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Section 1: 10-Q (10-Q 3-31-2018)

Document

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

FORM 10-Q 
(Mark One)

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2018
OR
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ to ______________
 Commission File Number 000-26584
BANNER CORPORATION
(Exact name of registrant as specified in its charter)
 
 
 
 
 
 
 
 
 
 
Washington
 
91-1691604
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
 
 
 
 
 
10 South First Avenue, Walla Walla, Washington 99362
 
 
(Address of principal executive offices and zip code)
 
 
 
 
 
 
 
Registrant's telephone number, including area code:  (509) 527-3636
 
 
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
 
 
 
 
 
 
 
Yes
[x]
 
No
[  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
 
 
 
Large accelerated filer  [x]
Accelerated filer    [ ]
Non-accelerated filer   [  ]
Smaller reporting company  [ ]
Emerging growth company [ ]
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
[  ]
 
No
[x]
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Title of class:
 
As of April 30, 2018
Common Stock, $.01 par value per share
 
32,331,108 shares
Non-voting Common Stock, $.01 par value per share
 
 
 
 
 
76,928 shares
 
 
 

1


BANNER CORPORATION AND SUBSIDIARIES

Table of Contents
PART I – FINANCIAL INFORMATION
 
 
 
Item 1 – Financial Statements.  The Unaudited Condensed Consolidated Financial Statements of Banner Corporation and Subsidiaries filed as a part of the report are as follows:
 
 
 
Consolidated Statements of Financial Condition as of March 31, 2018 and December 31, 2017
 
 
Consolidated Statements of Operations for the Three Months Ended March 31, 2018 and 2017
 
 
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2018 and 2017
 
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2018 and the Year Ended December 31, 2017
 
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017
 
 
Selected Notes to the Consolidated Financial Statements
 
 
Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Executive Overview
 
 
Comparison of Financial Condition at March 31, 2018 and December 31, 2017
 
 
Comparison of Results of Operations for the Three Months Ended March 31, 2018 and 2017
 
 
Asset Quality
 
 
Liquidity and Capital Resources
 
 
Capital Requirements
 
 
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Market Risk and Asset/Liability Management
 
 
Sensitivity Analysis
 
 
Item 4 – Controls and Procedures
 
 
PART II – OTHER INFORMATION
 
 
 
Item 1 – Legal Proceedings
 
 
Item 1A – Risk Factors
 
 
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
 
 
Item 3 – Defaults upon Senior Securities
 
 
Item 4 – Mine Safety Disclosures
 
 
Item 5 – Other Information
 
 
Item 6 – Exhibits
 
 
SIGNATURES

2


Special Note Regarding Forward-Looking Statements

Certain matters in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements relate to our financial condition, liquidity, results of operations, plans, objectives, future performance or business.  Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.”  Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance and projections of financial items.  These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited to: 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 non-performing assets, 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 economic conditions in general and in Washington, Idaho, Oregon and California in particular; 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 safety and soundness and compliance examinations of us by the Board of Governors of the Federal Reserve System 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, require restitution or institute an informal or formal enforcement action against us or any of our bank subsidiaries 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 changes related to Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 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 and securities 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; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; 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; future goodwill impairment due to changes in our business, changes in market conditions, or other factors; 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 non-voting 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 U.S. Securities and Exchange Commission (SEC), including this report on Form 10-Q.  Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made.  We do not undertake and specifically disclaim any obligation to update any forward-looking statements included in this report or the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise.  These risks could cause our actual results to differ materially from those expressed in any forward-looking statements by, or on behalf of, us.  In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements.

As used throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to Banner Corporation and its consolidated subsidiaries, unless the context otherwise requires.  All references to “Banner” refer to Banner Corporation and those to “the Banks” refer to its wholly-owned subsidiaries, Banner Bank and Islanders Bank, collectively.


3


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited) (In thousands, except shares)
March 31, 2018 and December 31, 2017
ASSETS
March 31
2018

 
December 31
2017

Cash and due from banks
$
188,418

 
$
199,624

Interest bearing deposits
53,630

 
61,576

Total cash and cash equivalents
242,048

 
261,200

Securities—trading, amortized cost $27,275 and $27,246, respectively
25,574

 
22,318

Securities—available-for-sale, amortized cost $1,427,764 and $926,112, respectively
1,406,505

 
919,485

Securities—held-to-maturity, fair value $260,918 and $262,188, respectively
262,645

 
260,271

Federal Home Loan Bank (FHLB) stock
18,036

 
10,334

Loans held for sale (includes $137.7 million and $32.4 million, at fair value, respectively)
141,808

 
40,725

Loans receivable
7,556,046

 
7,598,884

Allowance for loan losses
(92,207
)
 
(89,028
)
Net loans
7,463,839

 
7,509,856

Accrued interest receivable
32,824

 
31,259

Real estate owned (REO), held for sale, net
328

 
360

Property and equipment, net
156,005

 
154,815

Goodwill
242,659

 
242,659

Other intangibles, net
21,251

 
22,655

Bank-owned life insurance (BOLI)
163,519

 
162,668

Deferred tax assets, net
76,843

 
71,427

Other assets
63,380

 
53,177

Total assets
$
10,317,264

 
$
9,763,209

LIABILITIES
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
3,383,439

 
$
3,265,544

Interest-bearing transaction and savings accounts
4,141,268

 
3,950,950

Interest-bearing certificates
1,018,355

 
966,937

Total deposits
8,543,062

 
8,183,431

Advances from FHLB
192,195

 
202

Other borrowings
101,844

 
95,860

Junior subordinated debentures at fair value (issued in connection with Trust Preferred Securities)
112,516

 
98,707

Accrued expenses and other liabilities
72,497

 
71,344

Deferred compensation
41,027

 
41,039

Total liabilities
9,063,141

 
8,490,583

COMMITMENTS AND CONTINGENCIES (Note 12)

 

SHAREHOLDERS’ EQUITY
 
 
 
