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Banner Corporation (NASDAQ:BANR)

Q2 2013 Earnings Conference Call

July 25, 2013 11:00 a.m. ET

Executives

Mark Grescovich – President & CEO

Rick Barton – Chief Credit Officer

Lloyd Baker – EVP & CFO

Albert Marshall – Secretary

Analysts

Jeff Rulis – D.A. Davidson & Co.

Tim Coffey – FIG Partners

Don Worthington – Raymond James

Jacquelynne Chimera – Keefe, Bruyette & Woods

Louis Feldman – Wells Capital Management

Operator

Good day ladies and gentlemen, thank you for standing by. Welcome to the Banner Corporation Second Quarter 2013 Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions)

This conference is being recorded Thursday, July 25, 2013. I would now like to turn the conference over Mark Grescovich, President and Chief Executive Officer of Banner Corporation. Please go ahead, sir.

Mark Grescovich

Thank you, Cheryl, and good morning everyone. I would also like to welcome you to the second quarter earnings call for Banner Corporation. As is customary, joining me on the call today is Rick Barton, our Chief Credit Officer; Lloyd Baker, our Chief Financial Officer; and Albert Marshall, the Secretary of the Corporation. Albert, would you please read our forward looking safe harbor statement.

Albert Marshall

Certainly. Good morning. Our presentation today discusses Banner's business outlook and will include forward-looking statements. Those statements include descriptions of management's plans, objectives and goals for future operations, products or services, forecasts of financial and other performance measures and statements about Banner's general outlook for economic and other condition.

We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today.

Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and a recently filed Form 10-Q for the ended March 31, 2013. Forward-looking statements are effective only as of the date they are made and Banner assumes no obligation to update information concerning its expectations.

Thank you.

Mark Grescovich

Thank you, Al. As announced, Banner Corporation had another strong quarter of performance reporting a net profit available to common shareholders of $11.8 million or $0.60 per share for the period ended 06/30/2013. This compared to a net profit for common shareholders of $23.4 million or $1.27 per share for the second quarter of 2012.

As you all know the second quarter of 2012 had several extraordinary accounting items. Therefore, when looking at earnings before tax and changes in fair value Banner's income improved to $0.91 per share for the second quarter of 2013, compared to $0.58 in the second quarter of 2012, and $0.87 per share in the first quarter of 2013. The second quarter performance continued our positive momentum and solidified that through the hard work of our employees throughout the company we continue the successful execution of our strategies and priorities to deliver sustainable profitability to Banner, and our return to profitability for the last nine quarters further demonstrates that our strategic plan is effective and we continue building shareholder value.

Our operating performance showed improvement on several core key metrics again this quarter when compared to the same quarter a year ago. The second quarter of 2013 marked the 15th consecutive quarter that we have achieved a year-over-year increase in revenues from core operations.

Our net interest margin held strong at 4.20% in the second quarter of 2013 compared to 4.16% in the first quarter of 2013, and our cost of deposits again decreased in the most recent quarter to 29 basis points compared to 31 basis points in the first quarter and 48 basis points in the same quarter of 2012.

Our solid performance resulted in a return on average assets of 1.11% in the quarter consistent with the first quarter of 2013. All of these improvements are reflective of the execution on our super community bank strategy that is reducing our funding costs by remixing our deposits away from high price CDs, growing new client relationships, and improving our core funding position.

To that point, our core deposits increased 12% compared to June 30, 2012. Also our non-interest bearing deposits increased 19% from one year ago. The predominant portion of this balance growth is from the generation of new client relationships. Our net client growth in these product categories is 47% since 12/31 of 2009. It’s important to note that this is all our organic growth from our existing branch network.

In a moment, Lloyd Baker will discuss our operating performance in more detail for you. While we have been effectively executing on our strategies to protect our net interest margin, grow client relationships, and deliver sustainable profitability, improving the risk profile of Banner and aggressively managing our troubled assets also has been a primary focus of the organization. Again this quarter, we continued making excellent progress on ensuring Banner maintains a moderate risk profile.

