenced first by a
significant widening of the bid-ask spread in the brokered markets in which TRUP CDOs trade and then by a significant decrease in
the volume of trades relative to historical levels. The new issue market is also inactive as almost no new TRUP CDOs have been issued
since 2007. There are still very few market participants who are willing and/or able to transact for these securities. Thus, a low market
price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit
problems with a particular issuer or of the fair value of the security.
Given these conditions in the debt markets and the absence of observable transactions in the secondary and new issue markets,
management determined that for the TRUP CDOs at December 31, 2012 and 2011:
• The few observable transactions and market quotations that were available were not reliable for purposes of determining fair
value,
• An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and
minimizes the use of unobservable inputs was equally or more representative of fair value than the market approach valuation
technique, and
• The Company’s TRUP CDOs should be classified exclusively within Level 3 of the fair value hierarchy because of the significant
assumptions required to determine fair value at the measurement date.
The TRUP CDO valuations were derived using input from independent third parties who used proprietary cash flow models for analyzing
collateralized debt obligations. Their approaches to determining fair value involve considering the credit quality of the collateral,
assuming a level of defaults based on the probability of default of each underlying trust preferred security, creating expected cash flows
for each TRUP CDO security and discounting that cash flow at an appropriate risk-adjusted rate plus a liquidity premium.
Where appropriate, management reviewed the valuation methodologies, and assumptions used by the independent third party providers
and for certain securities determined that the fair value estimates were reasonable and utilized those estimates in the Company’s reported
financial statements, while for other securities management adjusted the third party providers modeling to be more reflective of the
137
characteristics of the Company’s remaining TRUP CDOs. The result of this fair value analysis of these Level 3 measurements was a
fair value gain of $3.3 million for the year-ended December 31, 2012. This gain was primarily the result of a reduction in the spread
between the benchmark credit equivalent indices used to establish an appropriate discount rate and a similar maturity point on the
interest rate swap curve. In management's opinion the reduction in this spread was consistent with a general market tightening in credit
spreads supported by other market observations.
At December 31, 2012, Banner also directly owned approximately $19 million in amortized cost of single issuer TPS securities for
which no market data or independent valuation source is available. Similar to the TRUP CDOs above, there were too few, if any,
issuances of new TPS securities or sales of existing TPS securities to provide Level 1 or even Level 2 fair value measurements for these
securities. Management, therefore, utilized a discounted cash-flow model to calculate the present value of each security’s expected
future cash flows to determine their respective fair values. Management took into consideration the limited market data that was available
regarding similar securities, assessed the performance of the three individual issuers of TPS securities owned by the Company and, in
June 2012, concluded that each had demonstrated sufficient improvement in asset quality, capital position and general performance
measures to warrant a reduction in the discount rate used in fair value modeling from the level used in prior periods. At year end, the
Company again sought input from independent third parties to help it establish an appropriate set of parameters to identify a reasonable
range of discount rates for use in its fair value model. In addition, management concluded that the general market tightening of credit
spreads reflected in the TRUP CDO valuations was also appropriate to apply to the valuation of the TPS securities. These factors were
then incorporated into the model at December 31, 2012, and discount rates equal to three-month LIBOR plus 525 basis points were
used to calculate the respective fair values of these securities, compared to three-month LIBOR plus 600-800 basis points at December 31,
2011. The result of this change in the discount rates of this Level 3 fair value measurement was a fair value gain of $2.3 million in the
year ended December 31, 2012. The Company has and will continue to assess the appropriate fair value hierarchy for determination
of these fair values on a quarterly basis.
For all other trading securities and securities available-for-sale we used matrix pricing models from investment reporting and valuation
services. Management considers this to be a Level 2 input method.
• Fair valuations for FHLB advances are estimated using fair market values provided by the lender, the FHLB of Seattle. The FHLB of
Seattle prices advances by discounting the future contractual cash flows for individual advances using its current cost of funds curve
to provide the discount rate. Management considers this to be a Level 2 input method.
• The fair valuations of junior subordinated debentures (TPS-related debt that the Company has issued) were also valued using discounted
cash flows. These debentures carry interest rates that reset quarterly, using the three-month LIBOR index plus spreads of 1.38% to
3.35%. While the quarterly reset of the index on this debt would seemingly keep its fair value reasonably close to book values, the
disparity in the fixed spreads above the index and the inability to determine realistic current market spreads, due to lack of new issuances
and trades, resulted in having to rely more heavily on assumptions about what spread would be appropriate if market transactions were
to take place. In periods prior to the third quarter of 2008, the discount rate used was based on recent issuances or quotes from brokers
on the date of valuation for comparable bank holding companies and was considered to be a Level 2 input method. However, as noted
above in the discussion of TPS and TRUP CDOs, due to the unprecedented disruption of certain financial markets, management concluded
that there were insufficient transactions or other indicators to continue to reflect these measurements as Level 2 inputs. Due to this
reliance on assumptions and not on directly observable transactions, management believes fair value for these instruments should follow
a Level 3 input methodology. From March 2009 to March 2012, the Company used a discount rate of LIBOR plus 800 basis points to
value its junior subordinated debentures. However, similar to the discussion above about the TPS securities, in June 2012, management
assessed the performance of Banner and concluded that it had demonstrated sufficient improvement in asset quality, capital position
and other performance measures to project sustainable profitability for the foreseeable future sufficient to warrant a reduction in the
discount rate used in its fair value modeling. Since the discount rate used in the fair value modeling is the most sensitive unobservable
estimate in the calculation, the Company again utilized input from the same independent third party noted above to help it establish an
appropriate set of parameters to identify a reasonable range of discount rates for use in its fair value model. In valuing the debentures
at June 30, 2012, these changes in credit quality were the primary factor contributing to a reduction in the discount rate from 800 basis
points to 550 basis points. In further valuing the debentures at September 30, 2012, management evaluated the general market tightening
of credit spreads as noted above and for the discount rate used the period-ending three-month LIBOR plus 525 basis points. This same
spread of 525 basis points was used again at December 31, 2012, resulting in a fair value loss on these instruments of $23.1 million for
the year ended December 31, 2012.
• Derivative instruments include interest rate commitments related to one- to four family loans and residential mortgage backed securities
and interest rate swaps. The fair value of interest rate lock commitments and forward sales commitments are estimated using quoted
or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical trends,
where appropriate. The fair value of interest rate swaps is determined by using current market quotes on similar instruments provided
by active broker/dealers in the swap market. Management considers these to be Level 2 input methods. The changes in the fair value
of all of these derivative instruments are primarily attributable to changes in the level of market interest rates. The Company has elected
to record the fair value of these derivative instruments on a net basis.
