Columbia Bank Closing Strong Ahead Of The Merger With Umpqua (NASDAQ:COLB)

Mergers of equals between banks usually garner a fair bit of skepticism from investors, and the stocks often don’t until there are actual synergies evident in the reported results – a process that can take a year or more from the close of the deal. Add in the unusual delays and uncertainty around bank merger approvals now, and I can understand why Columbia Bank (NASDAQ:COLB) shares have underwhelmed since the announcement of the merger with Umpqua (UMPQ) a little more than a year ago, underperforming the average regional bank by a few percentage points.

I still like this merger, and I like that both Columbia and Umpqua have posted fairly strong results heading into the close of the deal. Here of late, Columbia has shown some strong results in growing their commercial lending business and leveraging their high-quality deposit base, and I believe that will serve both companies well in the future.

Healthy Trends Across The Lending Franchise

Columbia’s third quarter results were solid, with a good pre-provision beat driven by strong spread lending growth, albeit offset somewhat by higher operating expenses.

Revenue rose 21% year-over-year and 10% quarter-over-quarter, or 20% and 7% on a core basis, with net interest income up 23% yoy and 10% qoq as reported or 24% and 9% on an adjusted FTE basis. Earning assets contracted modestly (down 0.6% qoq), but net interest margin improved 30bp yoy and 31bp qoq as reported to 3.47% (or 3.50% FTE). Fee income was up 11% yoy and more than 6% qoq as reported, but down 4% yoy and 8% qoq on a core basis, with the bank taking a hit from lower mortgage banking-related revenue.

Reported operating expenses rose 13% yoy and 6% qoq. While management offers an adjusted opex figure that excludes costs related to the merger, I have mixed views on the utility of that number, though it’s certainly fair to strip those out to see how the bank would fare on a standalone basis. Reported pre-provision profits rose 31% yoy and 14% qoq, and company-calculated core PPOP rose 30% and 13% qoq (while mine rose 30% and 7%, respectively). Either way, this was a very solid quarter on a core profit basis, though higher provisioning did claw back some of that (a common trend this quarter).

Delivering On Commercial Loan Growth Strategies And A Strong Core Deposit Franchise

I was impressed with what Columbia delivered in terms of its balance sheet performance (core lending and deposit-gathering).

Loans rose 3.3% qoq on an end-of-period basis and almost 5% qoq on an average balance basis, which was better than the average for regional banks. Unlike many banks, Columbia saw decent growth in commercial real estate lending (up 2.4% qoq), while C&I lending rose almost 4% (ahead of a sector-wide average closer to 2%). Loan yields improved 13bp yoy and 47bp to 4.56%.

Loan production was up 63% yoy and down 19% qoq; seasonality isn’t unusual, but management did discuss a softer economic outlook and some evidence that overall loan demand is starting to ease off. Countering that, though, are the companies’ organic efforts to grow the commercial loan business by hiring away bankers from rivals like U.S. Bancorp (USB) and Zions (ZION) in markets like Salt Lake City and Phoenix.

Deposits fell modestly from the second quarter, but non-interest-bearing deposits actually rose sequentially (up 1.9% end-of-period and 0.6% average balance) in a quarter where most banks have seen declines. With this strong core deposit performance, deposit costs and betas remain quite low – Colombia’s deposit cost was only 10bp in the quarter (up 6bp yoy and 5bp qoq) and the total funding cost was just 12bp (up 7bp yoy and 6bp qoq) – incredibly low on a relative basis (one of the lowest of the banks I follow).

Management does acknowledge that deposit costs are likely to increase from here, but if their projection of 25% deposit beta is accurate, it’ll be one of the better performances in the banking sector.

The Outlook

The Federal Reserve signed off on the Umpqua-Colombia deal on October 25, leaving just the FDIC left to approve the deal before the companies can move forward with a deal close. Your guess is as good as mine as to when that last approval will come, but I can’t immediately recall the FDIC being a roadblock to bank mergers, so I believe this is a “when, not if” question (though “when” has become a much bigger question for bank mergers over the last two years). The two banks are proceeding with an expected first quarter 2023 close, and I suppose it’s possible the deal could actually close ahead of that if the FDIC approval comes through promptly.

I think Umpqua and Colombia will be a compelling combined entity in an attractive geographic area. Attrition of customers and employees is normal in mergers like this, and management addressed this on the call, noting a few personnel defections. Managing customer attrition will be important post-merger close, particularly as the attractive and under-utilized deposit franchise in Colombia (a loan/deposit ratio of just 64%) is a significant plus in the deal.

The Bottom Line

Combined, I expect the post-merger bank to grow core earnings at a 4% to 5% organic long-term rate, and I’m looking for synergies in areas like small business lending, healthcare lending, and asset-backed lending. Based on that core future growth rate, I believe Colombia shares are undervalued and priced for a double-digit long-term annualized return from here. Weak sentiment on banks is likely to remain a headwind for a while longer, and I expect that some investors will hold off until they see actual realized synergies from this deal, but I believe this is a stock worth considering for those investors who want to own the merged entity for the longer term.