Our non-performing assets have been reduced another 27% compared to the first quarter of 2013 and 55% compared to June 30 of 2012. The most problematic part of our portfolio, the non-performing loans, has reduced 45% from June 30 of 2012.

In a few moments Rick Barton, our Chief Credit Officer, will discuss the credit metrics of the company and provide some context around the loan portfolio and our success in aggressively managing our problem assets. Given our successful credit management, a reduction in non-performing loans, and our moderate risk profile, we did not record a provision for loan losses in the quarter.

Nonetheless, Banner’s coverage of allowance for loan losses to non-performing loans increased to 294% at June 30, 2013, up substantially from 169% in the second quarter a year ago. Banner’s reserve levels are substantial and our capital position and liquidity remain extremely strong.

At the end of the quarter, our ratio of allowance for loan and lease losses to total loans was 2.34%, our total capital to risk weighted assets ratio was just under 17%, our tangible common equity ratio improved to 12.2%, and our loan-to-deposit ratio was 95%.

In the quarter and throughout the preceding 39 months, we’ve continued to invest in our franchise. We continued to add talented commercial, retail, and mortgage banking personnel to our company in all of our markets, and we continued to invest in further developing and integrating all our bankers into Banner’s credit and sales culture. Also we have expanded our commercial product offering with the addition of an asset-based lending specialization this quarter.

These investments are yielding very positive results as evidenced by our strong customer acquisition that I mentioned, 8% year-over-year growth in C&I and Ag loans, strong mortgage banking revenue, and cross sell ratios, and our 15th consecutive quarter of year-over-year increases in revenues from core operations. Further, we’ve received marketplace recognition of our progress and value proposition as J.D. Power and Associates ranked us number one in customer satisfaction in the Pacific Northwest for the second consecutive year. The small business administration named Banner Bank Community Lender of the Year for our Seattle District, and Bankrate.com again awarded Banner Bank their highest rating for safety and soundness.

Finally, the successful execution of our Banner growth plan and our persistent focus on improving the risk profile of Banner has now resulted in nine consecutive quarters of profitability, and we again declared $0.12 per share dividend in the second quarter.

I will now turn the call over to Rich Barton, our Chief credit Officer, to discuss trends in our loan portfolio and our significantly improved credit metrics, Rich?

Richard Barton

Thanks Mark. As documented in our press release and noted this morning by Mark, Banner’s credit metrics showed solid improvement in the second quarter. Let me comment on a few highlights.

Net charge offs for the quarter were a very low $275,000, down from a similarly low $363,000 in the linked quarter or just 0.01% of average loans outstanding.

Non-performing assets ended the quarter at $33 million, a reduction of $12 million or 27% from [prior quarter]. Non-performing assets now stand at 0.78% of total assets. More specifically, non-performing loans decreased $7.3 million or 22%, and OREO decreased $4.5 million or 40%. When compared to 6/30/2012 the reduction in non-performing assets is $40 million or 55%. It is significant to note that quarter end OREO totaled only $6.7 million, down from its peak balance of $107 million at September 30th 2010. Also noteworthy is that for the past six quarters Banner has recorded a net gain on the sale of OREO assets, and for the past four quarters the net gain has exceeded any valuation adjustments

These statistics highlight not only the effectiveness of our OREO staff and valuation methodology, but also continuing stabilization in our major real estate markets. Performing troubled debt restructures also are continuing to decrease. At quarter end they totaled $51.7 million, down $2.9 million or 5% from the linked quarter. Compared to a year ago June 30, 2012, performing TDRs were down $6.3 million or 11%. Importantly, these reductions were driven by payments and pay offs, not migrations and non-accrual status.

Delinquencies remained well under control during the second quarter. The delinquency percentage dropped to 0.97% of total loans compared to 1.25% at March 31, 2013, and the delinquency rate for loans 30 to 89 days past due and on accrual was only 0.18%. Because of the low level of net losses and the credit metrics just summarized no provision for loan losses was made for the second consecutive quarter.