138
The following tables present financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 and 2011 (in
thousands):
December 31, 2012
Level 1
Level 2
Level 3
Total
— $
—
—
—
—
—
—
—
—
—
—
—
—
—
$
96,980
44,938
10,729
277,757
42,516
472,920
1,637
5,684
—
28,107
63
35,491
510
8,353
— $
—
—
—
—
—
—
—
35,741
—
—
35,741
—
—
96,980
44,938
10,729
277,757
42,516
472,920
1,637
5,684
35,741
28,107
63
71,232
510
8,353
— $
517,274
$
35,741
$
553,015
— $
10,304
$
10,304
—
—
—
—
73,063
73,063
195
8,353
—
—
195
8,353
— $
18,852
$
73,063
$
91,915
Assets:
Securities—available-for-sale
U.S. Government and agency
Corporate bonds
Municipal bonds
Mortgage-backed securities
Asset-backed securities
Securities—trading
U.S. Government and agency
Municipal bonds
TPS and TRUP CDOs
Mortgage-backed securities
Equity securities and other
Derivatives
Interest rate lock commitments
Interest rate swaps
Liabilities
Advances from FHLB at fair value
Junior subordinated debentures net of unamortized deferred
issuance costs at fair value
Derivatives
Interest rate forward sales commitments
Interest rate swaps
$
$
$
$
139
December 31, 2011
Level 1
Level 2
Level 3
Total
— $
—
—
—
—
—
—
—
—
—
—
—
—
$
338,971
6,260
27,309
93,255
465,795
— $
—
—
—
—
2,635
5,962
4,600
36,673
402
50,272
617
5,667
—
—
30,455
—
—
30,455
—
—
338,971
6,260
27,309
93,255
465,795
2,635
5,962
35,055
36,673
402
80,727
617
5,667
— $
522,351
$
30,455
$
552,806
— $
10,533
$
— $
10,533
—
—
—
—
49,988
49,988
617
5,666
—
—
617
5,666
— $
16,816
$
49,988
$
66,804
Assets:
Securities—available-for-sale
U.S. Government and agency
Corporate bonds
Municipal bonds
Mortgage-backed securities
Securities—trading
U.S. Government and agency
Municipal bonds
TPS and TRUP CDOs
Mortgage-backed securities
Equity securities and other
Derivatives
Interest rate lock commitments
Interest rate swaps
Liabilities
Advances from FHLB at fair value
Junior subordinated debentures net of unamortized deferred
issuance costs at fair value
Derivatives
Interest rate forward sales commitments
Interest rate swaps
$
$
$
$
140
The following table provides a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3)
on a recurring basis during the year ended December 31, 2012 and 2011 (in thousands):
Year Ended December 31, 2012
Level 3 Fair Value Inputs
TPS and TRUP
CDOs
Borrowings—
Junior Subordinated
Debentures
$
30,455
$
49,988
5,286
—
—
—
—
—
23,075
—
—
—
73,063
Beginning balance at December 31, 2011
Total gains or losses recognized
Assets gains (losses)
Liabilities (gains) losses
Purchases, issuances and settlements
Paydowns and maturities
Transfers in and/or out of Level 3
Ending balance at December 31, 2012
$
35,741
$
Beginning balance at December 31, 2010
Total gains or losses recognized
Assets gains (losses)
Liabilities (gains) losses
Purchases, issuances and settlements
Paydowns and maturities
Transfers in and/or out of Level 3
Year Ended December 31, 2011
Level 3 Fair Value Inputs
TPS and TRUP
CDOs
Borrowings—
Junior Subordinated
Debentures
$
29,661
$
48,425
794
—
—
—
—
—
1,563
—
—
—
Ending balance at December 31, 2011
$
30,455
$
49,988
The Company has elected to continue to recognize the interest income and dividends from the securities reclassified to fair value as a component
of interest income as was done in prior years when they were classified as available-for-sale. Interest expense related to the FHLB advances
and junior subordinated debentures continues to be measured based on contractual interest rates and reported in interest expense. The change
in fair value of these financial instruments has been recorded as a component of other operating income.
Items Measured at Fair Value on a Non-recurring Basis:
Carrying values of certain impaired loans are periodically evaluated to determine if valuation adjustments, or partial write-downs, should be
recorded. These non-recurring fair value adjustments are recorded when observable market prices or current appraised values of collateral
indicate a shortfall in collateral value or discounted cash flows indicate a shortfall compared to current carrying values of the related loan. If
the Company determines that the value of the impaired loan is less than the carrying value of the loan, the Company either establishes an
impairment reserve as a specific component of the allowance for loan and lease losses (ALLL) or charges off the impaired amount. The remaining
impaired loans are evaluated for reserve needs in homogenous pools within the Company’s ALLL methodology. As of December 31, 2012, the
Company reviewed all of its classified loans totaling $131 million and identified $92 million which were considered impaired. Of those $92
million in impaired loans, $63 million were individually evaluated to determine if valuation adjustments, or partial write-downs, should be
recorded, or if specific impairment reserves should be established. The $63 million had original carrying values of $66 million which have been
reduced by partial write-downs totaling $3 million. In addition to these write-downs, in order to bring the impaired loan balances to fair value,
Banner also established $6 million in specific reserves on these impaired loans. Impaired loans that were collectively evaluated for reserve
purposes within homogenous pools totaled $29 million and were found to require allowances totaling $3 million. The $29 million evaluated
for reserve purposes within homogeneous pools included $11 million of restructured loans which are currently performing according to their
restructured terms. The valuation inputs for impaired loans are considered to be Level 3 inputs.
The Company records REO (acquired through a lending relationship) at fair value on a non-recurring basis. All REO properties are recorded
at the lower of the estimated fair value of the properties, less expected selling costs, or the carrying amount of the defaulted loans. From time
to time, non-recurring fair value adjustments to REO are recorded to reflect partial write-downs based on an observable market price or current
141
appraised value of property. Banner considers any valuation inputs related to REO to be Level 3 inputs. The individual carrying values of these
assets are reviewed for impairment at least annually and any additional impairment charges are expensed to operations. For the years ended
December 31, 2012 and 2011, the Company recognized $5.2 million and $15.1 million, respectively of impairment charges related to these types
of assets.
Mortgage servicing rights are reported in other assets. Mortgage servicing rights are initially reported at fair value and are amortized in proportion
to, and over the period of, the estimated future net servicing income of the underlying financial assets. Mortgage servicing rights are subsequently
evaluated for impairment based upon the fair value of the rights compared to the amortized cost (remaining unamortized initial fair value). If
the fair value is less than the amortized cost, a valuation allowance is created through an impairment charge to servicing fee income. However,
if the fair value is greater than the amortized cost, the amount above the amortized cost is not recognized in the carrying value. In 2012, the
Company recorded $400,000 in impairment charges against mortgage servicing rights. In 2011 the Company did not record an impairment
charge. Loans serviced for others totaled $1.031 billion and $773 million at December 31, 2012 and 2011, respectively.
The following tables present financial assets and liabilities measured at fair value on a non-recurring basis and the level within the fair value
hierarchy at December 31, 2012 and 2011 (in thousands):
December 31, 2012
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Losses
Recognized
During the Year
Fair Value
$
52,475
15,778
6,244
— $
—
—
— $
—
—
$
52,475
15,778
6,244
(6,381)
(1,915)
(400)
December 31, 2011
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Losses
Recognized
During the Year
Fair Value
$
47,959
42,965
— $
—
— $
—
$
47,959
42,965
(21,902)
(7,325)
$
$
Impaired loans
REO
MSRs
Impaired loans
REO
The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable
inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring and nonrecurring basis at December
31, 2012:
Financial Instruments
Valuation Technique
Unobservable
Inputs
Weighted
Average
TPS securities
TRUP CDOs
Discounted cash flows
Discount rate
Discounted cash flows
Discount rate
Junior subordinated debentures
Discounted cash flows
Discount rate
Impaired loans
REO
MSRs
Discounted cash flows
Collateral valuations
Appraisals
Discount rate
Market values
Market values
Discounted cash flows
Prepayment rate
Discount rate
5.56%
3.83%
5.56%
various
n/a
n/a
19.80%
11.11%
TPS and TRUP CDOs: Management believes that the credit risk-adjusted spread used to develop the discount rate utilized in the fair value
measurement of our trust preferred securities and trust preferred collateralized debt obligations is indicative of the risk premium a willing market
participant would require under current market conditions for instruments with similar contractual rates and terms and conditions and issuers
with similar credit risk profiles and with similar expected probability of default. Management attributes the change in fair value of these
instruments during 2012 primarily to perceived general market adjustments to the risk premiums for these types of assets and to improved
performance of the underlying issuers. A widening of the risk-adjusted spreads subsequent to issuance of these instruments has resulted in a
142
cumulative fair value loss on these instruments; however, more recently contraction in those spreads has resulted in positive fair value adjustments
in 2012 and 2011.
Junior subordinated debentures: Similar to the trust preferred and TRUP CDOs securities discussed above, management believes that the credit
risk-adjusted spread utilized in the fair value measurement of the junior subordinated debentures is indicative of the risk premium a willing
market participant would require under current market conditions for an issuer with Banner's credit risk profile. Management attributes the
change in fair value of the junior subordinated debentures during 2012 primarily to perceived general market adjustments to the risk premiums
for these types of liabilities and to changes to our entity-specific credit risk profile as a result of improved operating performance. Future
contractions in the risk adjusted spread relative to the spread currently utilized to measure the Company's junior subordinated debentures at fair
value as of December 31, 2012, or the passage of time, will result in negative fair value adjustments. At December 31, 2012 the discount rate
utilized was based on a credit spread of 525 basis points and three month Libor of 31 basis points.
Impaired loans: Loans are considered impaired when, based on current information and events; we determine that it is probable that we will be
unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include,
but are not limited to, the financial condition of the borrower, the value of the underlying collateral and the current status of the economy.
Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a
practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. Subsequent changes
in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized
or as a reduction in the provision that would otherwise be reported.
