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Umpqua Holdings Corporation (NASDAQ:UMPQ)

Q2 2014 Results Earnings Conference Call

July 24, 2014 01:43 PM ET

Executives

Ron Farnsworth - EVP and CFO

Ray Davis - President and CEO

Greg Seibly - President of Consumer Banking

Analysts

Steven Alexopoulos - JP Morgan

Joe Morford - RBC Capital Markets

Jeff Rulis - D.A. Davidson

Brett Rabatin - Sterne Agee

Jacque Chimera - KBW

Doug Johnson - Evercore

Operator

Good day, and welcome to the Umpqua Holdings Second Quarter Earnings Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Mr. Ron Farnsworth. Please go ahead, sir.

Ron Farnsworth

Okay, good morning and thank you for joining us today us today as we discuss the results of operations for the second quarter of 2014 for Umpqua Holdings Corporation.

With me this morning are Ray Davis, President and CEO of Umpqua Holdings Corporation; Greg Seibly, President of Consumer Banking; and Mark Wardlow, our Chief Credit Officer. Our President of Commercial Banking Cort O’Haver is out on vacation. Greg and Mark will join us for the Q&A session.

Last night we issued an earnings release discussing our financial results. We have also prepared a slide presentation which will refer to during our remarks this morning. Both of these materials can be found on our website at umpquabank.com under the Ask Us, Investor Relations section.

I would also like to remind you that today's presentation may include forward-looking statements, within the meaning of the Safe Harbor provisions for the Private Securities Litigation Reform Act of 1995, which management believes are a benefit to shareholders. These statements are necessarily subject to risk and uncertainty and actual results could differ materially due to certain risk factors including those set forth in our filings with the SEC. You should not place undue reliance on forward-looking statements. The company does not intend to correct or update any of the forward-looking statements that we make today.

We ask that you review the forward-looking statement disclosures contained within our SEC filings such as our most recent Form 10-Q, our earnings release as well as on page two of our second quarter earnings presentation. A two-week re-broadcast of this call will be available two hours after the call by dialing 888-203-1112. This phone number and the access code are also noted in the earnings release we issued yesterday afternoon.

And I will now turn the call over to Ray Davis.

Ray Davis

Okay. Thanks, Ron. Good morning, everybody. The second quarter was a very busy and productive one for us as we continued to capitalize on opportunities to grow Umpqua in a profitable manner. Our second quarter performance reflects the results of operations from Sterling since the date of acquisition on April 18th. I am also pleased to report our integration is proceeding smoothly and is on schedule.

We have a lot to get through today, since the reporting of the combined Umpqua Sterling financial results includes purchase accounting rules for the acquisition. After my remarks, Ron will take us through the financial and operating results in greater detail and provide an update on integration planning, cost synergies and the key deal performance metrics. After that of course we’ll then take your questions.

For the quarter Umpqua Holdings reported operating earnings of $53.9 million or $0.27 per diluted share, up 29% from the prior quarter. As a reminder, operating earnings are defined as earnings available to common shareholders before gains and losses on junior subordinated debentures carried at fair value and merger related expenses, both net of tax.

The increase in operating earnings was driven by accretion from the Sterling deal along with continued organic growth for the combined company. This past quarter, although focused on a successful integration, we’re also pleased to report that our momentum for additional growth has not slowed. Our progress is reflected in the strong organic loan and deposit growth results this past quarter. Excluding those acquired from Sterling or subsequently divested, our non-covered loan portfolio grew by $338 million sequentially offset by $44 million in loan sales for net growth of $294 million or 8% annualized. Similarly, organic deposit growth was a $189 million sequentially on annualized growth rate of 5% and a loan deposit ratio ended the quarter at 92.7%.

In both the consumer and commercial banking areas, our focus will continue to be on leveraging the strength of the Umpqua brand and bringing our unique way of banking to more customers. Umpqua is the West Coast’s largest community bank with locations across Oregon, Washington, California, Idaho and Nevada. The acquisition of Sterling has given us market density in Oregon and Washington, while positioning us for continued growth in California, specifically the Bay Area and through the Central Coast and to Southern California.