The reserve for loan losses, however, remains a source of significant strength for the company as a reserve to total loans is 2.34% and the coverage of non-performing loans is 294%.

To summarize my remarks this morning, I will draw on a theme stated in past calls. Our consistent and aggressive work out strategies have and are continuing to pay dividends as measured by our current credit metrics and substantially reduced credit costs that clearly support the company’s ability to grow the loan portfolio and execute our long-term strategic plans.

With that I will turn the mike over to Lloyd for his comments.

Lloyd Baker

Thank you, Rich and good morning everyone. As Rich and Mark have indicated and is reported in our press release our operating results for the second quarter were again very solid and position Banner Corporation well for continued good performance in future periods.

In particular, the continuation of strong revenues from core operations, further improvement in asset quality, additional client acquisition and loan growth all give evidence to the positive momentum we are enjoying, the result of a successful execution of our strategic initiatives and the strength of the Banner franchise.

While our past success is making comparisons to prior periods more challenging, particularly with respect to last year’s second quarter when we reversed most of the valuation loans for our deferred tax asset, however, as Mark noted the quarter ended June 30, 2013 marks Banner’s 15th consecutive quarter of year-over-year increases in revenues from core operations. This solid revenue generation again occurred with little help for the economy, which while slowly improving, continued to produce only modest growth and still exceptionally low interest rates.

For the quarter ended June 30, 2013 our revenues from core operations, which includes net interest income before provision for loan losses, plus other non-interest operating income that excludes gains on security sales, and fair value, and other-than-temporary impairment adjustments, revenues from core operation were $53.1 million, an increase of 4% from the immediately preceding quarter, and 2% compared to the second quarter a year ago.

For the six months end June 30, our revenues from core operations increased to $104 million, a little more than 1% increase, despite the fact that the same period last June was aided by one additional day of earnings because 2012 was a leap year.

Reflecting this revenue growth as well as reduced credit cost, our net income available to common share holders was 11.8 million or $0.60 per diluted share in the second quarter of ‘13 compared to 11.6 million also $0.60 per diluted share in the immediately preceding quarter, and $23.4 million or $1.27 per diluted share in the same period a year ago. It is important to note that the current quarter’s net income also reflects a normal provision for income taxes of $5.7 million, while the second quarter results of 2012 included a $31.8 million benefit from income taxes as a result of reversing most of the valuation allowance for our deferred tax asset.

As Rick has noted our credit metrics continued to improve during the quarter and as a result, similar to the first quarter, we did not record provisions for loan losses for the second quarter of 2013. This compares to a $4 million provision in the second quarter a year ago and $9 million for the first six months of 2012.

Of course not taking the provision for loan losses, which reflects the significant reduction in non-performing loans to net charge-offs, including further progress in the current quarter had a substantial positive effect on our net income for the quarter and the six months ended June 30, 2013.

As it has been the case for an extended period, our net interest margin remained strong, as did deposit fee revenues fueled by growth in core deposits, and again in the current quarter revenues from mortgage banking operations. Our net interest margin was 4.20% for the second quarter of 2013, 4 basis points increase from the preceding quarter, but 11 basis points lower than the same quarter a year ago.

For the first six months of 2013, our net interest margin was 4.18% compared to 4.23% for the first six months of 2012. The year-over-year margin comparison for both the quarter and the six month period again reflect a meaningful reduction in our funding cost, as well as a reduction in the adverse effects of non-performing assets, which were generally offset by declining yields on other performing assets. Compared to the second quarter a year ago, the margin also benefited from a sizable reduction in the average balance of low yielding interest earning cash equivalents, or as I have noted before, it is clear that the net interest margin will remain under pressure in the current low interest rate environment.

Benefiting from an additional day compared to the first quarter and the stronger net interest margin, Banner Corporation’s net interest income increased to $42.2 million for the quarter ended June 30, 2013, compared to $41 million in the first quarter. However, net interest income decreased a small amount compared to $42.7 million in the second quarter a year ago, as an increase in the average balance of earning assets was offset by a 11 basis point decline in the net interest margin.