REO: Fair value adjustments on REO are based on updated real estate appraisals which are based on current market conditions. In many of our
markets real estate sales are still slow and prices are negatively affected by an over-supply of properties for sale. These market conditions
decrease the amount of comparable sales data and increase the reliance on estimates and assumptions about current and future market conditions
and could negatively affect our operating results.
MSRs: Management believes that the discount rate utilized in the fair valuation of our MSRs is indicative of a reasonable yield expectation in
an orderly transaction between willing market participants at the measurement date. Generally, any significant increases in the prepayment
rate and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in negative fair value adjustments and
a decrease in the fair value measurement. Alternatively, a decrease in the prepayment rate and discount rate will result in a positive fair value
adjustment and increase in the fair value measurement. An increase in the weighted average life assumptions will result in a decrease in the
prepayment rate and a decrease in the weighted average life will result in an increase of the prepayment rate.
143
Fair Values of Financial Instruments:
The following table presents estimated fair values of the Company’s financial instruments as of December 31, 2012 and 2011, whether or not
recognized or recorded in the consolidated balance sheets. The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data
in the development of the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts. The carrying value and estimated fair value of financial instruments at December 31, 2012
and 2011 are as follows (in thousands):
Assets:
Cash and due from banks
Securities—trading
Securities—available-for-sale
Securities—held-to-maturity
Loans receivable held for sale
Loans receivable
FHLB stock
BOLI
Mortgage servicing rights
Derivatives
Liabilities:
Demand, interest-bearing-checking and money market
Regular savings
Certificates of deposit
FHLB advances at fair value
Junior subordinated debentures at fair value
Other borrowings
Derivatives
Off-balance-sheet financial instruments:
Commitments to originate loans
Commitments to sell loans
December 31, 2012
December 31, 2011
Carrying
Value
Estimated Fair
Value
Carrying
Value
Estimated Fair
Value
$
$
181,298
71,232
472,920
86,452
11,920
3,223,794
36,705
59,891
6,244
8,863
1,800,555
727,956
1,029,293
10,304
73,063
76,633
8,548
$
181,298
71,232
472,920
92,458
12,059
3,143,853
36,705
59,891
6,244
8,863
1,729,351
694,609
1,033,931
10,304
73,063
76,633
8,548
$
132,436
80,727
465,795
75,438
3,007
3,293,331
37,371
58,563
5,584
6,284
1,555,561
669,596
1,250,497
10,533
49,988
152,128
6,283
132,436
80,727
465,795
80,107
3,069
3,224,112
37,371
58,563
5,584
6,284
1,487,080
630,450
1,258,431
10,533
49,988
152,128
6,283
510
(195)
510
(195)
617
(617)
617
(617)
Fair value estimates, methods and assumptions are set forth below for the Company’s financial and off-balance-sheet instruments:
Cash and Due from Banks: The carrying amount of these items is a reasonable estimate of their fair value. These fair values are considered
Level 1 measures.
Securities: The estimated fair values of investment securities and mortgaged-backed securities are priced using current active market quotes,
if available, which are considered Level 1 measurements. For most of the portfolio, matrix pricing based on the securities’ relationship to other
benchmark quoted prices is used to establish the fair value. These measurements are considered Level 2. Due to the increasing credit concerns
in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads for some of the Company’s
TPS and TRUP CDO securities (see earlier discussion above in determining the securities’ fair market value), management has classified these
securities as a Level 3 fair value measure.
Loans Receivable Held for Sale: Carrying values are based on the lower of estimated fair values or book values. Fair values are estimated based
on secondary market pricing for similar loans. This is considered a Level 2 fair value measure.
Loans Receivable: Fair values are estimated first by stratifying the portfolios of loans with similar financial characteristics. Loans are segregated
by type such as multifamily real estate, residential mortgage, nonresidential mortgage, commercial/agricultural, consumer and other. Each loan
category is further segmented into fixed- and adjustable-rate interest terms and by performing and non-performing categories.
A preliminary estimate of fair value is then calculated based on discounted cash flows using as a discount rate the current rate offered on similar
products, plus an adjustment for liquidity to reflect the non-homogeneous nature of the loans. The preliminary estimate is then further reduced
by the amount of the allowance for loan losses to arrive at a final estimate of fair value.
144
The fair value of performing residential mortgages held for sale is estimated based upon secondary market sources by type of loan and terms
such as fixed or variable interest rates. Fair value for significant non-performing loans is based on recent appraisals or estimated cash flows
discounted using rates commensurate with risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and
discount rates are judgmentally determined using available market information and specific borrower information. Fair value estimates for loans
are considered Level 3 measures.
FHLB Stock: The fair value is based upon the redemption value of the stock which equates to its carrying value. This fair value is considered
a Level 1 measure.
Bank Owned Life Insurance: The fair value of BOLI policies owned are based on the various insurance contracts' cash surrender value. This
fair value is considered a Level 1 measure.
Mortgage Servicing Rights: The fair value of mortgage servicing rights is estimated using a discounted cash flow model. Assumptions used
include market discount rates, anticipated prepayment speed, delinquency rates, and fee income. The fair value estimates are also compared to
observable trades of similar portfolios, when available. Due to the limited observability of the significant inputs used in the valuation model,
particularly the discount rate and prepayment speeds; and the lack of readily available quotes or observable trades of similar assets, we consider
this fair value estimate as a Level 3 measure.
Derivative Instruments: The fair value of derivative instruments is estimated using quoted or published prices for similar instruments, adjusted
for factors such as pull-through rate assumptions based on historical information, where appropriate. Fair value estimates for derivatives are
considered Level 2 measures.
Deposit Liabilities: The fair value of deposits with no stated maturity, such as savings and checking accounts, is estimated by applying decay
rate assumptions to segregated portfolios of similar deposit types to generate cash flows which are then discounted using short-term market
interest rates. The market value of certificates of deposit is based upon the discounted value of contractual cash flows. The discount rate is
determined using the rates currently offered on comparable instruments. Fair value estimates for deposits are considered Level 3 measures.
FHLB Advances and Other Borrowings: Fair valuations for Banner’s FHLB advances are estimated using fair market values provided by the
lender, the FHLB of Seattle. The FHLB of Seattle prices advances by discounting the future contractual cash flows for individual advances
using its current cost of funds curve to provide the discount rate. This is considered to be a Level 2 input method. Other borrowings are priced
using discounted cash flows to the date of maturity based on using current rates at which such borrowings can currently be obtained. This fair
value is considered a Level 3 measure.
Junior Subordinated Debentures: Due to the increasing credit concerns in the capital markets and inactivity in the trust preferred markets that
have limited the observability of market spreads (see earlier discussion above in determining the junior subordinated debentures’ fair market
value), junior subordinated debentures have been classified as a Level 3 fair value measure. Management believes that the credit risk adjusted
spread and resulting discount rate utilized is indicative of those that would be used by market participants. Fair value estimates for these debentures
are considered Level 3 measures.
Commitments: Commitments to sell loans with notional balances of $85 million and $54 million at December 31, 2012 and 2011, respectively,
have a carrying value of $510,000 and $617,000, representing the fair value of such commitments. Interest rate lock commitments to originate
loans held for sale with notional balances of $89 million and $54 million at December 31, 2012 and 2011, respectively, have a carrying value
of ($195,000) and ($617,000). The fair value of commitments to sell loans and of interest rate locks reflect changes in the level of market interest
rates from the date of the commitment or rate lock to the date of the Company’s financial statements. Other commitments to fund loans totaled
$925 million and $780 million at December 31, 2012 and 2011, respectively, and have no carrying value at both dates, representing the cost of
such commitments. There was one commitment to purchase securities at December 31, 2012, for $11.5 million, and no commitments to purchase
or sell securities at December 31, 2011. Fair value estimates for commitments are considered Level 2 measures
Limitations: The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2012
and 2011. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have
not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may
differ significantly from the amounts presented herein.
Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated
future business. The fair value has not been estimated for assets and liabilities that are not considered financial instruments. Significant assets
and liabilities that are not financial instruments include the deferred tax assets/liabilities; land, buildings and equipment; costs in excess of net
assets acquired; and real estate held for sale.
