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Section 1: 10-Q (10-Q)

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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 SEPTEMBER 30, 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 every Interactive Data File required to be submitted 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 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 October 31, 2018
Common Stock, $.01 par value per share
 
32,324,789 shares
Non-voting Common Stock, $.01 par value per share
 
 
 
 
 
74,933 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 September 30, 2018 and December 31, 2017
 
 
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2018 and 2017
 
 
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017
 
 
Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2018 and the Year Ended December 31, 2017
 
 
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 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 September 30, 2018 and December 31, 2017
 
 
Comparison of Results of Operations for the Three and Nine Months Ended September 30, 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: expected revenues, cost savings, synergies and other benefits from the proposed merger of Banner and Skagit Bancorp, Inc. (Skagit) might not be realized within the expected time frames or at all and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; the remaining closing conditions to the merger may be delayed or may not be obtained, or the merger agreement may be terminated; business disruption may occur following or in connection with the proposed merger of Banner and Skagit; Banner’s or Skagit’s businesses may experience disruptions due to transaction-related uncertainty or other factors making it more difficult to maintain relationships with employees, customers, other business partners or governmental entities; the possibility that the proposed merger is more expensive to complete than anticipated, including as a result of unexpected factors or events; diversion of managements’ attention from ongoing business operations and opportunities as a result of the proposed merger or otherwise; the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses and provisions 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 the allowance for loan losses not being adequate to cover actual losses and require a material increase in reserves; results of examinations by regulatory authorities, including the possibility that any such regulatory authority may, among other things, require the writing down of assets or increases in the allowance for loan losses; the ability to manage loan delinquency rates; competitive pressures among financial services companies; changes in consumer spending or borrowing and spending habits; interest rate movements generally and the relative differences between short and long-term interest rates, loan and deposit interest rates, net interest margin and funding sources; the impact of repricing and competitors’ pricing initiatives on loan and deposit products; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values; the ability to adapt successfully to technological changes to meet customers’ needs and developments in the marketplace; the ability to access cost-effective funding; increases in premiums for deposit insurance; the ability to control operating costs and expenses; the use of estimates in determining fair value of certain assets and liabilities, which estimates may prove to be incorrect and result in significant changes in valuation; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect employees, and potential associated charges; disruptions, security breaches or other adverse events, failures or interruptions in, or attacks on, information technology systems or on the third-party vendors who perform critical processing functions; changes in financial markets; changes in economic conditions in general and in Washington, Idaho, Oregon and California in particular; secondary market conditions for loans and the ability to sell loans in the secondary market; the costs, effects and outcomes of litigation; legislation or regulatory changes or reforms, 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; results of safety and soundness and compliance examinations by the Board of Governors of the Federal Reserve System, 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 which could require an increase in reserves for loan losses, write-downs of assets or changes in regulatory capital position, or affect the ability to borrow funds, or maintain or increase deposits, or impose additional requirements and restrictions, any of which could adversely affect liquidity and earnings; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; the inability of key third-party providers to perform their obligations; changes in accounting principles, policies or guidelines, 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 operations, pricing, products and services; future acquisitions by Banner of other depository institutions or lines of business; and future goodwill impairment due to changes in Banner’s business, changes in market conditions, or other factors; 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)
September 30, 2018 and December 31, 2017
ASSETS
September 30
2018

 
December 31
2017

Cash and due from banks
$
184,417

 
$
199,624

Interest bearing deposits
64,244

 
61,576

Total cash and cash equivalents
248,661

 
261,200

Securities—trading, amortized cost $27,340 and $27,246, respectively
25,764

 
22,318

Securities—available-for-sale, amortized cost $1,451,897 and $926,112, respectively
1,412,273

 
919,485

Securities—held-to-maturity, fair value $254,094 and $262,188, respectively
258,699

 
260,271

     Total securities
1,696,736

 
1,202,074

Federal Home Loan Bank (FHLB) stock
19,196

 
10,334

Loans held for sale (includes $67.1 million and $32.4 million, at fair value, respectively)
72,850

 
40,725

Loans receivable
7,822,519

 
7,598,884

Allowance for loan losses
(95,263
)
 