Net interest margin for the first six months -- for the six months ended June 30, 2013 was $83.2 million, also a modest decrease compared to the same period a year earlier, which was $84.2 million, and the year earlier, of course, was augmented by the leap year effect in the first quarter. The decline occurred as both average balance and net interest margin were only marginally changed.

Deposit cost decreased by another 2 basis points during the second quarter, and 19 basis points lower than a year ago, reflecting further changes to the deposit mix, as well as additional downward pricing on interest earnings accounts. The decrease in deposit cost compared to the second quarter a year ago marginally reflects significant growth in non interest bearing account balances, and decrease in higher cost certificates to deposits.

As a result of the lower deposit cost and lower borrowing cost, our average cost of funds decreased by 3 basis points compared to the preceding quarter, and also was 19 basis points lower than the second quarter of 2012. The low interest rate environment continued to put downward pressure on asset yields, however, compared to a year ago, our net interest margin further benefited from decreased levels of non-accruing loans and OREO, as well as modest changes in the mix of earning assets, which offset some of this pricing pressure.

The yield on earnings assets at 4.53% was nearly unchanged from the preceding quarter, but was 23 basis points lower than the second quarter of 2012. The yield on loans was 5.22% for the second quarter of 2013, which was a decrease of just 1 basis point compared to the preceding quarter, but 31 basis points lower than the second quarter a year ago. The yield on loans in the current quarter benefited from increased balances of construction and development loans, and the significant velocity of turnover on those loans, which generally carry higher interest rates and fees than many other types of loans.

In addition, the collection of delinquent interest on non-accrual loans added 2 basis points to the margin in the current quarter. By contrast, non-accruing loans had an adverse impact of 4 basis points in the preceding quarter, and 8 basis points for the second quarter a year ago.

As I previously indicated, pressure on asset yields will clearly be an issue going forward. As a result, improvement in our net interest income will be dependent on growth in earning assets in future periods. To that point, our quarter end average loan balances increased compared to the preceding quarter, and compared to a year ago. While continued economic uncertainty has kept demand for both business and consumer loans modest, and credit line utilizations remain low, we have seen growth in targeted loan categories, and we are optimistic about the potential in our loan production pipelines.

Compared to a year earlier, owner occupied commercial real estate loans increased 5%, total commercial and agricultural business loans have increased 8%, including 5% in the current quarter, as expected seasonal borrowing boosted the total. And aggregate construction and development loans have increased by 20%.

Following a normal seasonal pattern, non-interest-bearing deposit balances declined by 2% during the first six months of the year to $958 million at June 30, 2013, but have increased by $154 million or 19% compared to a year earlier. Similarly following a seasonal pattern, interest-bearing transaction and savings accounts increased modestly during the quarter, but at $1.56 billion these account balances have increased by 2% for the first six months of 2013, and were 8% greater than a year earlier.

As a result of growth in total transaction and savings accounts and further reductions in high cost certificates of deposit, core deposits now represent nearly 73% of total deposits compared to 66% at the end of the second quarter of 2012, and as I've noted before the continued growth in the number of accounts and customer relationships has significantly contributed to increased deposit fee revenues. This was again evident in the current quarter and six-month results, as total deposit fees and service charges were 5% and 6% greater than for the same periods a year ago.

Revenues from mortgage banking activity continued to be strong at $3.6 million for the second quarter of 2013. This revenue was augmented in the current quarter by $600,000 as the result of a partial reversal of a valuation allowance and previously recorded impairment charges to our mortgage servicing asset. Nonetheless, excluding this valuation adjustment, mortgage banking revenues still compared favorably to $2.8 million in the first quarter of 2013 and $2.7 million in the second quarter of 2012.

While these increases in mortgage rates have clearly slowed the flow of applications for refinanced loans into our production pipeline, purchase activity continues to be strong, and we remain optimistic that this business line will make a significant contribution to revenues going forward.