145
Note 23: BANNER CORPORATION (PARENT COMPANY ONLY)
Summary financial information is as follows (in thousands):
Statements of Financial Condition
ASSETS
Cash
Investment in trust equities
Investment in subsidiaries
Other assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Miscellaneous liabilities
Deferred tax liability
Junior subordinated debentures at fair value
Stockholders’ equity
December 31
2012
2011
$
36,884
3,716
556,125
2,601
73,033
3,716
532,561
1,207
599,326
$
610,517
$
6,401
12,943
73,063
506,919
2,106
25,973
49,988
532,450
599,326
$
610,517
$
$
$
$
Statements of Operations
INTEREST INCOME:
Years Ended December 31
2012
2011
Certificates, time deposits and dividends
$
218
$
277
$
OTHER INCOME (EXPENSE):
Dividend income from subsidiaries
Equity in undistributed income of subsidiaries
Other income
Net change in valuation of financial instruments carried at fair value
Interest on other borrowings
Other expenses
Net income (loss) before taxes
BENEFIT FROM INCOME TAXES
61,329
23,507
55
(23,075)
(3,395)
(2,375)
56,264
(8,618)
990
9,478
46
(1,563)
(4,193)
(2,313)
2,722
(2,735)
2010
362
1,760
(58,766)
46
(730)
(4,226)
(2,818)
(64,372)
(2,476)
NET INCOME (LOSS)
$
64,882
$
5,457
$
(61,896)
146
Statements of Cash Flows
OPERATING ACTIVITIES:
Net income (loss)
Years Ended December 31
2012
2011
2010
$
64,882
$
5,457
$
(61,896)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Equity in undistributed earnings of subsidiaries
Increase (decrease) in deferred taxes
Net change in valuation of financial instruments carried at fair value
Increase in other assets
Increase (decrease) in other liabilities
Net cash provided by (used by) operating activities
INVESTING ACTIVITIES:
Funds transferred to deferred compensation trust
Additional funds invested in subsidiaries
Net cash used by investing activities
FINANCING ACTIVITIES:
Issuance of stock for stockholder reinvestment program
Redemption of senior preferred stock
Issuance of stock in secondary offering, net of costs
Cash dividends paid
Net cash provided by (used by) financing activities
NET INCREASE (DECREASE) IN CASH
CASH, BEGINNING OF PERIOD
(23,507)
(13,030)
23,075
(496)
4,941
55,865
(332)
—
(332)
36,316
(121,528)
—
(6,470)
(91,682)
(36,149)
73,033
(9,478)
(562)
1,563
1,933
(957)
(2,044)
(162)
—
(162)
21,556
—
—
(8,827)
12,729
10,523
62,510
58,766
703
730
(847)
3
(2,541)
(110)
(110,000)
(110,110)
16,201
—
161,637
(8,867)
168,971
56,320
6,190
CASH, END OF PERIOD
$
36,884
$
73,033
$
62,510
Note 24: STOCK REPURCHASES
During 2012, the Company repurchased or redeemed all of its Series A Preferred Stock, realizing gains aggregating $2.5 million, which was
partially offset by accelerated amortization of a portion of the initial discount recorded at the issuance of the Series A Preferred Stock. As a
result, the accrual for the quarterly dividend was reduced by the retirement of the repurchased shares. As of December 31, 2012, all of the Series
A Preferred Stock had been retired. The Company did not repurchase any of its common stock during the years ended December 31, 2012, 2011
or 2010.
147
Note 25: CALCULATION OF EARNINGS PER COMMON SHARE
The following tables show the calculation of earnings (loss) per common share (in thousands, except per share data):
Years Ended December 31
2012
2011
2010
Net income (loss)
$
64,882
$
5,457
$
(61,896)
Preferred stock dividend accrual
Preferred stock discount accrual
Gain on repurchase of preferred stock
(4,938)
(3,298)
2,471
(6,200)
(1,701)
—
(6,200)
(1,593)
—
Net income (loss) available to common shareholders
$
59,117
$
(2,444) $
(69,689)
Weighted average number of common shares outstanding
Basic
Diluted
Earnings (loss) per common share
Basic
Diluted
18,650
18,723
16,724
16,724
$
$
3.17
3.16
$
$
(0.15) $
(0.15) $
9,665
9,665
(7.21)
(7.21)
At December 31, 2012 there were 72,523 issued but unvested restricted stock shares that were included in the computation of diluted earnings
per share.
Options to purchase an additional 42,521 shares of common stock were not included in the computation of diluted earnings per share because
their exercise price resulted in them being anti-dilutive. Also, as of December 31, 2012, the warrant issued to the Treasury in the fourth quarter
of 2008 to purchase up to 243,998 shares (post reverse-split) of common stock was not included in the computation of diluted EPS because the
exercise price of the warrant was greater than the average market price of common shares.
Note 26: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Results of operations on a quarterly basis for the years ended December 31, 2012 and 2011 were as follows (dollars in thousands except for per
share data):
Interest income
Interest expense
Net interest income before provision for loan losses
Provision for loan losses
Net interest income
Other operating income
Other operating expenses
Income (loss) before provision for income taxes
Provision (benefit) for income taxes
Net income
Preferred stock dividend
Preferred stock discount accretion
Gain on repurchase and retirement of preferred stock
Net income available to common shareholders
Basic earnings per share
Diluted earnings per share
Cumulative dividends declared
Year Ended December 31, 2012
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$
$
$
47,198
6,072
41,126
5,000
36,126
10,971
37,913
9,184
—
9,184
1,550
454
—
7,180
0.40
0.40
0.01
$
$
$
148
$
$
$
47,265
4,975
42,290
4,000
38,290
(9,064)
35,666
(6,440)
(31,830)
25,390
1,550
454
—
23,386
1.27
1.27
0.01
$
$
$
47,174
4,476
42,698
3,000
39,698
11,684
33,355
18,027
2,407
15,620
1,227
1,216
(2,070)
15,247
0.80
0.79
0.01
45,525
3,991
41,534
1,000
40,534
13,311
34,519
19,326
4,638
14,688
611
1,174
(401)
13,304
0.69
0.69
0.01
Interest income
Interest expense
Net interest income before provision for loan losses
Provision for loan losses
Net interest income
Other operating income
Other operating expenses
Income before provision for income taxes
Provision (benefit) for income taxes
Net loss
Preferred stock dividend
Preferred stock discount accretion
Net loss available to common shareholders
Basic earnings (loss) per share
Diluted earnings (loss) per share
Cumulative dividends declared
Interest income
Interest expense
Net interest income before provision for loan losses
Provision for loan losses
Net interest income
Other operating income
Other operating expenses
Income before provision for income taxes
Provision (benefit) for income taxes
Net loss
Preferred stock dividend
Preferred stock discount accretion
Net loss available to common shareholders
Basic earnings (loss) per share
Diluted earnings (loss) per share
Cumulative dividends declared
Year Ended December 31, 2011
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$
49,663
9,607
40,056
17,000
23,056
7,246
38,144
(7,842)
—
(7,842)
1,550
426
(9,818) $
(0.61) $
(0.61)
0.07
$
49,888
8,687
41,201
8,000
33,201
9,253
40,255
2,199
—
2,199
1,550
425
$
$
224
0.01
0.01
0.01
49,561
7,833
41,728
5,000
36,728
10,340
41,038
6,030
—
6,030
1,550
425
4,055
0.24
0.24
0.01
Year Ended December 31, 2010
First
Quarter
Second
Quarter
Third
Quarter
$
55,970
17,820
38,150
14,000
24,150
7,724
35,415
(3,541)
(2,024)
(1,517)
1,550
398
$
55,634
16,693
38,941
16,000
22,941
6,186
38,024
(8,897)
(3,951)
(4,946)
1,550
399
54,250
14,328
39,922
20,000
19,922
7,652
46,328
(18,754)
23,988
(42,742)
1,550
398
$
$
$
$
48,451
6,865
41,586
5,000
36,586
7,151
38,667
5,070
—
5,070
1,550
425
3,095
0.18
0.18
0.01
Fourth
Quarter
52,228
11,471
40,757
20,000
20,757
7,586
41,034
(12,691)
—
(12,691)
1,550
398
(3,465) $
(6,895) $
(44,690) $
(14,639)
(1.12) $
(1.12)
0.07
(1.96) $
(1.96)
0.07
(2.80) $
(2.80)
0.07
(0.91)
(0.91)
0.07
$
$
$
$
$
$
Note 27: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Banks have financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of their
customers. These financial instruments include commitments to extend credit, commitments related to standby letters of credit, commitments
to originate loans held for sale, commitments to sell loans secured by one- to four-family residential properties and commitments to sell mortgage-
backed securities. These instruments involve, to varying degrees, elements of credit and interest rate risk similar to the risk involved in on-
balance sheet items recognized in our Consolidated Statements of Financial Condition.