Turning to the balance sheet, we restructured Sterling's liabilities to optimize the net interest margin of the combined entity. Our adjusted net interest margin was 4.85% this quarter, up from 4.12% in the prior quarter. Part of this increase was driven by interest income from purchase accounting rules and part from restructuring the Sterling balance sheet.

Under all of that though was an increase in net interest income from continued organic growth. Key to the margin over time includes taking actions to continue to position our balance sheet to enhance our interest rate sensitivity for a rising interest rate scenario.

Mortgage banking, revenues were up by $13.9 million from the prior quarter. Through the integration of the Sterling home lending operation into Umpqua, we're taking action to improve their gain on sale margins for increased profitability in the future. We also remain focused on disciplined expense management and are on track for capturing the cost energies we guided to.

For the month of June, we achieved approximately 30% of the $87 million in annualized synergies we announced with this transaction. As we discussed in April, we are very comfortable, we will eventually exceed the $87 million synergy target and look forward to reporting on that through mid-2015. For the second quarter our efficiency ratio on an operating basis was 60%, the lowest it has been since 2008.

On credit quality our ratio of non-covered non-performing assets to total assets decreased to 0.36% from 0.53% in the prior quarter.

Umpqua’s capital and liquidity position remains strong after the acquisition and after applying the effects of Basel I and Basel III we will remain above well capitalized and our internal policy limits. We also paid a dividend of $0.15 per share which represents a yield of somewhere around 3.5%.

Now back to Ron.

Ron Farnsworth

Okay, thanks Ray. As I go through my comments I will be referring to the earnings release along with certain slides from the presentation deck which we posted on the Investor Relations section of umpquabank.com. On the date of the acquisition April 18 we added Sterling’s balance sheet and as required under purchase accounting rules recorded it at estimated fair value. That is detailed on page three of the earnings release we issued yesterday. Let’s walk through the key elements of this transaction as it will help explain the combined operating results.

Last quarter, we told you we had intentional increased to our liquidity to provide flexibility for the deal and balance sheet restructuring. Shortly after closing, we utilized some liquidity to pay off the majority of the Sterling repurchase agreements which was funded by the sale of investment securities along with the portion of the term borrowing. This had the effect of shrinking the balance sheet by $800 million. Our total available liquidity coming out of this past quarter remains strong at $7 billion or 43% of deposit.

Now for a recap of the purchase accounting effects. As you are aware Sterling for loan losses was eliminated and replaced with the credit discount or mark of approximately $264 million. Of this, we expect approximately 180 million to accrete back into interest income over the life of the acquired loan portfolio. What that means is that each quarter reported interest income will be higher by the amount of credit discount and the remaining credit mark will decrease by the same amount.

This will flow in overtime based on the number and amount of pay downs, maturities and refinancing of loans on the books as of April 18. For the second quarter, this credit discount accretion was $24.5 million. Offsetting that discount accretion with a $7.7 million provision for loans related to new loans originated by the former Sterling workforce included in the refinancing of existing and legacy Sterling loan. We are required to provide them as reserved income due to purchase accounting rules.

Please look at slide seven of the presentation. For the second quarter, Umpqua reported operating earnings per share of $0.27. Overall the Sterling deal was 32% accretive to operating earnings here in the second quarter. However on a pro forma basis, when you excluded the $24.5 million of credit discount accretion and add back the $7.7 million provision for loan loss, the acquisition added $10.1 million in after tax operating earnings or $0.05 per share. Again simply, because we cannot bring over the loan loss reserve. So, on a pro forma basis, taking that $10 million after tax or $0.05 away from operating earnings the deal was 7% accretive to legacy Umpqua operating earnings. This 7% pro forma accretion is inline with our previous comments on expected accretion this year, up about half to 12% plus of accretion we'll see next year following full realization of cost synergies.