Our operating expenses for the second quarter increased compared to the immediately preceding quarter, but were nearly unchanged compared to the same quarter a year ago, primarily due to lower costs associated with loan collection and real estate owned, as well as decreased FDIC insurance charges. The increase in all other operating expenses generally reflects higher compensation cost, and other expenses related to increased production and transaction volumes.

Finally, as I noted, our results for the second quarter and first six months of 2013 reflect the normal tax rate adjusted for certain non-taxable income and tax credits. By contrast for both the second quarter and six months ended June 30, 2012, our operating results reflect a net tax benefit, which substantially added to our income and earnings per share in those periods. This tax benefit was partially offset by a substantial fair value adjustment for our junior subordinated debentures.

While both of these adjustments resulted from the significant improvement in Banner’s operating results, it will make the year-over-year comparison of our financial somewhat challenging. Nonetheless, focusing on our poor operating result, it is clear that the current quarter and six-month periods represent strong financial performance that is producing increased shareholder value and apparently is being well recognized by the market.

So with that final comment, I will turn the call back to Mark. As always, I look forward to your questions.

Mark Grescovich

Thank you, Lloyd and Rick. That concludes our prepared remarks and Cheryl, we will now open the call and we welcome your questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Jeff Rulis with D.A. Davidson & Co. Please go ahead.

Jeff Rulis - D.A. Davidson & Co.

Thanks. Good morning guys.

Mark Grescovich

Good morning Jeff.

Lloyd Baker

Hi Jeff.

Jeff Rulis - D.A. Davidson & Co.

On the -- just looking at the loan deposit ratio sort of approaching 100% here, you guys have had really great core deposit growth, will be interested in the philosophy going forward if you have to become maybe less picky on the CD side, or would you access other sources of funding, I guess, how do you see the -- is that a concern at all on the leverage?

Mark Grescovich

Yes, Jeff, this is Mark. As we have stated publicly, we would like to keep that loan to deposit ratio between 90% and 95%. I think the rundown in deposits this quarter again was much more of a seasonal component rather than a systemic issue, and I think what you are going to find is that our new client generation is going to keep us within that loan to deposit ratio, and keep pace with the loan growth.

Jeff Rulis - D.A. Davidson & Co.

Got it. And then you guys commented on sort of a low-lying utilization, maybe if you could share what that level is and I guess kind of what -- where you are targeting that in a reasonable fashion, say six months out or kind of a tough number to peg, but do you have that figure?

Lloyd Baker

Hi, Jeff, this is Lloyd. By the way I am looking forward to having concerns about funding loans. That is a good problem to have.

Jeff Rulis - D.A. Davidson & Co.

Okay.

Lloyd Baker

Utilization levels are still in the low 40s range on most -- the line of credit type lending, which as I noted continues to be low, and now obviously Ag loan had a seasonal increase this quarter, which brought the utilization up there. So where it is going to go from here, boy, that is the great question, isn’t it, we all would like to see the economy present opportunities that will want people to utilize those credit lines, and if they do, as I said, I look forward to being concerned about how to fund it.

Jeff Rulis - D.A. Davidson & Co.

And then lastly Mark, I got to harass you on sort of the update on the capital plan with the TCE above 12%, a little clarity on Basel, maybe you have in the past just sort of prioritized capital usage methods, could you share that with us, update it?

Mark Grescovich

Sure. I don’t think there is anything different in my commentary. We clearly have the shareholders interest in mind and the prudent use of capital. Clearly the organization with the capital and our reserve levels is going to provide us great flexibility going forward in terms of capital utilization. The first priority is going to clearly be to get our dividend payout ratio to that 30% to 35% range. That will be the first priority along with continued reinvestment in the company. And then we would look for additional sources of capital utilization or capital management, which may include stock buybacks and the like.

Jeff Rulis - D.A. Davidson & Co.

Any increase in sort of the M&A chatter from your perspective, any sort of inbound calls or the like?

Mark Grescovich

Well, I think -- I think we have seen a couple of recent announcements in M&A. So I think there is opportunities that are out in the marketplace. Clearly with our business model, the scalability of our business model, the successful execution that we put in place, you know, there is always conversations, but as I have indicated before Jeff whatever we would do or look at would have to be very strategic and very beneficial for the shareholders.