149
The Banks exposure to credit loss in the event of nonperformance by the other party to the financial instrument from commitments to extend
credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Banks use the same credit policies
in making commitments and conditional obligations as for on-balance sheet instruments.
Outstanding commitments for which no liability has been recorded consisted of the following at the dates indicated (dollars in thousands):
Undisbursed loans and lines of credit
Standby letters of credit and financial guarantees
To originate loans
To originate loans held for sale
To sell loans secured by one- to four-family residential properties
To sell mortgage backed securities
Contract or Notional Amount
December 31, 2012
December 11, 2011
$
$
907,892
6,660
10,733
89,049
70,263
41,500
761,637
7,872
10,516
54,082
54,082
—
Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the
commitments may expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash
requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary
upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable,
inventory, property, plant and equipment, and income producing commercial properties.
Standby letters of credit are conditional commitments issued to guarantee a customer’s performance or payment to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Interest rates on residential one- to four-family mortgage loan applications are typically rate locked (committed) to customers during the application
stage for periods ranging from 30 to 60 days, the most typical period being 45 days. Historically, these loan applications with rate lock commitments
had the pricing for the sale of these loans locked with various qualified investors under a "best-efforts" delivery program at or near the time the
interest rate is locked with the customer. The Banks then attempted to deliver these loans before their rate locks expired. This arrangement
generally required delivery of the loans prior to the expiration of the rate lock. Delays in funding the loans required a lock extension. The cost
of a lock extension at times was borne by the customer and at times by the Banks. These lock extension costs have not had a material impact
to our operations. In 2012, the Company also began entering into forward commitments at specific prices and settlement dates to deliver either:
(1) residential mortgage loans for purchase by secondary market investors (i.e., Freddie Mac or Fannie Mae), or (2) mortgage-backed securities
to broker/dealers. The purpose of these forward commitments is to offset the movement in interest rates between the execution of its residential
mortgage rate lock commitments with borrowers and the sale of those loans to the secondary market investor. There were no counterparty default
losses on forward contracts during 2012 or 2011. Market risk with respect to forward contracts arises principally from changes in the value of
contractual positions due to changes in interest rates. We limit our exposure to market risk by monitoring differences between commitments to
customers and forward contracts with market investors and securities broker/dealers. In the event we have forward delivery contract commitments
in excess of available mortgage loans, the transaction is completed by either paying or receiving a fee to or from the investor or broker/dealer
equal to the increase or decrease in the market value of the forward contract. Changes in the value of rate lock commitments are recorded as
assets and liabilities as explained in Note 1: “Derivative Instruments.”
The Company has stand-alone derivative instruments in the form of interest rate swap agreements, which derive their value from underlying
interest rates (see Note 1). These transactions involve both credit and market risk. The notional amount is the amount on which calculations,
payments, and the value of the derivative are based. The notional amount does not represent direct credit exposure. Direct credit exposure is
limited to the net difference between the calculated amount to be received and paid. This difference represents the fair value of the derivative
instrument.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements. Credit risk of the
financial contract is controlled through the credit approval, limits, and monitoring procedures and management does not expect the counterparty
to fail its obligations.
150
Information pertaining to outstanding interest rate swaps at December 31, 2012 and 2011 follows (dollars in thousands):
Notional amount
Weighted average pay rate
Weighted average receive rate
Weighted average maturity in years
Unrealized gain included in total loans
Unrealized gain included in other assets
Unrealized loss included in other liabilities
December 31
2012
2011
205,505
$
117,110
4.52%
4.11%
7.9
3,300
5,053
8,353
$
$
$
4.66%
3.85%
7.7
3,559
2,108
5,666
$
$
$
$
At December 31, 2012, the Company’s interest rate swap agreements are with the Pacific Coast Bankers Bank, Wells Fargo, N.A., Credit Suisse,
and various loan customers.
151
BANNER CORPORATION
Exhibit
3{a}
3{b}
3{c}
4{a}
4{b}
10{a}
10{b}
10{c}
10{d}
10{e}
10{f}
10{g}
10{h}
10{i}
10{j}
10{k}
10{l}
Index of Exhibits
Amended and Restated Articles of Incorporation of Registrant [incorporated by reference to the Registrant's Current Report on
Form 8-K filed on April 29, 2010 (File No. 000-26584)], as amended on May 26, 2011 [incorporated by reference to the Current
Report on Form 8-K filed on June 1, 2011 (File No. 000-26584)].
Certificate of designation relating to the Company's Fixed Rate Cumulative Perpetual Preferred Stock Series A [incorporated by
reference to the Registrant's Current Report on Form 8-K filed on November 24, 2008 (File No. 000-26584)].
Bylaws of Registrant [incorporated by reference to the Registrant's Current Report on Form 8-K filed on April 1, 2011 (File No.
0-26584)].
Warrant to purchase shares of Company's common stock dated November 21, 2008 [incorporated by reference to the Registrant's
Current Report on Form 8-K filed on November 24, 2008 (File No. 000-26584)]
Letter Agreement (including Securities Purchase Agreement Standard Terms attached as Exhibit A) dated November 21, 2008
between the Company and the United States Department of the Treasury [incorporated by reference to the Registrant's Current
Report on Form 8-K filed on November 24, 2008 (File No. 000-26584)].
Executive Salary Continuation Agreement with Gary L. Sirmon [incorporated by reference to exhibits filed with the Annual Report
on Form 10-K for the year ended March 31, 1996 (File No. 0-26584)].
Employment Agreement with Michael K. Larsen [incorporated by reference to exhibits filed with the Annual Report on Form 10-
K for the year ended March 31, 1996 (File No. 0-26584)].
Employment Agreement, as amended, with Mark J. Grescovich [incorporated by reference to Exhibit 10.1 to the Current Report
on Form 8-K filed on March 28, 2012 (File No. 000-265840].
Executive Salary Continuation Agreement with Michael K. Larsen [incorporated by reference to exhibits filed with the Annual
Report on Form 10-K for the year ended March 31, 1996 (File No. 0-26584)].
1996 Stock Option Plan [incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 dated August 26,
1996 (File No. 333-10819)].
1996 Management Recognition and Development Plan [incorporated by reference to Exhibit 99.2 to the Registration Statement on
Form S-8 dated August 26, 1996 (File No. 333-10819)].
Consultant Agreement with Jesse G. Foster, dated as of December 19, 2003 [incorporated by reference to exhibits filed with the
Annual Report on Form 10-K for the year ended December 31, 2003 (File No. 0-23584)].
Employment Agreement with Gary Sirmon dated as of January 23, 2003 [incorporated by reference to exhibits filed with the Annual
Report on Form 10-K for the year ended December 31, 2003 (File No. 0-23584)].
Supplemental Retirement Plan as Amended with Jesse G. Foster [incorporated by reference to exhibits filed with the Annual Report
on Form 10-K for the year ended March 31, 1997 (File No. 0-26584)].
Employment Agreement with Lloyd W. Baker [incorporated by reference to exhibits filed with the Annual Report on Form 10-K
for the year ended December 31, 2001 (File No. 0-26584)].
Employment Agreement with D. Michael Jones [incorporated by reference to exhibits filed with the Annual Report on Form 10-K
for the year ended December 31, 2001 (File No. 0-26584)].
Supplemental Executive Retirement Program Agreement with D. Michael Jones [incorporated by reference to exhibits filed with
the Annual Report on Form 10-K for the year ended December 31, 2003 (File No. 0-26584)].
10{m}
Form of Supplemental Executive Retirement Program Agreement with Gary Sirmon, Michael K. Larsen, Lloyd W. Baker, Cynthia
D. Purcell and Paul E. Folz [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended
December 31, 2001 and the exhibits filed with the Form 8-K on May 6, 2008].
10{n}
10{o}
10{p}
10{q}
10{r}
1998 Stock Option Plan [incorporated by reference to exhibits filed with the Registration Statement on Form S-8 dated February
2, 1999 (File No. 333-71625)].
2001 Stock Option Plan [incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 dated August 8, 2001
(File No. 333-67168)].