Turning to slide eight of the presentation. Our tangible book value per share starting the quarter at $8.54 and ended at $8.69. Excluding Sterling our tangible book value per share would have been $8.71, up from net retained earnings and an increase in unrealized gains on securities.

The deal ended up being only $0.02 dilutive tangible book value here at quarter end much lower than the $0.40 or 4.6% we projected last call. This reduction is coming mostly from slightly lower net fair value adjustments, a credit discount accretion which we did not model for and merger expense not all being recorded here in the first quarter rather the majority here in the first quarter with the balance spread over the coming year.

The pro-forma tangible book earned back on the acquisition will now be all of one quarter, much lower than the previously projected 2.5 years.

On slide nine, we list just a few of the major integration activities noting there are many more detailed plans both complete and underway throughout the organization. As Ray mentioned the integration is on track and we are making good progress in achieving the $87 million in total annual cost synergies that we guided to when we announced the deal.

In June we achieved approximately 30% of our target cost synergies on an annualized basis. The majority of these were staffing related as a combined organizational chart was finalized on day one. Aside from staffing, consolidations and system conversions we also are including inter synergy analysis and improvement in the legacy Sterling home lending bottom line.

Our home lending operation the expense while mostly variable is directly tied to production revenue. So you cannot simply look at home lending expense as if that drops you will also see a drop in revenue. For this area we are focused on increasing the net non-interest revenue spread which is the non-interest revenue lesser expense. This spread has already improved for legacy Sterling from loss last year to breakeven here in June. We’ll talk more in a few minutes on mortgage banking revenue.

A few weeks ago we announced the plan of consolidation of 27 stores that will begin in September and runs through year-end. So, by the end of Q4 we’ll have most of the store consolidation synergies in place. But remaining facilities consolidations are planned from Q1 through next summer. As for system conversions we have many parallel pass running. Many of the smaller conversions are complete or underway and we’ll accommodate with our core system conversion which is planned for Q1 of 2015. Shortly thereafter, we believe that we will have fully realized the $87 million in annualized cost synergies.

Back on slides three through five, we provide some highlights for the quarter along with our income statement and balance sheet. Turning to slide six, you can see that our performance ratios improved in the second quarter driven by the improvement in operating performance. Return on tangible common equity on an operating basis improved to 12.76% from 10.13% from the prior quarter and our tangible common equity to tangible assets ratio increased to 9.34% from 8.67% in the prior quarter.

Moving ahead to slide 10. You can see we continue to demonstrate strong loan growth. The loan pipeline remained strong at $2.7 billion which is up from the first quarter and this pipeline is roughly 75% C&I. Our commercial loan offices are now fully staffed in San Jose, Glendale, Oxnard and Newport Beach. And in Southern California we’re in the process of staffing the Encino and (inaudible) offices.

FinPac, our leasing unit on July 1st, celebrated it's one year anniversary of join Umpqua. Since then that portfolio has grown by $174 million which represents an annual growth rate of 64%.

During the second quarter, FinPac generated $80 in new leases another large increase from the $61 million generated last quarter. This is several quarters in a row significant leasing growth. Showing the leverage we have within this team for contributing continued strong profits, organic loan growth and diversification.

Turning to slide 11. We saw solid organic deposit growth this quarter in area we are focused heavily on going forward. For overall consumer banking, we saw a good organic loan growth in our home lending, private banking and retail banking divisions. We improve the product array and market coverage and our private banking division and added lenders in Seattle and San Francisco. With the acquisition of Sterling will also entered with dealer banking business which experience the strongest quarterly growth rate since 2008.

Now turning to slide 12. Our adjusted net interest income increased by $102 million from the prior quarter and our adjusted net interest margin expanded to 4.85%. Part of this is was driven by the increase by the interest income related to the credit discount accretion I discussed earlier. Excluding that, our pro forma adjusted net interest margin would have been 4.28%, which is up 16 basis points from the 4.12%, we have for Classic Umpqua in the first quarter. That increase was driven primarily by the balance sheet restructuring with the deal.