(89,028
)
Net loans receivable
7,727,256

 
7,509,856

Accrued interest receivable
37,676

 
31,259

Real estate owned (REO), held for sale, net
364

 
360

Property and equipment, net
151,212

 
154,815

Goodwill
242,659

 
242,659

Other intangibles, net
18,499

 
22,655

Bank-owned life insurance (BOLI)
163,265

 
162,668

Deferred tax assets, net
78,471

 
71,427

Other assets
57,458

 
53,177

Total assets
$
10,514,303

 
$
9,763,209

LIABILITIES
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
3,469,294

 
$
3,265,544

Interest-bearing transaction and savings accounts
4,035,856

 
3,950,950

Interest-bearing certificates
1,180,674

 
966,937

Total deposits
8,685,824

 
8,183,431

Advances from FHLB
221,184

 
202

Other borrowings
98,979

 
95,860

Junior subordinated debentures at fair value (issued in connection with Trust Preferred Securities)
113,110

 
98,707

Accrued expenses and other liabilities
82,530

 
71,344

Deferred compensation
40,478

 
41,039

Total liabilities
9,242,105

 
8,490,583

COMMITMENTS AND CONTINGENCIES (Note 13)

 

SHAREHOLDERS’ EQUITY
 
 
 
Preferred stock - $0.01 par value per share, 500,000 shares authorized; no shares outstanding at September 30, 2018 and December 31, 2017

 

Common stock and paid in capital - $0.01 par value per share, 50,000,000 shares authorized; 32,327,824 shares issued and outstanding at September 30, 2018; 32,626,456 shares issued and outstanding at December 31, 2017
1,174,004

 
1,185,919

Common stock (non-voting) and paid in capital - $0.01 par value per share, 5,000,000 shares authorized; 74,933 shares issued and outstanding at September 30, 2018; 100,029 shares issued and outstanding at December 31, 2017
1,246

 
1,208

Retained earnings
109,942

 
90,535

Carrying value of shares held in trust for stock related compensation plans
(7,182
)
 
(7,351
)
Liability for common stock issued to stock related compensation plans
7,182

 
7,351

Accumulated other comprehensive loss
(12,994
)
 
(5,036
)
Total shareholders' equity
1,272,198

 
1,272,626

Total liabilities & shareholders' equity
$
10,514,303

 
$
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 and Nine Months Ended September 30, 2018 and 2017
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018

 
2017

 
2018

 
2017

INTEREST INCOME:
 
 
 
 
 
 
 
Loans receivable
$
104,868

 
$
95,221

 
$
298,743

 
$
281,304

Mortgage-backed securities
8,915

 
6,644

 
25,145

 
17,529

Securities and cash equivalents
3,865

 
3,413

 
11,003

 
9,976

Total interest income
117,648

 
105,278

 
334,891

 
308,809

INTEREST EXPENSE:
 
 
 
 
 
 
 
Deposits
5,517

 
3,189

 
13,139

 
9,162

FHLB advances
1,388

 
569

 
3,564

 
1,142

Other borrowings
60

 
84

 
179

 
241

Junior subordinated debentures
1,605

 
1,226

 
4,495

 
3,494

Total interest expense
8,570

 
5,068

 
21,377

 
14,039

Net interest income
109,078

 
100,210

 
313,514

 
294,770

PROVISION FOR LOAN LOSSES
2,000

 
2,000

 
6,000

 
6,000

Net interest income after provision for loan losses
107,078

 
98,210

 
307,514

 
288,770

NON-INTEREST INCOME:
 
 
 
 
 
 
 
Deposit fees and other service charges
12,255

 
11,058

 
35,535

 
32,611

Mortgage banking operations
5,816

 
4,498

 
15,324

 
15,854

Bank-owned life insurance (BOLI)
1,726

 
1,043

 
3,511

 
3,599

Miscellaneous
569

 
1,705

 
4,995

 
7,062

 
20,366

 
18,304

 
59,365

 
59,126

Net gain on sale of securities

 
270

 
48

 
230

Net change in valuation of financial instruments carried at fair value
45

 
(493
)
 
3,577

 
(1,831
)
Total non-interest income
20,411

 
18,081

 
62,990

 
57,525

NON-INTEREST EXPENSE:
 
 
 
 
 
 
 