Form of Employment Contract entered into with Cynthia D. Purcell, Richard B. Barton, Paul E. Folz and Douglas M. Bennett
[incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended December 31, 2003 (File No.
0-26584)].
2004 Executive Officer and Director Stock Account Deferred Compensation Plan [incorporated by reference to exhibits filed with
the Annual Report on Form 10-K for the year ended December 31, 2005 (File No. 0-26584)].
2004 Executive Officer and Director Investment Account Deferred Compensation Plan [incorporated by reference to exhibits filed
with the Annual Report on Form 10-K for the year ended December 31, 2005 (File No. 0-26584)].
152
10{s}
10{t}
10{u}
10{v}
10{w}
10{x}
14
21
23.1
31.1
31.2
32
99.1
99.2
101
Long-Term Incentive Plan and Form of Repricing Agreement [incorporated by reference to the exhibits filed with the Current Report
on Form 8-K on May 6, 2008].
Form of Compensation Modification Agreement [incorporated by reference to the Registrant's Current Report on Form 8-K filed
on November 24, 2008 (File No. 000-26584)].
2005 Executive Officer and Director Stock Account Deferred Compensation Plan [incorporated by reference to exhibits filed with
the Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-26584)].
Entry into an Indemnification Agreement with each of the Registrant's Directors [incorporated by reference to exhibits filed with
the Form 8-K on January 29, 2010].
2012 Restricted Stock Plan [incorporated by reference to Appendix B included in the Registrant's definitive proxy statement filed
on March 22, 2012 (File No. 000-26584)].
Form of Restricted Stock Award Agreement [incorporated by reference to Exhibit 10.1 included in the Registrant's Current Report
on Form 8-K filed on April 25, 2012 (File No. 000-26584)].
Code of Ethics [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended December 31,
2004 (File No. 0-26584)].
Subsidiaries of the Registrant.
Consent of Registered Independent Public Accounting Firm – Moss Adams LLP.
Certification of Chief Executive Officer pursuant to the Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Chief Financial Officer pursuant to the Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Certification of Principal Executive Officer of Banner Corporation to Chief Compliance Officer of the Troubled Asset Relief
Program Pursuant to 31 CFR § 30.15.
Certification of Principal Financial Officer of Banner Corporation to Chief Compliance Officer of the Troubled Asset Relief Program
Pursuant to 31 CFR § 30.15.
The following materials from Banner Corporation’s Annual Report on Form 10-K for the year ended December 31, 2012, formatted
in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Operations;
(c) Consolidated Statements of Comprehensive Income (Loss); (d) Consolidated Statements of Shareholders' Equity; (e)
Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements. *
* Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or
prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934,
as amended, and otherwise are not subject to liability under those sections.
153
SUBSIDIARIES OF THE REGISTRANT
EXHIBIT 21
Parent
Banner Corporation
Subsidiaries
Banner Bank (1)
Islanders Bank (1)
Banner Capital Trusts II, III, IV, V, VI, and VII (1)
Springer Development LLC (2)
Community Financial Corporation (2)
Northwest Financial Corporation (2)
(1) Wholly-owned by Banner Corporation
(2) Wholly-owned by Banner Bank
Percentage of
Ownership
Jurisdiction of State of
Incorporation
100%
100%
100%
100%
100%
100%
Washington
Washington
Washington
Washington
Oregon
Washington
154
EXHIBIT 23.1
CONSENT OF REGISTERED INDEPENDENT PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement Nos. 333-10819, 333-49193, 333-71625 and 333-67168 of Banner
Corporation and subsidiaries on Form S-8 and Registration Statement 333-153209, 333-156340, 333-161619, 333-164259, 333-165552,
333-167597, 333-171240 and 333-180925 on Form S-3 of our report dated March 14, 2013, with respect to the consolidated statements of
financial condition of Banner Corporation and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of
operations, comprehensive income (loss), changes in stockholders' equity, and cash flows for each of the years in the three-year period ended
December 31, 2012, and the effectiveness of internal control over financial reporting as of December 31, 2012, which report appears in the
December 31, 2012 annual report on Form 10-K of Banner Corporation.
/s/ Moss Adams LLP
Portland, Oregon
March 14, 2013
155
EXHIBIT 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER OF BANNER CORPORATION
PURSUANT TO RULES 13a-14(a) AND 15d-14(a) UNDER THE SECURITIES ACT OF 1934
I, Mark J. Grescovich, certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Banner Corporation;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to
the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;
an
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent
functions):
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report
financial information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
March 14, 2013
/s/Mark J. Grescovich
Mark J. Grescovich
Chief Executive Officer
156
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER OF BANNER CORPORATION
PURSUANT TO RULES 13a-14(a) AND 15d -14(a) UNDER THE SECURITIES ACT OF 1934
I, Lloyd W. Baker, certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Banner Corporation;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to
the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent
functions):
a)
b)
March 14, 2013
All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial
information; and
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
/s/Lloyd W. Baker
Lloyd W. Baker
Chief Financial Officer
157
EXHIBIT 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF BANNER CORPORATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify in his capacity as an officer of Banner Corporation, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form 10-K, that:
•
•
the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and
the information contained in the report fairly presents, in all material respects, the Company’s financial condition and results of
operations as of the dates and for the periods presented in the financial statements included in such report.
March 14, 2013
March 14, 2013
/s/Mark J. Grescovich
Mark J. Grescovich
Chief Executive Officer
/s/Lloyd W. Baker
Lloyd W. Baker
Chief Financial Officer
158
EXHIBIT 99.1
Appendix B-IFR Section 30.15-Certification for Years following First Fiscal Year
Banner Corporation UST #63
I, Mark J. Grescovich, the President and Chief Executive Officer of Banner Corporation, certify, based on my knowledge, that:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
(xi)
The following standard was not required to be met during the most recently completed fiscal year from January 1, 2012 to March 31,
2012 (the “TARP period”), the date Banner Corporation repaid its TARP obligation: The compensation committee of Banner Corporation
has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed
fiscal year that was a TARP period, senior executive officer (“SEO”) compensation plans and employee compensation plans and the
risks these plans pose to Banner Corporation;
The compensation committee of Banner Corporation has identified and limited during any part of the most recently completed fiscal
year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks
that could threaten the value of Banner Corporation and has identified any features of the employee compensation plans that pose risks
to Banner Corporation and has limited those features to ensure that Banner Corporation is not unnecessarily exposed to risks;
Banner repaid its TARP obligation on March 29, 2012 and the following standard was not required to be met during the TARP period:
The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that
was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the
manipulation of reported earnings of Banner Corporation to enhance the compensation of an employee, and has limited any such
features;
The compensation committee of Banner Corporation will certify that the reviews of the SEO compensation plans and employee
compensation plans required under (i) and (iii) above were not required;
The compensation committee of Banner Corporation will provide a narrative description of how it limited during any part of the most
recently completed fiscal year that was a TARP period the features in:
(A)
(B)
(C)
SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of
Banner Corporation;
Employee compensation plans that unnecessarily expose Banner Corporation to risks; and
Employee compensation plans that could encourage the manipulation of reported earnings of Banner Corporation to
enhance the compensation of an employee;
Banner Corporation has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as
defined in the regulations and guidance established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback”
provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on
materially inaccurate financial statements or any other materially inaccurate performance metric criteria;
Banner Corporation has prohibited any golden parachute payment, as defined in the regulations and guidance established under section
111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed
fiscal year that was a TARP period;
Banner Corporation has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations
and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;
Banner Corporation and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations
and guidance established under section 111 of EESA during any part of the most recently completed fiscal year that was a TARP period;
and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an
SEO, or an executive officer with a similar level of responsibility were properly approved;
Banner Corporation will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and
regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during any part
of the most recently completed fiscal year that was a TARP period;
Banner Corporation will disclose the amount, nature, and justification for the offering, during any part of the most recently completed
fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of
EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph
(viii);
159
(xii)
(xiii)
(xiv)
(xv)
Banner Corporation will disclose whether Banner Corporation, the board of directors of Banner Corporation, or the compensation
committee of Banner Corporation has engaged during any part of the most recently completed fiscal year that was a TARP period a
compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during
this period;
Banner Corporation has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section
111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed
fiscal year that was a TARP period;
Banner Corporation has substantially complied with all other requirements related to employee compensation that are provided in the
agreement between Banner Corporation and Treasury, including any amendments;
Banner Corporation repaid its TARP obligation on March 29, 2012, and is therefore not required to submit to Treasury a complete and
accurate list of the SEOs and the twenty next most highly compensated employees for the current fiscal year, with the non-SEOs ranked
in descending order of level of annual compensation, and with the name, title, and employer of each SEO and most highly compensated
employee identified; and
(xvi)
I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by
fine, imprisonment, or both (See, for example, 18 USC 1001).