Jeff Rulis - D.A. Davidson & Co.

Okay. That is it from me. Thanks.

Mark Grescovich

Thanks Jeff.

Operator

Thank you. Our next question comes from the line of Tim Coffey with FIG Partners. Please go ahead.

Tim Coffey - FIG Partners

Hi, good morning gentlemen.

Mark Grescovich

Good morning Tim.

Tim Coffey - FIG Partners

I heard in some of the prepared comments that this quarter’s loan activity experienced lower turnover, so I am wondering what kind of loan growth -- growth loans would have looked like had the quarter included kind of normalized loan turnover?

Mark Grescovich

Tim, this is Mark. I’m not sure exactly what you are referring to in terms of lower turnover. I think what you may have heard is that the velocity in our construction and development portfolio is still very strong. So our production levels in particular in construction and development are running at about 25% increase year-over-year, but the balances are not advancing as fast, and that is because the velocity in that portfolio, the turnover is quite significant, and that is just reflective of the demand, supply and demand if that is what you were indicating.

Tim Coffey - FIG Partners

Yes, that is very helpful. So the typical, the pay downs you saw this quarter, there has not been any real difference between this quarter and previous quarters?

Mark Grescovich

We have not -- I would not characterize the pay downs as being aggressive at all. We have been able to keep pace with that. one of the items you maybe referring to also Tim is that we have indicated that a lot of our loan growth, about production that we have had in our targeted portfolios has been masked by the refinance activity and the pay downs in our one to four family portfolio.

As rates ticked up and we all know that refi, the refi business has slowed that the pay offs in that portfolio has slowed as well, which has allowed us to grow the loan book, and we would anticipate that trend to continue.

Tim Coffey - FIG Partners

Okay, okay, now that is very helpful. Thank you. Speaking of the mortgage business, could you give me a break down between refi and purchase activity in the quarter, as well as loan sale margins?

Lloyd Baker

Tim, this is Lloyd. The refi activity in the quarter slowed as you would expect, and as Mark noted. So our production in the quarter was about 55% refi and 45% purchase transaction, and that is down, first-quarter production was about 70% refi. Margins have also come in a little bit. They are still very strong, but really didn’t come in a lot from the first quarter, where they have come in from was the very high levels in the second half of last year.

Tim Coffey - FIG Partners

Okay, okay.

Mark Grescovich

Tim this is Mark. Also just one additional comment on that as we have indicated in past calls and you are aware, we have invested heavily in our mortgage operation, and we again were investing in the fourth quarter and first quarter in additional mortgage officers that can -- that are adaptive to the purchase type of portfolio. So that we have been investing in that and that is also paying off for us.

Tim Coffey - FIG Partners

Okay, and then Rick, I had a question for you. The dollar value of the recoveries for the last three quarters has been substantial. Do you anticipate those kind of levels continuing, or do you see them declining in forward quarters?

Richard Barton

Well, that is a very good question Tim. You know, those things are very, very hard to predict. You know, they tend to come in lumps. But I think it is safe to say that the low hanging fruit has been picked off the tree at this point and that it is not going to be something that will be easy to replicate in future quarters.

Tim Coffey - FIG Partners

Well, thank you gentlemen.

Mark Grescovich

Tim, while I will characterize that a little differently, there are less favorable, because we have had such success in reducing problem assets and collecting on previous problem assets.

Tim Coffey - FIG Partners

So, you definitely have had a kind of success?

Mark Grescovich

Yes, it is not just low hanging fruit. It is just that there is less of it out there, which is a good thing.

Tim Coffey - FIG Partners

Well, gentlemen, thank you very much. Those are my questions.

Mark Grescovich

Thank you Tim.

Operator

Thank you, and our next question comes from Don Worthington with Raymond James. Please go ahead.

Don Worthington - Raymond James

Hi, good morning everyone.

Mark Grescovich

Good morning Don.