Salary and employee benefits
48,930

 
48,931

 
150,491

 
144,014

Less capitalized loan origination costs
(4,318
)
 
(4,331
)
 
(13,062
)
 
(13,245
)
Occupancy and equipment
12,385

 
11,737

 
35,725

 
35,778

Information/computer data services
4,766

 
4,420

 
13,711

 
12,513

Payment and card processing expenses
3,748

 
3,581

 
11,179

 
10,523

Professional services
3,010

 
3,349

 
11,276

 
12,233

Advertising and marketing
1,786

 
2,130

 
5,758

 
5,225

Deposit insurance
991

 
1,101

 
3,353

 
3,438

State/municipal business and use taxes
902

 
780

 
2,430

 
1,857

REO operations
433

 
240

 
553

 
(1,089
)
Amortization of core deposit intangibles
1,348

 
1,542

 
4,112

 
4,790

Miscellaneous
6,646

 
6,851

 
19,444

 
20,432

 
80,627

 
80,331

 
244,970

 
236,469

Acquisition-related costs
1,005

 

 
1,005

 

Total non-interest expense
81,632

 
80,331

 
245,975

 
236,469

Income before provision for income taxes
45,857

 
35,960

 
124,529

 
109,826

PROVISION FOR INCOME TAXES
8,084

 
10,883

 
25,542

 
35,502

NET INCOME
$
37,773

 
$
25,077

 
$
98,987

 
$
74,324

Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.17

 
$
0.76

 
$
3.06

 
$
2.25

Diluted
$
1.17

 
$
0.76

 
$
3.05

 
$
2.25

Cumulative dividends declared per common share
$
0.38

 
$
0.25

 
$
1.58

 
$
1.75

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
32,256,789

 
32,982,532

 
32,300,688

 
32,966,214

Diluted
32,376,623

 
33,079,099

 
32,406,414

 
33,061,172

See Selected Notes to the Consolidated Financial Statements

5


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (In thousands)
For the Three and Nine Months Ended September 30, 2018 and 2017

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018

 
2017

 
2018

 
2017

NET INCOME
$
37,773

 
$
25,077

 
$
98,987

 
$
74,324

OTHER COMPREHENSIVE (LOSS) INCOME, NET OF INCOME TAXES:
 
 
 
 
 
 
 
Unrealized holding (loss) gain on available-for-sale securities arising during the period
(10,010
)
 
493

 
(33,083
)
 
5,841

Reclassification for net gains on available-for-sale securities realized in earnings

 
(270
)
 
(51
)
 
(230
)
Changes in fair value of junior subordinated debentures related to instrument specific credit risk
(336
)
 

 
(14,403
)
 

Income tax related to other comprehensive (loss) income
2,483

 
(105
)
 
11,376

 
(2,032
)
Other comprehensive (loss) income
(7,863
)
 
118

 
(36,161
)
 
3,579

COMPREHENSIVE INCOME
$
29,910

 
$
25,195

 
$
62,826

 
$
77,903


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 Nine Months Ended September 30, 2018 and the Year Ended December 31, 2017

 
Common Stock
and Paid in Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive 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 Accumulated Other Comprehensive Income (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
 
 
 
 
98,987

 
 
 
98,987

Other comprehensive loss, net of income tax
 
 
 
 
 
 
(36,161
)
 
(36,161
)
Accrual of dividends on common stock ($1.58/share cumulative)
 
 
 
 
(51,377
)
 
 
 
(51,377
)
Repurchase of common stock
(269,711
)
 
(15,359
)
 
 
 
 
 
(15,359
)
Amortization of stock-based compensation related to restricted stock grants, net of shares surrendered
(54,017
)
 
3,482

 
 
 
 
 
3,482

Balance, September 30, 2018
32,402,757

 
$
1,175,250

 
$
109,942

 
$
(12,994
)
 
$
1,272,198



See Selected Notes to the Consolidated Financial Statements

7


BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In thousands)
For the Nine Months Ended September 30, 2018 and 2017
 
Nine Months Ended
September 30,
 
2018

 
2017

OPERATING ACTIVITIES:
 
 
 
Net income
$
98,987

 
$
74,324

Adjustments to reconcile net income to net cash provided from operating activities:
 
 
 
Depreciation
11,014

 
10,153

Deferred income and expense, net of amortization
(4,005
)
 