Non-interest income increased by 21.5 million from the prior quarter, again driven largely by the acquisition of Sterling.

Looking at slide 13, you can see mortgage banking revenue increased by $13.9 million from the prior quarter. This was driven by an increase in income from the origination in sale of mortgages, partially offset by a $3.2 million loss from the change in fair value of our MSR due to declining rates this quarter.

On slide 14 we breakout our mortgage production and gain on sale margin between legacy Umpqua and Sterling. The overall margin decline from 2.87% to 2.47% related generally to lower margin coming in from Sterling’s lock pipeline. Sterling historically priced for volume, while Umpqua priced for higher profitability, hence the legacy Sterling gain on sale margin was much lower. I need to stress this impact is temporary as we have uniform pricing now in place for all new originations.

For portfolio loans, they are included in the total production figures but we do not recognize mortgage banking revenue on them. Hence we have started to provide additional production stats in our earnings release on the for sale loans.

Now please turn to slide 15, the gain on sale margin calculated just on the loans for sale was 3.55% in total for Q2 with Umpqua Classic at 4.10% and Sterling at 3%. You can see from the trending, the Umpqua Classic margin only declined 2 basis points for loans that are intended to be sold. Again over the coming quarters the legacy Sterling production margins are expected to increase as we have consolidated pricing across the enterprise. It’s just the matter of time for those loans to flow through the system.

Turning to non-interest expense on slide 16, non-interest expense increase entirely related to the addition of legacy Sterling operation, along with the related merger expense this quarter. It is important to note the second quarter run rate does not include the full benefit of the cost synergies I outlined earlier. We expect the operating expense categories to continue declining over the balance of this year. In connection with store consolidations and then again decline coming out of Q1 next year following the core system conversion.

The majority of merger expense was recognized this quarter and then we'll have lower amounts for the next several quarters related primarily to store and facility consolidations along with the system conversions.

On slide 17. As for credit quality related cost, the non-covered provision for loan loss was $15.4 million for the quarter. As I mentioned earlier, $7.7 million of this related to the Sterling acquisition accounting. Another $5.5 million was from continued very strong lease growth at FinPac. The remaining $2.2 million was from organic loan growth at legacy Umpqua.

Now please turn to slide 18. All of our credit quality ratios remain strong. One thing to note, when you look at the level of allowance for loan losses, recall the allowance related to legacy Sterling was eliminated and replaced with the credit of discount against loan.

What we have done on the bottom of this slide is to show the ratio of allowance for non-covered credit losses to non-covered loans and leases, both as reported and after factoring in the Sterling where the credit discount remaining at quarter end. When you gross up the level of allowance and related loan portfolio, you can see that reserve ratio will be 2.2% which is very strong.

Lastly on the P&L, our effective income tax rate increased this quarter related to higher annualized income from the Sterling deal. The higher level for this specific quarter was to adjust the year-to-date operating effective tax rate to 35.8%. That is projected to be our full year operating effective tax rate. So, our quarterly tax run rate will drop back down in Q3.

Looking at capital on slide 19. All of our regulatory capital ratios are right in line with our estimates at quarter ago and remain in excess of well capitalized levels and our internal policy limits. Our Tier 1 common ratio should be approximately 11% for the remainder of the year, declining to the low 10% range in the Basel III next year.

Our total risk-based capital ratio should be in the high 14% range for the remainder of this year, declining to the mid 13% range on the Basel III next year. These Basel III estimates put our excess capital projections at approximately $175 million early next year, up slightly from our estimate last quarter $150 million.

Management's past actions are clearly evident and we'll continue to manage our capital efficiently and maintain maximum optionality.

Now I'll turn the call back to Ray to wrap up our prepared remarks.

Ray Davis

Okay, I believe it's clear that Umpqua's immediate attention continues to be focused on the successful integration of Sterling. As reported, integration is moving forward rapidly with little to no disruption throughout the institution’s operations.