Don Worthington - Raymond James

A couple of questions, in terms of the other comprehensive income account, and you have shown in the press release other components of stockholders equity, is that primarily what is in there?

Lloyd Baker

Hi Don. It is Lloyd here. That is exactly what is in there still. It was about a $5.6 million charge for the quarter. Other comprehensive income, which is the mark-to-market on the available for sale portfolio. Not surprising given the interest rate increase. I think what is -- what all of us need to bear in mind is that the bulk of that would be recovered over time as those assets continue to perform and roll down the curve.

Don Worthington - Raymond James

Okay, thank you. And then in terms of the loan pipeline, I know you don’t necessarily give specific numbers, but on a relative basis where was the pipeline versus last quarter?

Mark Grescovich

Our pipeline continued -- this is Mark Don, our pipeline continues to be very strong. We see those numbers increasing, and what I can tell you is one thing I commented in terms of year-over-year production, I commented on our construction and development production up about 25%. Our C&I and Ag production and real estate production is running at the same level. So we are seeing about 25% increase year-over-year.

Don Worthington - Raymond James

Okay. All right. Thank you.

Mark Grescovich

You are welcome. Thank you Don.

Operator

Thank you. (Operator instructions) And our next question comes from the line of Jacquelynne Chimera with Keefe, Bruyette & Woods. Please go ahead.

Jacquelynne Chimera - Keefe, Bruyette & Woods

Hi, good morning everyone.

Mark Grescovich

Good morning Jackie.

Jacquelynne Chimera - Keefe, Bruyette & Woods

I apologize if this was covered in the prepared remarks, and I just missed it. But I wanted to see what had happened in your securities portfolio, I was surprised by the decline in duration during the quarter, I had in my notes, and maybe this is incorrect, but I had in my notes it was 4.6 years last quarter and then the press release mentioned 3.8 years this quarter?

Lloyd Baker

Hi, Jackie, it is Lloyd. A couple of things there, we did have some securities sales in the (inaudible), which affected debt. We also, the duration analysis that we are utilizing is not very effective when interest rates are exceptionally low, and as we looked at it more closely this quarter, we just felt that the number that we have been putting out there before was overstating the duration of the portfolio, and effective duration really is that 3.8 type number that we put in the press release.

And it is -- there still is some duration there and I think the comments that we have made is over time is that we have added a little duration compared to where we were a year and a half ago, let us say, when we had a much larger balance of cash and cash equivalent because it is just too painful to stay invested at 25 basis points in cash. But again, we -- I think that the 3.8 number that is in there is a better indication of the true duration than what we had produced before.

Jacquelynne Chimera - Keefe, Bruyette & Woods

Okay. No, that is helpful. I was confused on the comments and the press release versus what appeared to be a decline in the quarter. But now that explains that perfectly. Thank you. And Mark I wondered if you can provide a little more background on the asset-based lending that you added in the quarter?

Mark Grescovich

Sure. We have added additional talent. It has been an objective of ours over the course of the last three years to continue investing in product categories for our commercial and retail platforms, and we have been doing so aggressively in the commercial bank with additional treasury management products, the addition of our small business administration team, the addition of our specialty product areas, and again, I mean, that is part of the expense increase, but at the same time it is generating increased revenue and pipeline activity for us.

In the quarter, we felt the timing was right to add an asset-based lending specialty to our product offerings in the commercial bank. So we have hired a couple of bankers to drive that performance for us, very experienced individuals in the marketplace that will drive our asset based lending specialty across our footprint.

Jacquelynne Chimera - Keefe, Bruyette & Woods

You have any preliminary growth expectations you are comfortable sharing?

Mark Grescovich

Well, we are certainly not giving guidance, but what I can tell you is I’m very pleased with our early success.

Jacquelynne Chimera - Keefe, Bruyette & Woods

Okay, and then lastly you have had success in the rundown in the deposit costs; do you think there is much room left in there?