(1,513
)
Amortization of core deposit intangibles
4,112

 
4,790

Gain on sale of securities
(48
)
 
(230
)
Net change in valuation of financial instruments carried at fair value
(3,577
)
 
1,831

Principal repayments and maturities of securities—trading

 
1,618

Gain on branch divestiture
(249
)
 

(Increase) decrease in deferred taxes
(7,044
)
 
8,361

Increase in current taxes payable
7,227

 
2,853

Stock-based compensation
4,844

 
4,232

Increase in cash surrender value of BOLI
(3,486
)
 
(3,046
)
Gain on sale of loans, net of capitalized servicing rights
(10,815
)
 
(11,653
)
Gain on disposal of real estate held for sale and property and equipment
(1,417
)
 
(2,438
)
Provision for loan losses
6,000

 
6,000

Provision for losses on real estate held for sale
187

 
256

Origination of loans held for sale
(637,702
)
 
(626,677
)
Proceeds from sales of loans held for sale
616,393

 
812,778

Net change in:
 
 
 
Other assets
521

 
(4,082
)
Other liabilities
5,269

 
(144
)
Net cash provided from operating activities
86,211

 
277,413

INVESTING ACTIVITIES:
 
 
 
Purchases of securities—available-for-sale
(668,456
)
 
(706,911
)
Principal repayments and maturities of securities—available-for-sale
123,132

 
135,163

Proceeds from sales of securities—available-for-sale
8,363

 
35,559

Purchases of securitiesheld-to-maturity
(8,469
)
 
(5,105
)
Principal repayments and maturities of securities—held-to-maturity
8,291

 
6,544

Loan originations, net of principal repayments
(214,487
)
 
(211,539
)
Purchases of loans and participating interest in loans
(5,487
)
 
(111,148
)
Proceeds from sales of other loans
6,629

 
9,456

Net cash paid related to branch divestiture
(20,412
)
 

Purchases of property and equipment
(12,982
)
 
(7,641
)
Proceeds from sale of real estate held for sale and sale of other property, net
6,982

 
15,873

Proceeds from FHLB stock repurchase program
110,078

 
80,056

Purchase of FHLB stock
(118,940
)
 
(88,404
)
Other
3,562

 
327

Net cash used in investing activities
(782,196
)
 
(847,770
)
FINANCING ACTIVITIES:
 
 
 
Increase in deposits, net
523,047

 
417,436

Proceeds from long term FHLB advances

 
150,000

Repayment of long term FHLB advances
(8
)
 
(7
)
Proceeds from overnight and short term FHLB advances, net
221,000

 
59,000

Increase in other borrowings, net
3,119

 
(1,971
)
Cash dividends paid
(46,989
)
 
(57,467
)
Taxes paid related to net share settlement of equity awards
(1,364
)
 
(1,187
)
Cash paid for the repurchase of common stock
(15,359
)
 
(1,400
)
Net cash provided from financing activities
683,446

 
564,404

NET CHANGE IN CASH AND CASH EQUIVALENTS
(12,539
)
 
(5,953
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
261,200

 
247,719

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
248,661

 
$
241,766



8



BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited) (In thousands)
For the Nine Months Ended September 30, 2018 and 2017
 
Nine Months Ended
September 30,
 
2018

 
2017

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Interest paid in cash
$
18,901

 
$
13,406

Taxes paid, net
13,029

 
25,599

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
1,451

 
10

    Dividends accrued but not paid until after period end
12,654

 
8,443


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 September 30, 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 nine 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 include transaction based deposit fees, non-transaction based deposit fees, interchange fees on credit and debit cards and merchant service fees which 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 either the timing or amount of recognized revenue in prior periods by the Company, however, the presentation of certain costs associated with our merchant services are offset against

10


deposit fees and other service charges in non-interest income. The Company previously recognized payment network related fees that were collected by the Company and passed through to another party related to its merchant services as non-interest expense. The change in presentation resulted in $5.9 million of expenses for the nine months ended September 30, 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, $6.1 million of merchant services related expenses for the nine months ended September 30, 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 and nine months ended September 30, 2018 and 2017, respectively (in thousands):
 
For the three months ended
September 30, 2018
 
For the three months ended
September 30, 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
$
12,255