March 14, 2013
/s/ Mark J. Grescovich
Mark J. Grescovich
President and Chief Executive Officer
160
EXHIBIT 99.2
Appendix B-IFR Section 30.15-Certification for Years following First Fiscal Year
Banner Corporation UST #63
I, Lloyd W. Baker, the Executive Vice President and Chief Financial Officer of Banner Corporation, certify, based on my knowledge, that:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
(xi)
The following standard was not required to be met during the most recently completed fiscal year from January 1, 2012 to March 31,
2012 (the “TARP period”), the date Banner Corporation repaid its TARP obligation: The compensation committee of Banner Corporation
has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed
fiscal year that was a TARP period, senior executive officer (“SEO”) compensation plans and employee compensation plans and the
risks these plans pose to Banner Corporation;
The compensation committee of Banner Corporation has identified and limited during any part of the most recently completed fiscal
year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks
that could threaten the value of Banner Corporation and has identified any features of the employee compensation plans that pose risks
to Banner Corporation and has limited those features to ensure that Banner Corporation is not unnecessarily exposed to risks;
Banner repaid its TARP obligation on March 29, 2012 and the following standard was not required to be met during the TARP period:
The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that
was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the
manipulation of reported earnings of Banner Corporation to enhance the compensation of an employee, and has limited any such
features;
The compensation committee of Banner Corporation will certify that the reviews of the SEO compensation plans and employee
compensation plans required under (i) and (iii) above were not required;
The compensation committee of Banner Corporation will provide a narrative description of how it limited during any part of the most
recently completed fiscal year that was a TARP period the features in:
(A)
(B)
(C)
SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of
Banner Corporation;
Employee compensation plans that unnecessarily expose Banner Corporation to risks; and
Employee compensation plans that could encourage the manipulation of reported earnings of Banner Corporation to
enhance the compensation of an employee;
Banner Corporation has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as
defined in the regulations and guidance established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback”
provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on
materially inaccurate financial statements or any other materially inaccurate performance metric criteria;
Banner Corporation has prohibited any golden parachute payment, as defined in the regulations and guidance established under section
111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed
fiscal year that was a TARP period;
Banner Corporation has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations
and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;
Banner Corporation and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations
and guidance established under section 111 of EESA during any part of the most recently completed fiscal year that was a TARP period;
and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an
SEO, or an executive officer with a similar level of responsibility were properly approved;
Banner Corporation will permit a non-binding shareholder resolution in compliance with any applicable federal securities rules and
regulations on the disclosures provided under the federal securities laws related to SEO compensation paid or accrued during any part
of the most recently completed fiscal year that was a TARP period;
Banner Corporation will disclose the amount, nature, and justification for the offering, during any part of the most recently completed
fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of
EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph
(viii);
161
(xii)
(xiii)
(xiv)
(xv)
Banner Corporation will disclose whether Banner Corporation, the board of directors of Banner Corporation, or the compensation
committee of Banner Corporation has engaged during any part of the most recently completed fiscal year that was a TARP period a
compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during
this period;
Banner Corporation has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section
111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed
fiscal year that was a TARP period;
Banner Corporation has substantially complied with all other requirements related to employee compensation that are provided in the
agreement between Banner Corporation and Treasury, including any amendments;
Banner Corporation repaid its TARP obligation on March 29, 2012, and is therefore not required to submit to Treasury a complete and
accurate list of the SEOs and the twenty next most highly compensated employees for the current fiscal year, with the non-SEOs ranked
in descending order of level of annual compensation, and with the name, title, and employer of each SEO and most highly compensated
employee identified; and
(xvi)
I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by
fine, imprisonment, or both (See, for example, 18 USC 1001).
March 14, 2013
/s/ Lloyd W. Baker
Lloyd W. Baker
Executive Vice President and Chief Financial Officer
162
Fellow Shareholders,
We sometimes complain when we think our lives never change from
day to day or year to year. When unwelcome changes come along,
though, we long for those ordinary days. In banking, we certainly
have not returned to some golden period of the past. But as there
continue to be uncertainties and difficulties, at Banner at least, we
seem to be returning to some familiar patterns. Rather than having
to invest major resources to overcome threats to our franchise, we
are spending our time doing what high performing financial
institutions do— providing all our clients value added financial
solutions through convenient delivery channels and capable bankers.
In what should become familiar and routine to you, I am pleased to
report that Banner Corporation’s financial results for the year ended
December 31, 2012 reflect a year of significant accomplishment. We
improved core performance, showing consistent and sustained
profitability. We achieved a moderate risk profile with steady
improvements in credit quality. We retired the Series A Preferred
Stock and welcomed the termination of regulatory actions by the
FDIC, Washington State Division of Banks and Federal Reserve Bank
of San Francisco. These accomplishments underscore the hard work
of our employees throughout the Company and their dedicated
focus on the execution of strategies and priorities to deliver
sustainable results. Our return to profitability for the last seven
quarters demonstrates that our strategic plan is effective as we
continue to strengthen the franchise and build shareholder value.
For the year 2012, Banner Corporation reported a net profit
available to common shareholders of $59.1 million or $3.16 per share
compared to a net loss of $2.4 million or a loss of $0.15 per share in
2011. Looking at earnings before tax, preferred stock dividends and
discount accretion, Banner’s net income improved to $40.1 million
or $2.14 per share compared to $5.5 million or $0.33 per share in
the prior year.
Our operating performance showed generally consistent
improvement quarter by quarter on key metrics when compared to
a year ago. Revenues from core operations increased by 8% to $211.4
million, a record for the Company, driven by significant improvement
in our net interest margin and resulting net interest income as well
as solid deposit fee revenues fueled by growth in core deposit
accounts and strong mortgage banking revenues. These results are
especially impressive as the low interest rate environment continues
to reflect a sluggish economy, making revenue growth particularly
challenging for banks.
This steady improvement demonstrates the value of our super
community bank strategy implemented in 2010. It is reducing our
funding costs by remixing our deposits away from high-priced
certificates of deposit, growing new client relationships, and
improving our core funding position. In 2012, our non-interest-
bearing deposits increased by 26% and our core deposits increased
by 14%, reflecting solid growth in the number of accounts and
customer relationships. It is noteworthy that this represents organic
growth within our existing 88-branch network. As a result of the
growth in transaction and savings accounts and planned reductions
in higher cost certificates of deposit, core deposits increased to 71%
of total deposits at 2012 year end compared to 64% a year earlier.
It gives me great pleasure to write that we can now fairly
characterize Banner’s credit risk profile as moderate. As you know,
our priority focus for several years has been to improve the risk
profile of Banner and aggressively manage our troubled assets.
Achieving this goal is the result of tremendous hard work and
creativeness by our bankers and workout teams. Through their
dedicated efforts, our non-performing assets have been reduced
by 83% over the past three years and now represent just 1.18% of
total assets compared to 6.27% at the end of 2009.
I want to make special mention of the significant reduction in real
estate owned (REO) as a notable success during 2012. Banner’s
special assets team reduced REO by 63% from $43 million at
December 31, 2011 to $16 million at December 31, 2012. REO sales
were nearly $41 million in 2012 and resulted in net gains on sale of
$4.7 million, demonstrating the team’s proficiency with regard to
both valuation and liquidation.
of 2012, the coverage of our allowance for loan and lease losses to
non-performing loans increased to 225%, despite a significant
reduction in the provision for loan and lease losses, and the ratio of
the allowance to total loans was 2.39%. Further, our capital position
and liquidity are extremely strong. Our total capital to risk-weighted
assets ratio was 16.96%, our tangible common equity ratio improved
to 11.80% and our loan-to-deposit ratio was 91%. As a result, our
balance sheet is one of the strongest in the banking industry. This
will provide considerable flexibility with regard to capital
management strategies going forward.