Preferred stock - $0.01 par value per share, 500,000 shares authorized; no shares outstanding at March 31, 2018 and December 31, 2017

 

Common stock and paid in capital - $0.01 par value per share, 50,000,000 shares authorized; 32,346,745 shares issued and outstanding at March 31, 2018; 32,626,456 shares issued and outstanding at December 31, 2017
1,171,914

 
1,185,919

Common stock (non-voting) and paid in capital- $0.01 par value per share, 5,000,000 shares authorized; 76,928 shares issued and outstanding at March 31, 2018; 100,029 shares issued and outstanding at December 31, 2017
1,046

 
1,208

Retained earnings
79,773

 
90,535

Carrying value of shares held in trust for stock related compensation plans
(7,371
)
 
(7,351
)
Liability for common stock issued to stock related compensation plans
7,371

 
7,351

Accumulated other comprehensive income (loss) (AOCI)
1,390

 
(5,036
)
Total shareholders' equity
1,254,123

 
1,272,626

Total liabilities & shareholders' equity
$
10,317,264

 
$
9,763,209

See Selected Notes to the Consolidated Financial Statements

4


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (In thousands, except shares and per share amounts)
For the Three Months Ended March 31, 2018 and 2017
 
Three Months Ended
March 31,
 
2018

 
2017

INTEREST INCOME:
 
 
 
Loans receivable
$
94,022

 
$
91,288

Mortgage-backed securities
7,331

 
4,647

Securities and cash equivalents
3,467

 
3,161

Total interest income
104,820

 
99,096

INTEREST EXPENSE:
 
 
 
Deposits
3,358

 
2,791

FHLB advances
677

 
273

Other borrowings
70

 
74

Junior subordinated debentures
1,342

 
1,104

Total interest expense
5,447

 
4,242

Net interest income
99,373

 
94,854

PROVISION FOR LOAN LOSSES
2,000

 
2,000

Net interest income after provision for loan losses
97,373

 
92,854

NON-INTEREST INCOME:
 
 
 
Deposit fees and other service charges
11,296

 
10,389

Mortgage banking operations
4,864

 
4,603

Bank-owned life insurance (BOLI)
853

 
1,095

Miscellaneous
1,037

 
3,636

 
18,050

 
19,723

Net gain on sale of securities
4

 
13

Net change in valuation of financial instruments carried at fair value
3,308

 
(688
)
Total non-interest income
21,362

 
19,048

NON-INTEREST EXPENSE:
 
 
 
Salary and employee benefits
50,067

 
46,063

Less capitalized loan origination costs
(4,011
)
 
(4,316
)
Occupancy and equipment
11,766

 
11,996

Information/computer data services
4,381

 
3,994

Payment and card processing expenses
3,700

 
3,223

Professional services
4,428

 
5,152

Advertising and marketing
1,830

 
1,328

Deposit insurance
1,341

 
1,266

State/municipal business and use taxes
713

 
799

REO operations
439

 
(966
)
Amortization of core deposit intangibles
1,382

 
1,624

Miscellaneous
5,670

 
6,118

Total non-interest expense
81,706

 
76,281

Income before provision for income taxes
37,029

 
35,621

PROVISION FOR INCOME TAXES
8,239

 
11,828

NET INCOME
$
28,790

 
$
23,793

Earnings per common share:
 
 
 
Basic
$
0.89

 
$
0.72

Diluted
$
0.89

 
$
0.72

Cumulative dividends declared per common share
$
0.35

 
$
0.25

Weighted average number of common shares outstanding:
 
 
 
Basic
32,397,568

 
32,933,444

Diluted
32,516,456

 
33,051,459

See Selected Notes to the Consolidated Financial Statements

5


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (In thousands)
For the Three Months Ended March 31, 2018 and 2017

 
Three Months Ended
March 31,
 
2018

 
2017

NET INCOME
$
28,790

 
$
23,793

OTHER COMPREHENSIVE (LOSS) INCOME, NET OF INCOME TAXES:
 
 
 
Unrealized holding (loss) gain on available-for-sale securities arising during the period
(14,768
)
 
2,448

Reclassification for net gains on available-for-sale securities realized in earnings
(2
)
 
(13
)
Changes in fair value of junior subordinated debentures related to instrument specific credit risk
(13,809
)
 

Income tax related to other comprehensive (loss) income
6,802

 
(876
)
Other comprehensive (loss) income
(21,777
)
 
1,559

COMPREHENSIVE INCOME
$
7,013

 
$
25,352


See Selected Notes to the Consolidated Financial Statements

6


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited) (In thousands, except shares)
For the Three Months Ended March 31, 2018 and the Year Ended December 31, 2017

 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income (Loss)
 
Shareholders’
Equity
 
Shares
 
Amount
 
 
 
Balance, January 1, 2017
33,193,387

 
$
1,213,837

 
$
95,328

 
$
(3,455
)
 
$
1,305,710

Net income
 
 
 
 
60,776

 
 
 
60,776

Other comprehensive loss, net of income tax
 
 
 
 
 
 
(786
)
 
(786
)
Reclassification of stranded tax effects from AOCI to retained earnings
 
 
 
 
795

 
(795
)
 

Accrual of dividends on common stock ($2.00/share cumulative)
 
 
 
 
(66,364
)
 
 
 
(66,364
)
Repurchase of common stock
(545,166
)
 
(31,045
)
 
 
 
 
 
(31,045
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
78,264

 
4,335

 
 
 
 
 
4,335

Balance, December 31, 2017
32,726,485

 
$
1,187,127

 
$
90,535

 
$
(5,036
)
 
$
1,272,626


Balance, January 1, 2018
32,726,485

 
$
1,187,127

 
$
90,535

 
$
(5,036
)
 
$
1,272,626

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

 

Net income
 
 
 
 
28,790

 
 
 
28,790

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

 
 
 
 
 
1,192

Balance, March 31, 2018
32,423,673

 
$
1,172,960

 
$
79,773

 
$
1,390

 
$
1,254,123



See Selected Notes to the Consolidated Financial Statements

7


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In thousands)
For the Three Months Ended March 31, 2018 and 2017
 