 
$
16,799

 
$
(4,544
)
 
$
11,058

 
$
13,316

 
$
(2,258
)
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest expense:
 
 
 
 
 
 
 
 
 
 
 
Payment and card processing expenses
$
3,748

 
$
8,292

 
$
(4,544
)
 
$
3,581

 
$
5,839

 
$
(2,258
)

 
For the nine months ended
September 30, 2018
 
For the nine months ended
September 30, 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
$
35,535

 
$
41,434

 
$
(5,899
)
 
$
32,611

 
$
38,739

 
$
(6,128
)
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest expense:
 
 
 
 
 
 
 
 
 
 
 
Payment and card processing expenses
$
11,179

 
$
17,078

 
$
(5,899
)
 
$
10,523

 
$
16,651

 
$
(6,128
)


11


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 nine months ended September 30, 2018, the Company recorded a $10.9 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 nine months ended September 30, 2018, the Company recorded a $68,000 gain for the increase 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 September 30, 2018, the Company held $416,000 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 of 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 based on 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 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 upon its issuance. 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 Company is continuing its evaluation of the provisions of ASU No. 2016-02 and ASU No. 2018-11 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 is substantially complete with its effort to compile a complete inventory of arrangements containing leases and analyzing the lease data necessary to meet the new requirements. The Company has 117 real property leases under non-cancelable operating leases, the majority of which will be subject to this ASU that will result in the recognition of right-of-use assets and lease liabilities.  ASU No. 2016-02 is effective for interim and annual reporting periods beginning after December 15, 2018, and entities are required to use a modified retrospective approach for leases.  The Company expects to elect the transition option provided in ASU No. 2018-11, and apply the modified retrospective approach.  The Company also expects to elect certain relief options for practical expedients; the option to not separate lease and non-lease components and instead to account for them as a single lease component, and the option to not recognize right-of-use assets and lease liabilities that arise from short-term leases (i.e. leases terms of twelve months or less).  All of the Company’s equipment is owned or on short-term leases.  The majority of the Company’s leases have been entered into the new leasing software solution and the Company is continuing to work through the provisions of ASU 2016-02 and ASU 2018-11 to assess all impacts under the new standard. 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.

12



In July 2018, FASB issued ASU No. 2018-11, Targeted Improvements. The amendments in this ASU provide entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). In addition, the amendments in this ASU provide lessors with a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue guidance (Topic 606). For entities that have not adopted Topic 842 before the issuance of this ASU, the effective date and transition requirements for the amendments in this ASU related to separating components of a contract are the same as the effective date and transition requirements in ASU No. 2016-02.
   
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 has selected a second third-party vendor to assist with building and developing the required models. The Company is currently in the process of building 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 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The adoption of this ASU is not expected to have a material impact 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 Tax

13


Cuts and Jobs Act (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 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 September 30, 2018, the Company did not incur any adjustments to the provisional recognition.

Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40)

In August 2018, FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The amendments in this ASU broaden the scope of ASC Subtopic 350-40 to include costs incurred to implement a hosting arrangement that is a service contract. The amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The costs are capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred, consistent with the accounting for costs for internal-use software. The amendments in this ASU result in consistent capitalization of implementation costs of a hosting arrangement that is a service contract and implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this ASU. This ASU is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. The amendments in this ASU should be applied either retrospectively to all implementation costs incurred after the date of adoption. Adoption of ASU 2018-15 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

Fair Value Measurement (Topic 820)

In August 2018, FASB issued ASU 2018-13, Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The ASU removes, modifies and adds disclosure requirements in Topic 820. The following disclosure requirements were removed: 1) the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, 2) the policy for timing of transfers between levels, and 3) the valuation processes for Level 3 fair value measurements. This ASU modified disclosure requirement by requiring: 1) that the measurement uncertainty disclosure communicates information about the uncertainty in measurement as of the reporting date. The following disclosure requirements were added: 1) changes in unrealized gains and losses for the period included in other comprehensive income for the recurring Level 3 fair value measurements held at the end of the reporting period, and 2) the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. Adoption of ASU 2018-13 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

NOTE 3: SUBSEQUENT EVENT
On November 1, 2018, the Company completed the acquisition of Skagit Bancorp, Inc. (“Skagit”) and its wholly-owned subsidiary, Skagit Bank, a Washington state-chartered commercial bank. Skagit was merged into Banner and Skagit Bank was merged into Banner Bank. Pursuant to the previously announced terms of the acquisition, Skagit shareholders received 5.6664 shares of Banner common stock in exchange for each share of Skagit common stock, plus cash in lieu of any fractional shares. At September 30, 2018, Skagit Bank had assets of $919 million, a loan portfolio of $604 million, and a deposit base of $819 million with 11 retail branches along the I-5 corridor from Seattle to the Canadian border. The combined company has approximately $11.4 billion in assets.