Regarding the organic growth, the momentum created by Umpqua a couple of years ago continues to propel the company forward as this past quarter's organic growth numbers indicate. The company’s success in differentiating itself with our unique delivery system and highly trained and empowered associates continues to build on an already flourishing company culture, now stronger than ever.

The Umpqua culture has also been instrumental in reinforcing the company's value proposition of being able to compete with more than price or rate. This competitive gap created over the years continues to be instrumental in our overall growth strategy. While our most important endeavors are completing the Sterling integration, continued organic growth and improving shareholder returns, I want to assure you that management also keeps an eye in the future to other initiatives. Some of these include the completion of our strategy to protect and grow deposits in a rising rate environment. Our long-term goal to adjust the loan portfolio concentration, noting this will be accomplished over an extended period of time. The standing efficiency ratio level below 60% after integration is complete and to continue to evolve our store design that enables us to sustain our strategy of utilizing technology to enhance the customer experience.

In closing, as expected the busy quarter and the very good one for the company with strong upside prospects. And with that we’ll now take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we’ll take our first question from Steven Alexopoulos with JP Morgan.

Steven Alexopoulos - JP Morgan

Hello everyone.

Ray Davis

Good morning Steve.

Steven Alexopoulos - JP Morgan

I wanted to start maybe if you’re on looking at it looks like you acquired $7 billion right?

Ray Davis

I am sorry. What's that Steve? He disconnected.

Operator

Steven, your line is open.

Ray Davis

Hello?

Steven Alexopoulos - JP Morgan

Is that any better?

Ray Davis

Yes, very good Steve. Thank you.

Steven Alexopoulos - JP Morgan

Okay. Sorry, I was on mute. So it looks like you’re acquiring $7 billion fair value loans from Sterling, I guess Ron what I am trying to figure out, so if I look at your supplement here you are saying the yield on the non-covered loan as far as by 44. How would that, what was the yield on the acquired and the yield on the non-acquired loan?

Ray Davis

We'll see when the great detail about the deal with the credit, you know the credit discount accretion expected the yield on non-covered loans and if you look at the trend, last quarter we were roughly 5%, this quarter were a bit higher you can do the math based on the acquired loan figure out what the specific loan was. But again I got to reiterate, we talked about the pro forma adjusted margins at 428 excluding the credit discount accretion that's really the number we're driving on. And overall with the deal 7% accretion on the bottom-line where we did not factor in any of the credit discount accretion into our 12% operating earnings per share plus accretion for next year's cost save. So I will just refer you back to that.

Steven Alexopoulos - JP Morgan

Right. Okay, let me ask this way. So if we look at, I guess if we take the interest income in the quarter and back out the 24, the 25 million that you cited from Sterling, we're left about 166 million. How much of that is related to the acquired loans which fakes out what you referred to?

Ray Davis

I think in terms of the overall yield, you can see we were roughly 5% if you back that, if you back out the credit discount accretion from the non-covered yield in total it can be roughly pretty consistent that's our Umpqua Classic yield excluding credit discount accretion.

Steven Alexopoulos - JP Morgan

So okay. And Ron how are you guys modeling the run off for the Sterling portfolio, what's your estimated run off per year that?

Ron Farnsworth

We talk about this back in September and again in April. The overall, we were looking at four to five years. But again as that impacts the credit discount accretion and the provision none of those numbers were factored into our accretion estimates to start with.

Steven Alexopoulos - JP Morgan

Okay. And then finally could you guys give us the breakdown of the organic loan growth I know you gave it overall and maybe talk about by category what you saw in the quarter?

Ron Farnsworth

You bet, so again, net organic loan growth was $294 million or 8% annualized which was very strong especially as we are putting together the two companies. By category it was pretty evenly split across commercial, consumer, residential, private and longest impact again this impact production growth at 80 million than that growth there was 45 million on the commercial side we were just a bit under a 100 and the balance would have been majority of that in residential and quite a bit of that was related to our private banking and jumbo business and Puget Sound and Bay area.