Three Months Ended
March 31,
 
2018

 
2017

OPERATING ACTIVITIES:
 
 
 
Net income
$
28,790

 
$
23,793

Adjustments to reconcile net income to net cash provided from operating activities:
 
 
 
Depreciation
3,584

 
2,888

Deferred income and expense, net of amortization
(608
)
 
(265
)
Amortization of core deposit intangibles
1,382

 
1,624

Gain on sale of securities
(4
)
 
(13
)
Net change in valuation of financial instruments carried at fair value
(3,308
)
 
688

Principal repayments and maturities of securities—trading

 
9

(Increase) decrease in deferred taxes
(5,416
)
 
3,625

Increase in current taxes payable
6,569

 
295

Stock-based compensation
1,320

 
1,125

Increase in cash surrender value of BOLI
(844
)
 
(1,085
)
Gain on sale of loans, net of capitalized servicing rights
(3,375
)
 
(5,496
)
Loss (gain) on disposal of real estate held for sale and property and equipment
58

 
(1,039
)
Provision for loan losses
2,000

 
2,000

Provision for losses on real estate held for sale
160

 
50

Origination of loans held for sale
(222,168
)
 
(167,550
)
Proceeds from sales of loans held for sale
124,460

 
339,878

Net change in:
 
 
 
Other assets
(5,100
)
 
(9,412
)
Other liabilities
(2,311
)
 
(5,283
)
Net cash (used in) provided from operating activities
(74,811
)
 
185,832

INVESTING ACTIVITIES:
 
 
 
Purchases of securities—available-for-sale
(537,864
)
 
(457,966
)
Principal repayments and maturities of securities—available-for-sale
28,839

 
32,446

Proceeds from sales of securities—available-for-sale

 
2,165

Purchases of securitiesheld-to-maturity
(5,312
)
 

Principal repayments and maturities of securities—held-to-maturity
2,358

 
954

Loan originations, net of principal repayments
40,846

 
119,569

Purchases of loans and participating interest in loans
(8,103
)
 
(99,206
)
Proceeds from sales of other loans
13,241

 
4,627

Purchases of property and equipment
(5,024
)
 
(3,598
)
Proceeds from sale of real estate held for sale and sale of other property, net
192

 
13,684

Proceeds from FHLB stock repurchase program
32,558

 
29,192

Purchase of FHLB stock
(40,260
)
 
(27,020
)
Other
228

 
75

Net cash used in investing activities
(478,301
)
 
(385,078
)
FINANCING ACTIVITIES:
 
 
 
Increase in deposits, net
359,631

 
300,546

Repayment of long term FHLB advances
(2
)
 
(2
)
Proceeds from (repayments of) overnight and short term FHLB advances, net
192,000

 
(54,000
)
Increase in other borrowings, net
5,984

 
14,560

Cash dividends paid
(8,165
)
 
(7,615
)
Taxes paid related to net share settlement of equity awards
(129
)
 
(445
)
Cash paid for the repurchase of common stock
(15,359
)
 
(809
)
Net cash provided from financing activities
533,960

 
252,235

NET CHANGE IN CASH AND CASH EQUIVALENTS
(19,152
)
 
52,989

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
261,200

 
247,719

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
242,048

 
$
300,708


(Continued on next page)

8


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited) (In thousands)
For the Three Months Ended March 31, 2018 and 2017
 
Three Months Ended
March 31,
 
2018

 
2017

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Interest paid in cash
$
5,185

 
$
4,202

(Refunds received) taxes paid, net
(3
)
 
8,543

NON-CASH INVESTING AND FINANCING TRANSACTIONS:
 
 
 
Loans, net of discounts, specific loss allowances and unearned income,
transferred to real estate owned and other repossessed assets
976

 

    Dividends accrued but not paid until after period end
11,450

 
8,338


See Selected Notes to the Consolidated Financial Statements

9


BANNER CORPORATION AND SUBSIDIARIES
SELECTED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 1:  BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements include the accounts of Banner Corporation (the Company or Banner), a bank holding company incorporated in the State of Washington and its wholly-owned subsidiaries, Banner Bank and Islanders Bank (the Banks).

These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (SEC). In preparing these financial statements, the Company has evaluated events and transactions subsequent to March 31, 2018 for potential recognition or disclosure. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC and the accounting standards for interim financial statements. Certain reclassifications have been made to the 2017 Consolidated Financial Statements and/or schedules to conform to the 2018 presentation. These reclassifications may have affected certain ratios for the prior periods. The effect of these reclassifications is considered immaterial. All significant intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Various elements of the Company’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are significant to an understanding of Banner’s financial statements. These policies relate to (i) the methodology for the recognition of interest income, (ii) determination of the provision and allowance for loan losses, (iii) the valuation of financial assets and liabilities recorded at fair value, including other-than-temporary impairment (OTTI) losses, (iv) the valuation of intangibles, such as goodwill, core deposit intangibles (CDI) and mortgage servicing rights, (v) the valuation of real estate held for sale, (vi) the valuation of assets and liabilities acquired in business combinations and subsequent recognition of related income and expense, and (vii) the valuation or recognition of deferred tax assets and liabilities. These policies and judgments, estimates and assumptions are described in greater detail in subsequent notes to the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations (Critical Accounting Policies) in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC (2017 Form 10-K).  There have been no significant changes in our application of these accounting policies during the first three months of 2018, except as described in Note 2.

The information included in this Form 10-Q should be read in conjunction with our 2017 Form 10-K.  Interim results are not necessarily indicative of results for a full year or any other interim period.