The primary reason for the acquisition was to expand the Company’s presence and density in the North Sound region of the Pacific Northwest along the I-5 corridor. Preliminary fair values for all assets and liabilities, as well as the consideration paid, are not reported herein as the Company is still in the process of completing the initial accounting for the acquisition. Goodwill expected to be recorded in the transaction will not be deductible for income tax purposes as the acquisition is accounted for as a tax-free exchange for tax purposes. The Company expects to disclose preliminary estimates of assets acquired and liabilities assumed, including fair value adjustments and the consideration paid, in the Company's December 31, 2018 Form 10-K. In addition, the Company's December 31, 2018 Form 10-K will include the results of operations produced by the acquired company beginning on November 1, 2018.


14



Note 4:  SECURITIES

The amortized cost, gross unrealized gains and losses and estimated fair value of securities at September 30, 2018 and December 31, 2017 are summarized as follows (in thousands):
 
September 30, 2018
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair
Value
Trading:
 
 
 
 
 
 
 
Municipal bonds
$
100

 
 
 
 
 
$
100

Corporate bonds
27,240

 
 
 
 
 
25,664

 
$
27,340

 
 
 
 
 
$
25,764

Available-for-Sale:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
139,329

 
$
9

 
$
(3,030
)
 
$
136,308

Municipal bonds
66,854

 
152

 
(1,020
)
 
65,986

Corporate bonds
5,054

 
4

 
(18
)
 
5,040

Mortgage-backed or related securities
1,218,204

 
29

 
(35,715
)
 
1,182,518

Asset-backed securities
22,456

 
86

 
(121
)
 
22,421

 
$
1,451,897

 
$
280

 
$
(39,904
)
 
$
1,412,273

Held-to-Maturity:
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
1,007

 
$
18

 
$
(4
)
 
$
1,021

Municipal bonds
191,777

 
1,433

 
(3,773
)
 
189,437

Corporate bonds
3,771

 

 
(20
)
 
3,751

Mortgage-backed or related securities
62,144

 

 
(2,259
)
 
59,885

 
$
258,699

 
$
1,451

 
$
(6,056
)
 
$
254,094


15




 
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



16


At September 30, 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):
 
September 30, 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
$
101,146

 
$
(1,940
)
 
$
27,397

 
$
(1,090
)
 
$
128,543

 
$
(3,030
)
Municipal bonds
25,768

 
(358
)
 
20,470

 
(662
)
 
46,238

 
(1,020
)
Corporate bonds
3,837

 
(11
)
 
293

 
(7
)
 
4,130

 
(18
)
Mortgage-backed or related securities
902,556

 
(22,907
)
 
270,846

 
(12,808
)
 
1,173,402

 
(35,715
)
Asset-backed securities
1,102

 
(1
)
 
9,891

 
(120
)
 
10,993

 
(121
)
 
$
1,034,409

 
$
(25,217
)
 
$
328,897

 
$
(14,687
)
 
$
1,363,306

 
$
(39,904
)
Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and agency obligations
$
143

 
$
(4
)
 
$

 
$

 
$
143

 
$
(4
)
Municipal bonds
59,854

 
(1,227
)
 
33,614

 
(2,546
)
 
93,468

 
(3,773
)
Corporate bonds
481

 
(20
)
 

 

 
481

 
(20
)
Mortgage-backed or related securities
43,293

 
(1,457
)
 
16,593

 
(802
)
 
59,886

 
(2,259
)
 
$
103,771

 
$
(2,708
)
 
$
50,207

 
$
(3,348
)
 
$
153,978

 
$
(6,056
)
 
 
 
 
 
 
 