Lloyd Baker

Jackie, this is Lloyd. There is still more room. There is still more room in terms of pricing on some certificates of deposit. We have continued to see more rollover, or migrate out, but the success will most importantly be made by growing core deposit, changing the mix of that portfolio further. As I indicated, we are at about 73% transaction accounts today, and we need to drive that number higher.

Jacquelynne Chimera - Keefe, Bruyette & Woods

Okay, great.

Mark Grescovich

And Jackie, this is Mark. I think the guidance we have said is we need that number north of 85%.

Jacquelynne Chimera - Keefe, Bruyette & Woods

Okay.

Lloyd Baker

So, those are our goals.

Jacquelynne Chimera - Keefe, Bruyette & Woods

Great. Thank you both very much. It was very helpful.

Mark Grescovich

Thank you Jackie.

Operator

Thank you. And our final question comes from the line of Louis Feldman with Wells Capital Management. Please go ahead.

Louis Feldman - Wells Capital Management

Good morning gentlemen.

Mark Grescovich

Hi Louis.

Lloyd Baker

Hi Louis.

Louis Feldman - Wells Capital Management

Quick question for Rick, where are you in terms of your provision, where you would like to see it versus where the regulators would like to see it versus where the accountants would like to see it, and how long -- while the loan portfolio is turning over, I mean with balances remaining similar, but you are getting new loans in, do you feel that you are going to be able to -- at what point do you think you are going to start taking provisions again?

Mark Grescovich

Well, that is a very complicated question with many facets to it Louis. You know, the credit guy always likes to have more in the stock than less. But I know, I think that over time as the portfolio continues to grow that the level of the reserve to total loans will come down and probably settle somewhere south of 2%, just talking of the top of my head. It is really very difficult to pinpoint any kind of period of time that we would begin to make some provision to the reserve.

It is going to depend upon, you know, a number of things, the rate of loan growth, the economic conditions that exist going forward, and also probably the mix of the loan growth we are realizing and enjoying. So I can’t really give you anything from my perspective more precise than that.

Louis Feldman - Wells Capital Management

Given -- I mean, while it is at a very nice level right now, and I don’t know a regulator that wouldn’t like to keep it up there, as well as you. Would you let it run off given the difficulties in effectively provisioning on the stocks? If you let it get down to a point, I guess the question is do you feel you can build it back up in a timely manner if you let it run down too far?

Mark Grescovich

Louis, this is Mark. I think if you were to do an analysis, you would look at the portfolio and you would say, we clearly have significant reserves right now. If we have several different models that we utilize in terms of reserve methodology, clearly if you get that reserve closer to 1.5 or 1.75 total loans, there is plenty of room to grow the balance sheet with our current reserves. So that should provide you enough clarity I think to indicate, you know, some type of comfort level.

Regulators are extremely comfortable with our reserve methodology, with the stress tests we provide, and along with our credit controls that we have in place. So it is more than just having a strong balance sheet. They look at our operations and say, you are effectively managing the loan portfolio and your reserve methodologies and stress tests are very sound, and we have a very good relationship with the regulators.

Louis Feldman - Wells Capital Management

Okay. Thank you very much.

Mark Grescovich

Thank you, Louis.

Operator

Thank you. There are no further questions at this time. I would like to hand the call back

To Mark Grescovich for closing remarks?

Mark Grescovich

Great, thanks Cheryl. As I stated, we are very pleased with our strong second-quarter performance, and the reinforcing evidence that we are making substantial and sustainable progress on our disciplined, strategic plan to build shareholder value, by executing on our super community bank model, by growing market share, strengthening our deposit franchise, improving our core operating performance and maintaining a moderate risk profile.

I want to thank all my colleagues who are driving this solid performance for our company. Thank you for your interest in Banner, and for joining our call today. We look forward to reporting our results to you again in the future. Have a good day everyone.

Operator

Ladies and gentlemen, this concludes the Banner Corporation second quarter 2013 conference call. If you'd like to listen to a replay of today's conference please dial 303-590-3030 or 1-800-406-7325 with the access code 4626349. We thank you for your participation, and at this time you may now disconnect.

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