Banner Posting Attractive Growth On Excellent Funding Trends

At a certain point, smaller banks all sort of blur together, with only modest differentiation in areas like geographic footprint, operating efficiency, and loan growth priorities. Banner (NASDAQ:BANR) is an exception, though, as this smaller bank not only serves an attractive customer profile and geographic footprint (smaller businesses in the Pacific Northwest), but has a credible efficiency drive underway, strong credit quality, and very strong funding.

The bad news, if you can call it that, is that Banner’s performance hasn’t gone unnoticed, and the bank has separated itself from the broader regional bank group on a one-year, two-year, and five-year basis, with the shares outperforming other regionals by around 20% over the last year or so. While I don’t think that Banner is overpriced now, it’s not a huge bargain and its appeal is more of the “growth at a reasonable price” variety.

Healthy Growth On The Back Of Higher Rates

With a primarily floating/variable-rate loan base, it’s not so surprising that Banner has seen a meaningful boost to the business from the Fed’s tightening cycle. Coupled with good expense control, Banner delivered strong, better-than-expected, double-digit pre-provision profit growth.

Revenue rose 8% year over year and 6% quarter over quarter on an adjusted basis, with net interest income up more than 12% yoy and 13% qoq. Net interest margin improved 42bp yoy and 41bp qoq (to 3.85%), and earning assets grew both annually and sequentially. Adjusted fee-based income declined 22% yoy and 36%, with a sharp decline in mortgage banking (falling from $9.6M a year ago and $4B to almost nothing this quarter).

I calculate core opex a little differently than management (including not backing out expenses tied to its Banner Forward project), and by my calculations Banner saw a 3% yoy decline in expenses and a 3% qoq increase. Pre-provision profits rose 30% yoy and 10% qoq, though higher provisioning expense did claw back some of the company’s earnings beat.

Reported tangible book value per share declined 20% yoy and 7% qoq, with Banner seeing the same hit to tangible book from mark-to-market adjustments on its securities book as many other banks. Adjusting for AOCI, tangible book value per share would have climbed more than 10% yoy.

Signs Of Moderation In Lending, But Funding Looks Outstanding

Relative to the “average” bank, Banner did well in terms of loan growth this quarter, with loans up 7% yoy and 4% qoq on a net end-of-period basis.

Banner saw a big spike in mortgage lending (up 56% yoy and 18% qoq), but this is a bit of a mirage as it was due to holding completed construction mortgage loans, and held-for-investment mortgage originations declined 27% sequentially. CRE lending was a little soft, declining 3% yoy and slightly on a sequential basis, with elevated payoffs. Multifamily lending grew 19% yoy and 3% qoq, though, and the bank also saw growth in its small C&I lending operation.

Loan yields declined slightly from the year-ago period and rose 27bp sequentially to 4.81% (adjusted).

Banner’s core loan customers are smaller businesses (commercial loans are typically $3M to $25M), and the company is seeing more caution here as rates go up and uncertainties about 2023 build. Originations were down 13% yoy and 27% qoq this quarter, and management is looking for mid-to-high single-digit loan growth in Q4’22 and 2023 barring a significant step down in the macro outlook.

While loan demand may be easing up, the company is performing really well on funding. Deposits rose slightly for the quarter (up less than 1% yoy and qoq), but non-interest-bearing deposits rose about 2% yoy and qoq, bucking a trend of around 4% to 5% qoq declines in NIB deposits for most regional banks. With strong NIB lending performance and a healthy loan/deposit ratio, total deposit costs are very low (7bp), as are total funding costs (13bp).

At a time when analysts and investors are increasingly aware of, and worried about, the likelihood of higher deposit betas (deposit costs moving up more rapidly as interest rates rise), Banner’s beta is basically zero now. Management has been prudent in guiding that this won’t continue, but with a core deposit base made up of sticky commercial deposits from smaller businesses, I think Banner will do better than most provided that there isn’t a severe economic downturn.

Credit quality remains excellent, but likely cannot get appreciably better from here, and I would expect higher provisioning costs in the coming quarters.

The Outlook

Banner has a solid top-10 position in Washington and Oregon and has been growing its business in Idaho as well. These states are growing faster than the national average, and I like the bank’s focus on smaller commercial clients – these are clients that aren’t necessarily priorities for huge banks like U.S. Bancorp (USB), but even smaller banks often lack the resources to serve them effectively. I also like the bank’s “Banner Forward” program that includes enhanced customer relationship focus (which can drive collection/retention of low-cost deposits) and improved back-office processes.

I do think customer service is still an area of potential improvement. While the bank won a J.D. Power award for customer satisfaction earlier this year, the bank’s net promoter score is below the average of the top 100 banks in the country and below regional rivals like Columbia (COLB), Glacier (GBCI), and Umpqua (UMPQ), and there tends to be a correlation between bank performance and net promoter scores (a measure of customer satisfaction and likeliness to recommend to others).

I do see risks to the macro outlook in 2023/2024, but I think Banner is serving an attractive constituency that can support long-term growth in the 5% to 6% range, excluding potential M&A. I do believe further M&A is a strong possibility, though management has recently been having success luring away producers from larger banks, and with the pending U.S. Bancorp-MUFG and Columbia-Umpqua transactions, there could be some opportunities here.

The Bottom Line

Between long-term discounted core earnings, ROTCE-driven P/TBV, and P/E, I believe Banner is modestly undervalued now, with a 12-month fair value in the low $70’s. I do see double-digit appreciation potential over the longer term, though, so this is still a credible name as a “growth at a reasonable price” (or GARP) stock.

I would also note, though, that sentiment is likely to remain weak on banks for a while longer and there could still be downside risks to sell-side estimates for ’23 and ’24. I think Banner is in better-than-average shape, though, and were the stock to weaken on sector-wide weakness, it’s definitely a name worth considering.