 
 
 
 
 
 
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 September 30, 2018, there were 336 securities—available-for-sale with unrealized losses, compared to 226 at December 31, 2017.  At September 30, 2018, there were 113 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 September 30, 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 nine-month periods ended September 30, 2018 or 2017. The Company did not recognize any OTTI charges or recoveries on securities—trading during the nine-month periods ended September 30, 2018 or 2017. There were no securities—trading in a nonaccrual status at September 30, 2018 or December 31, 2017.  Net unrealized holding gains of $3.5 million were recognized during the nine months ended September 30, 2018 compared to $389,000 of net unrealized holdings gains recognized during the nine months ended September 30, 2017.


17


There were nine sales of securities—available-for-sale during the nine months ended September 30, 2018, and partial calls of securities resulted in a net gain of $51,000 for the nine months ended September 30, 2018.  Sales of securities—available-for-sale totaled $35.6 million which resulted in a net gain of $230,000 for the nine months ended September 30, 2017. There were no securities—available-for-sale in a nonaccrual status at September 30, 2018 or December 31, 2017.

There were no sales of securities—held-to-maturity during the nine-month periods ended September 30, 2018 and 2017 although there were partial calls of securities that resulted in a net gain of $2,000 for the nine months ended September 30, 2018. There were no securities—held-to-maturity in a nonaccrual status at September 30, 2018 or December 31, 2017.

The amortized cost and estimated fair value of securities at September 30, 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.
 
September 30, 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

 
$
5,004

 
$
4,990

 
$
3,331

 
$
3,322

Maturing after one year through five years

 

 
64,250

 
63,572

 
49,608

 
48,484

Maturing after five years through ten years

 

 
268,844

 
259,593

 
83,662

 
82,497

Maturing after ten years through twenty years
27,240

 
25,664

 
222,061

 
218,114

 
83,124

 
83,163

Maturing after twenty years

 

 
891,738

 
866,004

 
38,974

 
36,628

 
$
27,340

 
$
25,764

 
$
1,451,897

 
$
1,412,273

 
$
258,699

 
$
254,094


The following table presents, as of September 30, 2018, investment securities which were pledged to secure borrowings, public deposits or other obligations as permitted or required by law (in thousands):
 
September 30, 2018
 
Carrying Value
 
Amortized Cost
 
Fair
Value
Purpose or beneficiary:
 
 
 
 
 
State and local governments public deposits
$
128,020

 
$
128,101

 
$
127,902

Interest rate swap counterparties
13,782

 
14,023

 
13,494

Repurchase agreements
128,991

 
132,361

 
128,991

Other
3,852

 
3,852

 
3,658

Total pledged securities
$
274,645

 
$
278,337

 
$
274,045



18


Note 5: LOANS RECEIVABLE AND THE ALLOWANCE FOR LOAN LOSSES

Loans receivable at September 30, 2018 and December 31, 2017 are summarized as follows (dollars in thousands):
 
September 30, 2018
 
December 31, 2017
 
Amount
 
Percent of Total
 
Amount
 
Percent of Total
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
1,271,363

 
16.2
%
 
$
1,284,363

 
16.9
%
Investment properties
1,943,793

 
24.8

 
1,937,423

 
25.5

Multifamily real estate
309,809

 
3.9

 
314,188

 
4.1

Commercial construction
154,071

 
2.0

 
148,435

 
2.0

Multifamily construction
172,433

 
2.2

 
154,662

 
2.0

One- to four-family construction
498,549

 
6.4

 
415,327

 
5.5

Land and land development:
 

 
 
 
 

 
 
Residential
171,610

 
2.2

 
164,516

 
2.2

Commercial
22,382

 
0.3

 
24,583

 
0.3

Commercial business
1,358,149

 
17.4

 
1,279,894

 
16.8

Agricultural business, including secured by farmland
359,966

 
4.6

 
338,388

 
4.4

One- to four-family residential
849,928

 
10.9

 
848,289

 
11.2

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
539,143

 
6.9

 
522,931

 
6.9

Consumer—other
171,323

 
2.2

 
165,885

 
2.2

Total loans
7,822,519

 
100.0
%
 
7,598,884

 
100.0
%
Less allowance for loan losses
(95,263
)
 
 