Note 2:  ACCOUNTING STANDARDS RECENTLY ISSUED OR ADOPTED

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, which creates Topic 606 and supersedes Topic 605, Revenue Recognition. Subsequent to the issuance of ASU 2014-09, FASB issued ASU 2016-10 in April 2016 and issued ASU 2016-12 in May 2016. Both of these ASUs amend or clarify aspects of Topic 606. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The Company adopted Topic 606 on January 1, 2018 using the full retrospective method, meaning the standard is applied to all periods presented in the financial statements with the cumulative effect of initially applying the standard recognized at the beginning of the earliest period presented. In adopting Topic 606, the Company applied the following five steps in determining the correct treatment for the applicable revenue streams:

1.
Identify the contract with a customer;
2.
Identify the performance obligations in the contract;
3.
Determine the transaction price;
4.
Allocate the transaction price to performance obligations in the contract, and
5.
Recognize revenue when or as the Company satisfies the performance obligation.

The majority of the Company’s revenue streams including interest income, deferred loan fee accretion, premium/discount accretion, gains on sales of loans and investments, loan servicing income and other loan fee income are outside the scope of Topic 606. Revenue streams reported as deposit fees and other service charges which include transaction based deposit fees, non-transaction based deposit fees, interchange fees on credit and debit cards and merchant service fees are within the scope of Topic 606. The Company applied the requirements of Topic 606 to the revenue streams that are within its scope. The adoption of Topic 606 did not result in any changes in the either timing or amount of recognized

10


revenue in prior periods by the Company however, the presentation of certain costs associated with our merchant services will now be offset against deposit fees and other service charges in non-interest income. The Company previously recognized payment network related fees that were collected by Company and passed through to another party related to its merchant services as non-interest expense. The change in presentation resulted in $1.8 million of expenses for the three months ended March 31, 2018 being netted against deposit fees and other services charges and reported in non-interest income instead of as payment and card processing expenses in non-interest expense. In addition, to conform to the current period presentation, $1.8 million of merchant services related expenses for the three months ended March 31, 2017 were reclassified from payment and card processing expense in non-interest expense to being netted against deposit fees and other service charges in non-interest income. The Company elected to apply the practical expedient and therefore does not disclose information about remaining performance obligations that have an original expected term of one year or less and allows the Company to expense costs related to obtaining a contract as incurred when the amortization period would have been one year or less.

The following table presents the impact of adopting of the new revenue standard on our Consolidated Statements of Operations for the three months ended March 31, 2018 and 2017 (in thousands):
 
For the three months ended March 31, 2018
 
For the three months ended March 31, 2017
 
As Reported
 
Balance without Adoption of ASC 606
 
Effect of Change
 
As Reported
 
Balance without Adoption of ASC 606
 
Effect of Change
Non-interest income:
 
 
 
 
 
 
 
 
 
 
 
Deposit fees and other service charges
$
11,296

 
$
13,100

 
$
(1,804
)
 
$
10,389

 
$
12,186

 
$
(1,797
)
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest expense:
 
 
 
 
 
 
 
 
 
 
 
Payment and card processing expenses
$
3,700

 
$
5,504

 
$
(1,804
)
 
$
3,223

 
$
5,020

 
$
(1,797
)

Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU require equity securities to be measured at fair value with changes in the fair value recognized through net income. The amendments allow equity investments that do not have readily determinable fair values to be remeasured at fair value under certain circumstances and require enhanced disclosures about those investments. This ASU simplifies the impairment assessment of equity investments without readily determinable fair values. This ASU also eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The amendments in this ASU require separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. This ASU excludes from net income gains or losses that the entity may not realize because those financial liabilities are not usually transferred or settled at their fair values before maturity. The amendments in this ASU require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or in the accompanying notes to the financial statements. The Company adopted this ASU on January 1, 2018. The adoption of this ASU resulted in the Company reclassifying $28.1 million from retained earnings to AOCI for the cumulative fair value adjustments on its junior subordinated debentures related to instrument specific credit risk. During the quarter end March 31, 2018, the Company recorded a $10.5 million, net of tax, reduction in other comprehensive income (loss) for the change in instrument specific credit risk on its junior subordinated debentures; prior to the adoption of this ASU this amount would have been recorded in the Consolidated Statement of Operations. In addition, as a result of adopting this ASU the Company recorded a $137,000 reduction in retained earnings representing the unrealized loss on available for sale equity securities at the date of adoption. Any future changes in fair value on equity securities will be recorded in the Consolidated Statement of Operations. During the quarter ended March 31, 2018, the Company recorded a $70,000 loss for the decrease in fair value of its equity securities as a component of the net change in financial instruments carried at fair value in the Consolidated Statement of Operations. At March 31, 2018, the Company held $5.7 million of equity investment securities which were previously reported as available for sale securities and are now reported in other assets.

In addition, the adoption of this ASU resulted in changing how the Company estimates the fair value portfolio loans for disclosure purposes. 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. An 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, as well as, a quarterly loss rate based on historical losses to arrive at an estimated exit price fair value. Fair value for impaired loans is also based on recent appraisals or estimated cash flows discounted using rates commensurate with risk associated with the estimated cash

11


flows.  Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.

In February 2018, FASB issued ASU No. 2018-03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU do not change the core principle of the guidance in Subtopic 825-10. Rather, the amendments in this ASU clarify the application of the guidance regarding the fair value measurement of equity securities without readily determinable fair value. The Company adopted this ASU on January 1, 2018. The impact of the Company's adoption of this ASU is described in the preceding paragraph.

Leases (Topic 842)

In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842). The amendments in this ASU require lessees to recognize the following for all leases (with the exception of short-term) at the commencement date; a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The amendments in this ASU leave lessor accounting largely unchanged, although certain targeted improvements were made to align lessor accounting with the lessee accounting model. This ASU simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently evaluating the provisions of ASU No. 2016-02 to determine the potential impact the new standard will have on the Company's Consolidated Financial Statements and regulatory capital ratios and has contracted with a third party software solution to meet the new requirements of this ASU, with implementation currently in process. The Company leases 107 buildings and offices under non-cancelable operating leases, the majority of which will be subject to this ASU. While the Company has not quantified the impact to its balance sheet, upon the adoption of this ASU the Company expects to report increased assets and increased liabilities on its Consolidated Statements of Financial Condition as a result of recognizing right-of-use assets and lease liabilities related to these leases and certain equipment under non-cancelable operating lease agreements, which currently are not reflected in its Consolidated Statements of Financial Condition.