Steven Alexopoulos - JP Morgan

And maybe just one final one for Ray, I know you said you plan to exceed the cost saves now that you actually have Sterling integrated what are your thoughts on maybe required investment there in terms of changing some of their branches to your look exporting your culture et cetera? Thanks.

Ray Davis

Steve, first of all we are entirely integrated we are integrating so we got some work we still have work to do, but all of the capital expenditures related to store redesign, store upgrades, all factored in the original announcement of the deal, but we forecast to that as somewhere around $40 million.

Steven Alexopoulos - JP Morgan

Okay, so no change to that?

Ray Davis

No change to that.

Steven Alexopoulos - JP Morgan

Okay, those were my questions. Thanks.

Operator

We will take our next question from Joe Morford with RBC Capital Markets.

Joe Morford - RBC Capital Markets

Thanks, good morning guys.

Ray Davis

Good morning Joe.

Joe Morford - RBC Capital Markets

I guess first just following up on Steve’s question on the loan side can you talk about the loan production levels at both Umpqua and Sterling in the quarter both in terms of the magnitude and the mix. And again it's unrelated to that, I'm just trying to understand why the provision for Sterling's production is as high as it is at least relative to Umpqua Classic excluding FinPac?

Ron Farnsworth

Well also keep in mind that on the Umpqua Classic side, there is a loan loss reserve behind the things. So not all of that production equates to provision for loan loss, just get another changes in the reserve, which is why we went into the detail on that. And the calculation for overall production, it was just a bit under $900 million for the quarter the majority of that, a bit over half of that was on the commercial side.

I talked about FinPac earlier at $80 million very strong quarter for production. On the residential side, the portfolio, it is as roughly $200 million and private banking and consumer combined were just under $100 million.

Joe Morford - RBC Capital Markets

And was Sterling a big piece of that 900 or I mean do you breaking that out the way again trying to understand this, kind of get to the provision level going forward for Sterling as well?

Ron Farnsworth

Sterling would have been roughly half of that number.

Joe Morford - RBC Capital Markets

Okay.

Ron Farnsworth

Keep in mind too Sterling was on the balance sheet for 72 days during the quarter, not a full 90.

Joe Morford - RBC Capital Markets

Okay. I guess relative to that problematic question given we don’t have the full run rate and expenses as well. But also given that you've already achieved 30% of the targeted cost savings. Can you talk about the expectations for further expense reductions over the rest of 2014, before you complete the systems conversion, kind of the pace of declines that we may see in next couple of quarters?

Ray Davis

I think, Joe, this is Ray. I think you are going to see it continue to move forward on a steady rate. I think the two big hits if that's accurate would be the completion of the consolidation of the storage which is going to have an impact. And then last but not least in our third quarter of February 2015 our planned technology conversion which will be completed. So that sort of the timeline you should be looking at I would say that shortly after that conversion give or take a couple of months we should be just about wrapping up total synergies.

Joe Morford - RBC Capital Markets

Okay, thanks so much guys.

Ray Davis

Thank you.

Operator

We'll take our next question from Jeff Rulis with D.A. Davidson.

Jeff Rulis - D.A. Davidson

Thanks, good morning.

Ron Farnsworth

Good morning.

Jeff Rulis - D.A. Davidson

Question on the -- I guess since Sterling is not a full quarter just trying to back into that expense base. I guess could you remind me what the original expense base of the 87 million cost synergy targets based on is that just a 290 annualized number?

Ron Farnsworth

Yes. Again it was based on as we talked about last couple of quarters it was based on the second quarter 2013, operating expense run rate annualized. That was roughly $318 million on an annualized basis, 30% of that was 87 million.