 
(89,028
)
 
 

Net loans
$
7,727,256

 
 

 
$
7,509,856

 
 


Loan amounts are net of unearned loan fees in excess of unamortized costs of $1.7 million as of September 30, 2018 and were net of unamortized costs of $158,000 as of December 31, 2017. Net loans include net discounts on acquired loans of $15.4 million and $21.1 million as of September 30, 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 $20.7 million at September 30, 2018 and $32.5 million at December 31, 2017. The carrying balance of PCI loans was $12.9 million at September 30, 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 and nine months ended September 30, 2018 and 2017 (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Balance, beginning of period
$
6,109

 
$
7,666

 
$
6,520

 
$
8,717

Accretion to interest income
(2,907
)
 
(1,720
)
 
(4,738
)
 
(5,210
)
Disposals

 

 
58

 
(497
)
Reclassifications from non-accretable difference
1,873

 
918

 
3,235

 
3,854

Balance, end of period
$
5,075

 
$
6,864

 
$
5,075

 
$
6,864


As of September 30, 2018 and December 31, 2017, the non-accretable difference between the contractually required payments and cash flows expected to be collected was $6.9 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

19


the borrower, the value of the underlying collateral and the current status of the economy. Impaired loans are comprised of loans on nonaccrual, 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 September 30, 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):
 
September 30, 2018
 
Unpaid Principal Balance
 
Recorded Investment
 
Related Allowance
 
 
Without Allowance (1)
 
With Allowance (2)
 
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
3,333

 
$
2,907

 
$
201

 
$
20

Investment properties
7,247

 
1,249

 
5,637

 
277

Multifamily construction
479

 

 

 

One- to four-family construction
1,297

 
1,297

 

 

Land and land development:
 
 
 
 
 
 
 
Residential
1,134

 
798

 

 

Commercial business
3,925

 
3,008

 
384

 
17

Agricultural business/farmland
4,546

 
1,645

 
2,560

 
71

One- to four-family residential
7,302

 
3,227

 
4,021

 
64

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
2,075

 
1,893

 
135

 
6

Consumer—other
191

 
106

 
66

 
2

 
$
31,529

 
$
16,130

 
$
13,004

 
$
457

 
 
 
 
 
 
 
 
 
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 $10.3 million and $10.6 million, respectively, of homogenous and small balance loans as of September 30, 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.

20



The following tables summarize our average recorded investment and interest income recognized on impaired loans by loan class for the three and nine months ended September 30, 2018 and 2017 (in thousands):
 
Three Months Ended
September 30, 2018
 
Three Months Ended
September 30, 2017
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
3,281

 
$
3

 
$
3,657

 
$
3

Investment properties
6,808

 
79

 
8,849

 
37

Multifamily real estate

 

 
115

 
1

One- to four-family construction
991

 

 

 

Land and land development:
 
 
 
 
 
 
 
Residential
798

 

 
1,095

 
6

Commercial

 

 
928

 

Commercial business
3,210

 
5

 
8,128

 
6

Agricultural business/farmland
4,218

 
23

 
6,196

 
69

One- to four-family residential
7,667

 
77

 
8,899

 
73

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
1,841

 
5

 
1,608

 
2

Consumer—other
164

 
1

 
140

 
1

 
$
28,978

 
$
193

 
$
39,615

 
$
198

 
 
 
 
 
 
 
 
 
Nine Months Ended
September 30, 2018
 
Nine Months Ended
September 30, 2017
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
Commercial real estate:
 
 
 
 
 
 
 
Owner-occupied
$
4,070

 
$
8

 
$
3,079

 
$
7

Investment properties
8,114

 
237

 
8,393

 
124

Multifamily real estate

 

 
335

 
10

One- to four-family construction
637

 
4

 
524

 
27

Land and land development:
 
 
 
 
 
 
 
Residential
1,059

 
10

 
1,574

 
42

Commercial

 

 
950

 

Commercial business
3,474

 
17

 
5,838

 
63

Agricultural business/farmland
5,895

 
79

 
5,605

 
131

One- to four-family residential
8,261

 
237

 
9,602

 
240

Consumer:
 
 
 
 
 
 
 
Consumer secured by one- to four-family
1,530

 
10

 
1,647

 
7

Consumer—other