Financial Instruments—Credit Losses (Topic 326)

In June 2016, FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The ASU affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial asset not excluded from the scope that have the contractual right to receive cash. The ASU replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU requires a financial asset (or group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses will be based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This ASU broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The use of forecasted information incorporates more timely information in the estimate of expected credit loss, which will be more decision useful to users of the financial statements. This ASU will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is still evaluating the effects this ASU will have on the Company’s Consolidated Financial Statements. The Company has formed an internal committee to oversee the project, engaged a third-party vendor to assist with the project and has completed its gap analysis phase of the project. In addition, the Company is in the process of selecting a second third-party vendor to assist with building and developing the required models. Upon adoption, the Company expects changes in the processes and procedures used to calculate the allowance for loan losses, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. The new guidance may result in an increase in the allowance for loan losses which will also reflect the new requirement to include the nonaccretable principal differences on purchased credit-impaired loans; however, the Company is still in the process of determining the magnitude of the change and its impact on the Consolidated Financial Statements. In addition, the current accounting policy and procedures for other-than-temporary impairment on investment securities available-for-sale will be replaced with an allowance approach.

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

In March 2017, FASB issued ASU No. 2017-08, Premium Amortization on Purchased Callable Debt Securities. The amendments in this ASU shorten the premium amortization period for callable debt securities purchased at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. Under current GAAP, premiums and discounts on callable debt securities generally are amortized to the maturity date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to the maturity date. The amendments in this ASU more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. The amendments in this ASU are effective for fiscal years beginning after December

12


15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company is still evaluating the effects this ASU will have on the Company’s Consolidated Financial Statements.

Derivatives and Hedging (Topic 815)

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

Income Statement - Reporting Comprehensive Income (Topic 220)

In February 2018, FASB Issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU allows a reclassification from AOCI to retained earnings for the stranded tax effects on available-for-sale securities resulting from the 2017 Tax Act. The ASU eliminates the stranded tax effects resulting from the 2017 Tax Act and improves the usefulness of information reported to financial statement users. The ASU also requires certain disclosures about the stranded tax effects. This ASU is effective for all entities for fiscal years beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. The ASU should be applied to either in the period of adoption or retrospectively to each period in which the effect of the change in the federal corporate tax rate is recognized. The Company elected to early adopt this ASU and to reclassify $795,000 of stranded tax effects from AOCI to retained earnings in the fourth quarter of 2017.

Income Taxes (Topic 740)

In March 2018, FASB issued ASU No. 2018-05, Income Taxes (Topic 740). This ASU was issued to provide guidance on the income tax accounting implications of the Tax Cuts and Jobs Act (the Act) and allows for entities to report provisional amounts for specific income tax effects of the Act for which the accounting under ASC Topic 740 was not yet complete but a reasonable estimate could be determined. A measurement period of one year is allowed to complete the accounting effects under ASC Topic 740 and revise any previous estimates reported. Any provisional amounts or subsequent adjustments included in an entity’s financial statements during the measurement period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts are determined. The Company adopted this ASU with the provisional adjustments as reported in the Consolidated Financial Statements in the 2017 Form 10-K. As of March 31, 2018, the Company did not incur any adjustments to the provisional recognition.
      


13


Note 3:  SECURITIES

The amortized cost, gross unrealized gains and losses and estimated fair value of securities at March 31, 2018 and December 31, 2017 are summarized as follows (in thousands):
 
March 31, 2018
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair
Value
Trading:
 
 
 
 
 
 
 
Municipal bonds
$
100

 
 
 
 
 
$
100

Corporate bonds
27,175

 
 
 
 
 
25,474

 
$
27,275

 
 
 
 
 
$
25,574

Available-for-Sale:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
145,280

 
$
10

 
$
(1,984
)
 
$
143,306

Municipal bonds
69,516

 
315

 
(873
)
 
68,958

Corporate bonds
6,152

 
5

 
(45
)
 
6,112

Mortgage-backed or related securities
1,179,084

 
718

 
(19,389
)
 
1,160,413

Asset-backed securities
27,732

 
128

 
(144
)
 
27,716

 
$
1,427,764

 
$
1,176

 
$
(22,435
)
 
$
1,406,505

Held-to-Maturity:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
1,260

 
$
27

 
$

 
$
1,287

Municipal bonds:
192,931

 
2,334

 
(2,644
)
 
192,621

Corporate bonds
3,941

 

 
(8
)
 
3,933

Mortgage-backed or related securities
64,513

 
19

 
(1,455
)
 
63,077

 
$
262,645

 
$
2,380

 
$
(4,107
)
 
$
260,918


14




 
December 31, 2017
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair
Value
Trading:
 
 
 
 
 
 
 
Municipal bonds
$
100

 
 
 
 
 
$
100

Corporate bonds
27,132

 
 
 
 
 
22,058

Equity securities
14

 
 
 
 
 
160

 
$
27,246

 
 
 
 
 
$
22,318

Available-for-Sale:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
72,829

 
$
68

 
$
(431
)
 
$
72,466

Municipal bonds
68,513

 
665

 
(445
)
 
68,733

Corporate bonds
5,431

 
6

 
(44
)
 
5,393

Mortgage-backed or related securities
745,956

 
1,003

 
(7,402
)
 
739,557

Asset-backed securities
27,667

 
184

 
(93
)
 
27,758

Equity securities
5,716

 
10

 
(148
)
 
5,578

 
$
926,112

 
$
1,936

 
$
(8,563
)
 
$
919,485

Held-to-Maturity:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
1,024

 
$
29

 
$

 
$
1,053

Municipal bonds:
189,860

 
3,385

 
(1,252
)
 
191,993

Corporate bonds
3,978

 
7

 

 
3,985

Mortgage-backed or related securities
65,409

 
266

 
(518
)
 
65,157

 
$
260,271

 
$
3,687

 
$
(1,770
)
 