Jeff Rulis - D.A. Davidson

Okay, great. And then, Ron, I don't know if you -- is the loss on the sub debt 1.4 million is that sort of fair value calculation a good run rate for future quarters, is there anything kind of again with Sterling not being on for a full quarter, does that impact?

Ron Farnsworth

It would be modestly adjusted just given 72 days, but again that's real consistent with where we've been. So that was entirely related to the fair value adjustment on the trust preferred borrowing $91 million total adjustment running off over 20 plus years. Nothing now on the new combined base going forward.

Jeff Rulis - D.A. Davidson

Okay. So you referenced the adjustment up or down from Q2 of the loss.

Ron Farnsworth

That number going forward is going to be real consistent with what it is here in Q2; 18 days not going to make a big difference on that number.

Jeff Rulis - D.A. Davidson

Okay. All right, thank you.

Ray Davis

Yes, thanks.

Operator

(Operator Instructions). And we’ll go next to Brett Rabatin with Sterne Agee.

Brett Rabatin - Sterne Agee

Hi guys. Good morning.

Ray Davis

Good morning, Brett.

Brett Rabatin - Sterne Agee

I wanted to I guess just revisit this question around the provision on the Sterling. I guess I’ve seen other transactions where in the first quarter or two as loans matured on the portfolio acquired, you had a pretty heavy provision and then it tapered off pretty significantly. I know you just talked about how the life of Sterling’s loan portfolio is four to five years. Would it be logical to assume that the provision needed for Sterling’s portfolio re-pricing or re-upping so to speak declines over the next quarter or two? Or can you give us a little more color around just the provision you might need to make on to your car portfolio as it re-prices or re-ups so to speak?

Ray Davis

Brett, this is Ray. Yes, I think it’s safe to say that number is probably going to come down. The only caveat to that depends on loan production. But as far as historical refinances pay downs, yes, I think that number will slow down.

Brett Rabatin - Sterne Agee

Okay. And then the other thing, I just wanted to make sure I understood was the $24.5 million credit discount accretion in the quarter versus the credit mark that you’re not accreting “through income over the life of the portfolio.” Can you walk us through a little bit maybe A; the pace of the first piece and then B; the piece is not accreting kind of the credit on the credit side, what ends up happening with that?

Ron Farnsworth

Sure. This is Ron. And we've talked about the total credit market $264 million with $180 million of that being sit up accretable on day one. That will be $80 million for non-accretable as an estimate based on the PCI pool, which is roughly $400 million. We think there is upside of that but we’re going to be conservative with it. That will come in over time assuming payments on those PCI loans are better than forecasted, very minor amount here in Q1. But that's why it's non-accretable, it's based on payment performance over time.

In terms of the $24.5 million that came out of the $180 million accretable pool, again as Ray just mentioned similar answer on the provision from loan loss that's really going to be driven by payments on the performing portfolio when including refinancing. And so it's difficult to give an exact estimate of that going forward other than we know over time it should trend down slightly based off of life of the portfolio four to five years that’s we expected to run.

Brett Rabatin - Sterne Agee

Okay. And then just last question, we saw another transaction in Idaho today and I know Sterling is your big focus right now but Ray, as we get out another quarter or two, do you think you’ll be back in the M&A market, maybe give us some thoughts on what you should be doing with excess capital in 2015?

Ray Davis

You're right that are focus right now is to make sure that integration of Sterling goes very well and exceeds all expectations which I feel very comfortable in saying to everybody that it has exceeded everything that we forecasted on our original call when the deal was announced. It couldn't be going much better. The strength of the Sterling people has been terrific there. The culture between the two companies is so similar. It's really been a very pleasant experience. I can say that from everybody’s point of view here. So that’s our focus. We never take our eyes off of opportunities but I don’t want to give any impression or indication that Umpqua is out looking for deals right now. At some point when we see light at the end of the tunnel on the overall integration of the company, we’ll -- we look again, again, we are a growth company as you well know Brett. And as long as potential acquisition has through strategic value to us, we would certainly take a look at it. But right now our focus is continue to make sure that this transaction ramps up and exceeds every expectation that everybody has.