Throughout 2012 we continued to invest in our franchise, adding
talented commercial, retail and mortgage banking personnel to our
Company in all of our markets, and we continued to invest in further
developing and integrating all our bankers into Banner’s new credit
and sales culture. The “Banner Way” sales management process
within the retail division and the disciplined calling efforts and
responsiveness of all of our bankers are resulting in a consistent
pipeline of new business and lending opportunities. Our customer
service model places clients’ interests at the forefront, with a focus
on retaining clients and expanding relationships that will ultimately
drive revenue growth. These efforts are yielding very positive results
as evidenced by our strong account growth and record mortgage
banking revenues and cross-sell ratios. Our 13th consecutive quarter
of year-over-year increases in revenues from core operations serves
as affirmation of our course. Moreover, we have received
marketplace recognition, which we believe reflects this progress, as
J.D. Power and Associates ranked Banner Bank as “Highest
Customer Satisfaction with Retail Banking in the Northwest Region.”
Our persistent focus on improving the risk profile of Banner and
our successful execution of our strategic turnaround plan has now
resulted in seven consecutive quarters of profitability. With
confidence in the sustainability of our future profitability along with
our commitment to prudently manage capital, we chose to
repurchase all of our Series A Preferred Stock in private transactions
and a final redemption on December 24, 2012, resulting in an
average price slightly below net book value.
Among other accomplishments during the year, we expanded
specialty lending products, resulting in record SBA loan production
and sales, completed a project to upgrade the entire Company’s
communication system, enhancing performance and significantly
reducing costs, and continued investing in our workforce through
the launch of a wellness program.
In closing, I would like to congratulate my colleagues throughout
the Company and thank them for their hard work and focus on
executing the strategic plan. Our performance in 2012 demonstrates
that we are making substantial and sustainable progress in
improving core operating performance, growing the client base,
extending the franchise through market share gains and building
shareholder value.
In addition, I want to thank Mr. Edward Epstein, who is retiring from
our Board of Directors this year, for his steadfast contribution to
Banner over his ten years of service and his personal commitment
to provide me counsel through this turnaround.
Thank you for your continuing interest in and commitment to
Banner. While we are understandably pleased with our results for
2012, we are committed to remaking the Company into a high
performance Bank. For the coming year, we will focus on enriching
the experience of Banner’s clients, improving operational efficiency
and increasing shareholder returns. We have largely completed the
task of strengthening the foundation of the Company and have
turned our strategic priorities toward optimizing the franchise value
of Banner Corporation. We believe we have made good progress in
2012 and look forward to reporting further improvements in 2013.
Although 2012 credit costs were still above our long-term goal, since
initiating our turnaround plan we have reduced problem assets
significantly while maintaining substantial reserve levels. At the end
Mark J. Grescovich
President & Chief Executive Officer
Banner Corporation & Banner Bank
CORPORATE HEADQUARTERS
10 South First Avenue
P.O. Box 907
Walla Walla, WA 99362-0265
509-527-3636
800-272-9933
Web site: www.bannerbank.com
E-mail: bannerbank@bannerbank.com
SUBSIDIARIES
Banner Bank - bannerbank.com
Islanders Bank - islandersbank.com
Community Financial Corporation
TRANSFER AGENT and REGISTRAR
Computershare Trust Company, N.A.
P.O. Box 43036
Providence, RI 02940
INDEPENDENT PUBLIC
ACCOUNTANTS and AUDITORS
Moss Adams LLP
805 SW Broadway, Suite 1200
Portland, OR 97205
SPECIAL COUNSEL
Breyer & Associates PC
8180 Greensboro Drive, Suite 785
McLean, VA 22102
ANNUAL MEETING of SHAREHOLDERS
10 a.m., Tuesday, April 23, 2013
Marcus Whitman Hotel
6 West Rose Street
Walla Walla, WA 99362
DIVIDEND PAYMENTS SENT QUARTERLY
Dividend payments are reviewed quarterly by
the Board of Directors and, if appropriate and
authorized, have historically been paid during
the months of January, April, July and October.
To avoid delay or lost mail, and to reduce costs,
we encourage you to request direct deposit of
dividend payments to your bank account.
To enroll in the Direct Deposit Plan, telephone the
Company’s Investor Services Department at
800-272-9933.
DIVIDEND REINVESTMENT and
STOCK PURCHASE PLAN
Banner Corporation offers a dividend
reinvestment program whereby shareholders
may reinvest all or a portion of their dividends
in additional shares of the Company’s common
stock. Information concerning this optional
program is available from the Investor Services
Department or from Computershare Investor
Services at 800-697-8924.
INVESTOR INFORMATION
Shareholders and others will find the Company’s
financial information, press releases and other
information on the Company’s web site at
www.bannerbank.com. There is a direct link from the
web site to the Securities and Exchange Commission
(SEC) filings via the EDGAR database, including
Forms 10-K, 10-Q and 8-K.
Shareholders may contact:
Investor Relations, Banner Corporation
P.O. Box 907
Walla Walla, WA 99362
or call 800-272-9933 to obtain a hard copy
of these reports without charge.
DIRECTORS
Robert D. Adams
Gordon E. Budke
Edward L. Epstein
Jesse G. Foster
Mark J. Grescovich
D. Michael Jones
David A. Klaue
Constance H. Kravas
Robert J. Lane
John R. Layman
Brent A. Orrico
Gary Sirmon
Michael M. Smith
EXECUTIVE OFFICERS
Mark J. Grescovich,
President and Chief Executive Officer
Lloyd W. Baker
EVP and Chief Financial Officer
Richard B. Barton
EVP, Chief Lending Officer
Douglas M. Bennett
EVP, Real Estate Lending Operations
Tyrone J. Bliss
EVP, Risk Management and Compliance Officer
Cynthia D. Purcell
EVP, Retail Banking and Administration
James T. Reed, Jr.
SVP, West Region Commercial Banking
M. Kirk Quillin
SVP, East Region Commercial Banking
Steven W. Rust
EVP and Chief Information Officer
Gary W. Wagers
EVP, Retail Products and Services
John T. Wagner
EVP, Corporate Administration
Banner Bank - 2012 Annual Report INSIDE COVER | w/1/4” bleed: 17.5” x 11.25” (inludes 1/4” backbone), cover trims to: 8.25” x 10.75” | Agency: Uppercut Advertising, agency contact: Laurie Jaglois office: 206-623-3308. cell: 425-922-6490 laurie@uppercutadvertising.com
CORPORATE PROFILEBanner Corporation is a dynamic banking organization that has developed a significant and expanding regional franchise throughout the Pacific Northwest. Formed in 1995, Banner Corporation is the holding company for Banner Bank, a Washington-chartered commercial bank headquartered in Walla Walla, Washington, with roots that date back to 1890. In 2007, the Company acquired Islanders Bank, which operates in Washington’s San Juan Islands. Banner Bank and Islanders Bank strive to deliver a high level of individualized service as community banks while offering advantages available from being part of a larger financial institution. The Company’s leadership consists of an experienced executive management team headed by President and CEO, Mark J. Grescovich. Banner Corporation aims to be the premier Pacific Northwest banking franchise. Serving a growing and prosperous region with a full range of deposit services and business, commercial real estate, construction, residential, agricultural and consumer loans, the Company provides community banking services through a combined total of 88 branch offices and seven loan offices located in 29 counties of Washington, Oregon and Idaho. The Company’s employees take pride in extending the highest levels of service, convenience, and banking knowledge to their clients. Banner Bank and Islanders Bank are members of the Federal Home Loan Bank of Seattle and their deposits are insured by the Federal Deposit Insurance Corporation. Banner Bank and Islanders Bank are wholly-owned subsidiaries of Banner Corporation. Banner Corporation common stock is traded over the counter on The NASDAQ Stock Market® under the symbol “BANR.” This document, together with the Company’s Form 10-K, represents the annual report to shareholders of Banner Corporation.Banner Bank - 2012 Annual Report OUTSIDE COVER | w/1/4” bleed: 17.5” x 11.25” (inludes 1/4” backbone), cover trims to: 8.25” x 10.75” | Agency: Uppercut Advertising, agency contact: Laurie Jaglois office: 206-623-3308. cell: 425-922-6490 laurie@uppercutadvertising.com BANNER CORPORATION 2012 ANNUAL REPORTCorporate Headquarters: 10 South First Avenue, P.O. Box 907Walla Walla, WA 99362-0265509-527-3636 | 800-272-9933 bannerbank.com bannerbank@bannerbank.comBetter ideas. Better banking.