$
262,188



15


At March 31, 2018 and December 31, 2017, the gross unrealized losses and the fair value for securities available-for-sale and held-to-maturity aggregated by the length of time that individual securities have been in a continuous unrealized loss position was as follows (in thousands):
 
March 31, 2018
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
112,704

 
$
(1,479
)
 
$
22,943

 
$
(505
)
 
$
135,647

 
$
(1,984
)
Municipal bonds
30,019

 
(463
)
 
13,065

 
(410
)
 
43,084

 
(873
)
Corporate bonds
647

 
(7
)
 
4,550

 
(38
)
 
5,197

 
(45
)
Mortgage-backed or related securities
835,758

 
(15,250
)
 
114,653

 
(4,139
)
 
950,411

 
(19,389
)
Asset-backed securities

 

 
9,873

 
(144
)
 
9,873

 
(144
)
 
$
979,128

 
$
(17,199
)
 
$
165,084

 
$
(5,236
)
 
$
1,144,212

 
$
(22,435
)
Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
$
55,484

 
$
(669
)
 
$
32,189

 
$
(1,975
)
 
$
87,673

 
$
(2,644
)
Corporate bonds
492

 
(8
)
 

 

 
492

 
(8
)
Mortgage-backed or related securities
54,224

 
(1,229
)
 
4,315

 
(226
)
 
58,539

 
(1,455
)
 
$
110,200

 
$
(1,906
)
 
$
36,504

 
$
(2,201
)
 
$
146,704

 
$
(4,107
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
31,276

 
$
(211
)
 
$
23,341

 
$
(220
)
 
$
54,617

 
$
(431
)
Municipal bonds
20,879

 
(185
)
 
13,360

 
(260
)
 
34,239

 
(445
)
Corporate bonds
296

 
(4
)
 
4,682

 
(40
)
 
4,978

 
(44
)
Mortgage-backed or related securities
559,916

 
(5,138
)
 
100,662

 
(2,264
)
 
660,578

 
(7,402
)
Asset-backed securities

 

 
9,926

 
(93
)
 
9,926

 
(93
)
Equity securities
5,480

 
(148
)
 

 

 
5,480

 
(148
)
 
$
617,847

 
$
(5,686
)
 
$
151,971

 
$
(2,877
)
 
$
769,818

 
$
(8,563
)
Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
21,839

 
(171
)
 
34,314

 
(1,081
)
 
56,153

 
(1,252
)
Mortgage-backed or related securities
38,023

 
(378
)
 
4,434

 
(140
)
 
42,457

 
(518
)
 
$
59,862

 
$
(549
)
 
$
38,748

 
$
(1,221
)
 
$
98,610

 
$
(1,770
)

At March 31, 2018, there were 277 securities—available-for-sale with unrealized losses, compared to 226 at December 31, 2017.  At March 31, 2018, there were 100 securities—held-to-maturity with unrealized losses, compared to 66 at December 31, 2017.  Management does not believe that any individual unrealized loss as of March 31, 2018 or December 31, 2017 represented other-than-temporary impairment (OTTI).  The decline in fair market value of these securities was generally due to changes in interest rates and changes in market-desired spreads subsequent to their purchase.

There were no sales of securities—trading during the three-month periods ended March 31, 2018 or 2017. The Company did not recognize any OTTI charges or recoveries on securities—trading during the three-month periods ended March 31, 2018 or 2017. There were no securities—trading in a nonaccrual status at March 31, 2018 or December 31, 2017.  Net unrealized holding gains of $3.4 million were recognized during the three months ended March 31, 2018 compared to $152,000 of net unrealized holdings gains recognized during the three months ended March 31, 2017.

There were no sales of securities—available-for-sale during the three months ended March 31, 2018, although partial calls of securities resulted in a net gain of $4,000 for the three months ended March 31, 2018.  Sales of securities—available-for-sale totaled $2.2 million which resulted

16


in a net gain of $13,000 for the three months ended March 31, 2017. There were no securities—available-for-sale in a nonaccrual status at March 31, 2018 or December 31, 2017.

There were no sales of securities—held-to-maturity during the three-month periods ended March 31, 2018 and 2017. There were no securities—held-to-maturity in a nonaccrual status at March 31, 2018 or December 31, 2017.

The amortized cost and estimated fair value of securities at March 31, 2018, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or without call or prepayment penalties.
 
March 31, 2018
 
Trading
 
Available-for-Sale
 
Held-to-Maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Maturing in one year or less
$
100

 
$
100

 
$
3,090

 
$
3,081

 
$
1,943

 
$
1,942

Maturing after one year through five years

 

 
63,013

 
62,113

 
38,334

 
37,896

Maturing after five years through ten years

 

 
281,112

 
276,039

 
96,044

 
95,696

Maturing after ten years through twenty years
17,175

 
16,889

 
186,470

 
184,722

 
84,150

 
85,000

Maturing after twenty years
10,000

 
8,585

 
894,079

 
880,550

 
42,174

 
40,384

 
$
27,275

 
$
25,574

 
$
1,427,764

 
$
1,406,505

 
$
262,645

 
$
260,918


The following table presents, as of March 31, 2018, investment securities which were pledged to secure borrowings, public deposits or other obligations as permitted or required by law (in thousands):
 
March 31, 2018
 
Carrying Value
 
Amortized Cost
 
Fair
Value
Purpose or beneficiary:
 
 
 
 
 
State and local governments public deposits
$
129,288

 
$
129,325

 
$
130,478

Interest rate swap counterparties
14,924

 
15,089

 
14,762

Repurchase agreements
118,820

 
120,410

 
118,588

Other
3,900

 
3,900

 
3,744

Total pledged securities
$
266,932

 
$
268,724

 
$
267,572



17


Note 4: LOANS RECEIVABLE AND THE ALLOWANCE FOR LOAN LOSSES

Loans receivable at March 31, 2018 and December 31, 2017 are summarized as follows (dollars in thousands):
 