Brett Rabatin - Sterne Agee

Okay, fair enough. Thanks for all the color.

Ray Davis

You bet.

Operator

We will take our next question from Jacque Chimera with KBW.

Jacque Chimera - KBW

Hi, good morning guys. Understanding and touching on the provision again, and I completely understand the portion that moves from the credit discount mark and then when you refinance that elevates the provision. But looking at just general net new generation; is there a difference in mix between Classic Umpqua and what’s being booked by the Sterling lenders because unless I misinterpreted, it sounded like perhaps those are being provisioned at a higher level?

Ron Farnsworth

No, not provisioned at a higher level, we have got that all confirmed with our credit underwriting policy.

Jacque Chimera - KBW

Okay. So most of what was provisioned in the quarter is driven by the refinance of existing loans?

Ron Farnsworth

And production, we had very strong production which led the very strong organic loan growth.

Jacque Chimera - KBW

Okay. But if 50% was from Sterling and 50% was from Umpqua and so I would consider those both to be very strong production. How do I reconcile the much larger provision from Sterling versus Classic Umpqua?

Ray Davis

Again, the provision for Sterling especially in this first quarter as you talked about earlier was related to the effect, there was not a reserve, we were able to bring over. On Classic Umpqua side, there is a reserve that's able to bucker some of the production.

Jacque Chimera - KBW

Okay, okay. And then moving on to the loan sales in the quarter. Is that something you would look to do on a go forward basis?

Ray Davis

Yes, I think we'll see us take advantage of loan sales were they make sense, especially as we continue to balance the portfolio. But I will say that I don't think anybody should plan on seeing any dramatic changes to the portfolio in a short period of time. This is, our rebalancing is going to take many years that you can imagine, it's like moving the Titanic in some ways.

But as Ron mentioned, everybody in the company and credit is working off of one set of policies, everybody knows the direction we're headed in. We're making I think pretty good progress. I will tell you this, that as we do rebalance the portfolio, I think you will see quarters where it looks more out of balance and then it will come back down, this isn't going to be a straight line depending again on production the type of loans that we book.

Jacque Chimera - KBW

Okay, great. Thanks for the color Ray.

Ray Davis

Yes.

Operator

(Operator Instructions). And we'll go next to Doug Johnson with Evercore.

Doug Johnson - Evercore

Good morning guys.

Ray Davis

Good morning Doug.

Doug Johnson - Evercore

A couple questions related to mortgage banking. I guess first you mentioned changing the pricing in Sterling and how they kind of price your volume and new price for margin. It sounds like margin are going to go higher but would you also expect originations to production to kind of decline a little bit from 2Q levels?

Greg Seibly

So this is Greg. Just a little color I think is that two companies came together in the first two announcements we saw really good progress, but we are working on as Ron said, a single rate achieved are we seeing really good growth and one quarter volume is it about 37% for the two companies and it looks like it's sustaining certainly in the first quarter to the third quarter.

And all that was against back drop of really a significant organizational shift where we're moving to a single platform (inaudible) platform. We're in the process of finalizing a decision round the move to a best in class loan servicing platform. And we continue to invest in the business across the footprint most notably build out in Northern California and select hires in Southern California and some new hires in our Pacific Northwest footprint as well.

Doug Johnson - Evercore

Okay, understood. Okay, great. And just one more on mortgage was the production expense this quarter, I know you’ve given that in the past?

Ron Farnsworth

Well production expense for the group was just under $19 million and I'll point out to that net manager spread improved as we talked about earlier.

Doug Johnson - Evercore

Okay, great thanks for taking the question.

Operator

(Operator Instructions). It appears we have no further questions at this time.

Ray Davis

Okay. Thank you. I want to thank everyone for their interest in Umpqua Holdings and their attendance on the call today. This will conclude the call. Good bye.

Operator

That does conclude today's conference. We appreciate your participation. You may now disconnect.

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