March 31, 2018
 
December 31, 2017
 
Amount
 
Percent of Total
 
Amount
 
Percent of Total
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
1,278,814

 
16.9
%
 
$
1,284,363

 
16.9
%
Investment properties
1,876,937

 
24.8

 
1,937,423

 
25.5

Multifamily real estate
321,039

 
4.2

 
314,188

 
4.1

Commercial construction
163,314

 
2.2

 
148,435

 
2.0

Multifamily construction
159,108

 
2.1

 
154,662

 
2.0

One- to four-family construction
434,204

 
5.7

 
415,327

 
5.5

Land and land development:
 

 
 
 
 

 
 
Residential
167,783

 
2.2

 
164,516

 
2.2

Commercial
24,331

 
0.3

 
24,583

 
0.3

Commercial business
1,296,691

 
17.2

 
1,279,894

 
16.8

Agricultural business, including secured by farmland
307,243

 
4.2

 
338,388

 
4.4

One- to four-family residential
833,598

 
11.0

 
848,289

 
11.2

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
522,826

 
6.9

 
522,931

 
6.9

Consumer—other
170,158

 
2.3

 
165,885

 
2.2

Total loans
7,556,046

 
100.0
%
 
7,598,884

 
100.0
%
Less allowance for loan losses
(92,207
)
 
 

 
(89,028
)
 
 

Net loans
$
7,463,839

 
 

 
$
7,509,856

 
 


Loan amounts are net of unearned loan fees in excess of unamortized costs of $731,000 as of March 31, 2018 and were net of unamortized costs of $158,000 as of December 31, 2017. Net loans include net discounts on acquired loans of $19.4 million and $21.1 million as of March 31, 2018 and December 31, 2017, respectively.

Purchased credit-impaired loans and purchased non-credit-impaired loans. Purchased loans, including loans acquired in business combinations, are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased credit-impaired (PCI) or purchased non-credit-impaired. PCI loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments. The outstanding contractual unpaid principal balance of PCI loans, excluding acquisition accounting adjustments, was $29.8 million at March 31, 2018 and $32.5 million at December 31, 2017. The carrying balance of PCI loans was $19.3 million at March 31, 2018 and $21.3 million at December 31, 2017.
The following table presents the changes in the accretable yield for PCI loans for the three months ended March 31, 2018 and 2017 (in thousands):
 
Three Months Ended
March 31,
 
2018
 
2017
Balance, beginning of period
$
6,520

 
$
8,717

Accretion to interest income
(1,097
)
 
(1,320
)
Disposals
58

 

Reclassifications from non-accretable difference
807

 
1,273

Balance, end of period
$
6,288

 
$
8,670


As of March 31, 2018 and December 31, 2017, the non-accretable difference between the contractually required payments and cash flows expected to be collected were $9.9 million and $11.3 million, respectively.

Impaired Loans and the Allowance for Loan Losses.  A loan is considered impaired when, based on current information and circumstances, the Company determines it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments.  Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, the value of the underlying collateral and the current status of the economy. Impaired loans are comprised of loans on nonaccrual,

18


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

The following tables provide information on impaired loans, excluding PCI loans, with and without allowance reserves at March 31, 2018 and December 31, 2017. Recorded investment includes the unpaid principal balance or the carrying amount of loans less charge-offs and net deferred loan fees (in thousands):
 
March 31, 2018
 
Unpaid Principal Balance
 
Recorded Investment
 
Related Allowance
 
 
Without Allowance (1)
 
With Allowance (2)
 
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
3,872

 
$
3,444

 
$
199

 
$
20

Investment properties
9,346

 
3,433

 
5,699

 
264

One- to four-family construction
186

 
186

 

 

Land and land development:
 
 
 
 
 
 
 
Residential
1,134

 
798

 

 

Commercial business
4,008

 
3,038

 
534

 
39

Agricultural business/farmland
9,598

 
6,440

 
3,031

 
201

One- to four-family residential
8,579

 
3,136

 
5,362

 
182

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
1,346

 
1,168

 
138

 
7

Consumer—other
180

 
76

 
71

 
4

 
$
38,249

 
$
21,719

 
$
15,034

 
$
717

 
 
 
 
 
 
 
 
 
December 31, 2017
 
Unpaid Principal Balance
 
Recorded Investment
 
Related Allowance
 
 
Without Allowance (1)
 
With Allowance (2)
 
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
7,807

 
$
6,447

 
$
199

 
$
18

Investment properties
11,296

 
4,200

 
6,884

 
263

One- to four-family construction
298

 
298

 

 

Land and land development:
 
 
 
 
 
 
 
Residential
1,134

 
798

 

 

Commercial business
4,441

 
3,424

 
555

 
50

Agricultural business/farmland
9,388

 
6,230

 
3,031

 
264

One- to four-family residential
9,547

 
3,709

 
5,775

 
178

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
1,498

 
1,324

 
139

 
7

Consumer—other
134

 
58

 
73

 
2

 
$
45,543

 
$
26,488

 
$
16,656

 
$
782


(1) 
Includes loans without an allowance reserve that have been individually evaluated for impairment and that evaluation concluded that no reserve was needed, and $10.6 million of homogenous and small balance loans as of both March 31, 2018 and December 31, 2017, that are collectively evaluated for impairment for which a general reserve has been established.
(2) 
Loans with a specific allowance reserve have been individually evaluated for impairment using either a discounted cash flow analysis or, for collateral dependent loans, current appraisals less costs to sell to establish realizable value.

19



The following tables summarize our average recorded investment and interest income recognized on impaired loans by loan class for the three months ended March 31, 2018 and 2017 (in thousands):
 
Three Months Ended
March 31, 2018
 
Three Months Ended
March 31, 2017
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
5,383

 
$
3

 
$
2,916

 
$
2

Investment properties
9,972

 
83

 
8,893

 
49

Multifamily real estate

 

 
495

 
4

One- to four-family construction
605

 
4

 
1,180

 
20

Land and land development:
 
 
 
 
 
 
 
Residential
798

 

 
1,899

 
17

Commercial

 

 
977

 

Commercial business
4,007

 
7

 
4,504

 
7

Agricultural business/farmland
9,109

 
33

 
6,282

 
32

One- to four-family residential
8,892

 
101

 
10,404

 
83

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
1,390

 
2

 
1,742

 
3

Consumer—other
149

 
1

 
268

 
3

 
$
40,305

 
$
234

 
$
39,560

 
$
220

 
 
 
 
 
 
 
 

Troubled Debt Restructurings. Some of the Company’s loans are reported as TDRs.  Loans are reported as TDRs when the bank grants one or more concessions to a borrower experiencing financial difficulties that it would not otherwise consider.  Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk.  Our TDRs have generally not involved forgiveness of amounts due, but almost always include a modification of multiple factors; the most common combination includes interest rate, payment amount and maturity date. As a result of these concessions, restructured loans are impaired as the Company will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement.  Loans identified as TDRs are accounted for in accordance with the Company's impaired loan accounting policies.

The following table presents TDRs by accrual and nonaccrual status at March 31, 2018 and December 31, 2017 (in thousands):
 
March 31, 2018
 
December 31, 2017
 
Accrual
Status
 
Nonaccrual
Status
 
Total
TDRs
 
Accrual
Status
 
Nonaccrual
Status
 
Total
TDRs
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
199

 
$
85

 
$
284

 
$
199

 
$
87

 
$
286

Investment properties
5,699

 

 
5,699

 
6,884

 

 
6,884

Commercial business
534

 

 
534

 
555

 

 
555

Agricultural business, including secured by farmland
2,531

 
29

 
2,560

 
3,129

 
29

 
3,158

One- to four-family residential
5,092

 
457

 
5,549

 
5,136

 
801

 
5,937

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Consumer secured by one- to four-family
138

 

 
138

 
139

 

 
139

Consumer—other
71

 

 
71

 
73

 

 
73

 
$
14,264

 
$
571

 
$
14,835

 
$
16,115

 
$
917

 
$
17,032



As of both March 31, 2018 and December 31, 2017, the Company had commitments to advance additional funds related to TDRs up to $45,000.

No new TDRs occurred during the three months ended March 31, 2018 or 2017.
 
 
 
 
 
 
 
 
 
 
 
 
There were no TDRs which incurred a payment default within twelve months of the restructure date during the three-month periods ended March 31, 2018 and 2017. A default on a TDR results in either a transfer to nonaccrual status or a partial charge-off, or both.
 
 
 
 

20


Credit Quality Indicators:  To appropriately and effectively manage the ongoing credit quality of the Company’s loan portfolio, management has implemented a risk-rating or loan grading system for its loans.  The system is a tool to evaluate portfolio asset quality throughout each applicable loan’s life as an asset of the Company.  Generally, loans and leases are risk rated on an aggregate borrower/relationship basis with individual loans sharing similar ratings.  There are some instances when specific situations relating to individual loans will provide the basis for different risk ratings within the aggregate relationship.  Loans are graded on a scale of 1 to 9.  A description of the general characteristics of these categories is shown below:

Overall Risk Rating Definitions:  Risk-ratings contain both qualitative and quantitative measurements and take into account the financial strength of a borrower and the structure of the loan or lease.  Consequently, the definitions are to be applied in the context of each lending transaction and judgment must also be used to determine the appropriate risk rating, as it is not unusual for a loan or lease to exhibit characteristics of more than one risk-rating category.  Consideration for the final rating is centered in the borrower’s ability to repay, in a timely fashion, both principal and interest.  There were no material changes in the risk-rating or loan grading system in the three months ended March 31, 2018.

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 which requires, however, 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.

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 indeterminable.  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 should be 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.


21


The following tables present the Company’s portfolio of risk-rated loans and non-risk-rated loans by grade or other characteristics as of March 31, 2018 and December 31, 2017 (in thousands):
 
March 31, 2018
By class:
Pass (Risk Ratings 1-5)(1)
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total Loans
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
1,244,007

 
$
13,686

 
$
21,121

 
$

 
$

 
$
1,278,814

Investment properties
1,866,062

 

 
10,875

 

 

 
1,876,937

Multifamily real estate
320,533

 

 
506

 

 

 
321,039

Commercial construction
163,314

 

 

 

 

 
163,314

Multifamily construction
159,108

 

 

 

 

 
159,108

One- to four-family construction
429,172

 

 
5,032

 

 

 
434,204

Land and land development:
 
 
 
 
 
 
 
 
 
 
 
Residential
156,144

 
10,321

 
1,318

 

 

 
167,783

Commercial
21,507

 

 
2,824

 

 

 
24,331

Commercial business
1,228,831

 
16,599

 
51,152

 
109

 

 
1,296,691

Agricultural business, including secured by farmland
286,925

 
6,203

 
14,115

 

 

 
307,243

One- to four-family residential
827,788

 
553

 
5,257

 

 

 
833,598

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Consumer secured by one- to four-family
520,263

 

 
2,563

 

 

 
522,826

Consumer—other
169,889

 
11

 
258

 

 

 
170,158

Total
$
7,393,543

 
$
47,373

 
$
115,021

 
$
109

 
$

 
$
7,556,046




22


 
December 31, 2017
By class:
Pass (Risk Ratings 1-5)(1)
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total Loans
Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Owner-occupied
$
1,246,125

 
$
12,227

 
$
26,011

 
$

 
$

 
$
1,284,363

Investment properties
1,918,940

 
9,118

 
9,365

 

 

 
1,937,423

Multifamily real estate
313,432

 

 
756

 

 

 
314,188

Commercial construction
148,435

 

 

 

 

 
148,435

Multifamily construction
154,662

 

 

 

 

 
154,662

One- to four-family construction
411,802

 

 
3,525

 

 

 
415,327

Land and land development:
 
 
 
 
 
 
 
 
 
 
 
Residential
153,073

 
10,554

 
889

 

 

 
164,516

Commercial
21,665

 

 
2,918