Friday, January 27, 2017

An AIM Equity Holding: Columbia Banking System (COLB) by Steven Hoffmann. “Hold and Keep Watch on COLB's Recent Acquisitions"

Columbia Banking System (COLB, $40.83): “Confident in Columbia to Conquer Expectations”
By: Steven Hoffmann, AIM Student at Marquette University

 Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

·         Columbia Banking System (NASDAQ: COLB) operates as a holding company, which provides financial services. Its activities include personal, business, and commercial banking and wealth management services. The company provides loans, checking and saving accounts, treasury management, mobile banking, and VISA credit cards. Columbia Banking System was founded in 1988 and is headquartered in Tacoma, WA.

·         On January 9, 2017, COLB announced its intent to acquire PCBK (not rated) for $644mm or $27.85 per share in a stock deal that equates to 3.06x TBV, 21.2x PCBK's 2017 EPS estimate, 21% core deposit premium, 34% market premium, and 14.2x the PF 2018 consensus EPS estimate with cost savings (34%).

·         COLB has achieved the highest loan production in its history with over $375 mm in new originations and COLB’s non-performing assets to period end assets ratio improved to the lowest it's been in eight years.

·         COLB has been preparing to surpass $10 billion in assets mark, which it will easily achieve with the recent PCBK acquisition.

·         The population and labor force of all three states continues to grow. Overall, there is excellent job creation and strong GDP throughout the Northwest.

·         This is the 11th consecutive quarter that COLB has paid a special cash dividend. The regular dividend combined with the special dividend constitutes a payout ratio of 83% for the quarter and a dividend yield of 4.9% based on the closing price on October 26.

Key Points
COLB’s acquisition comes at a favorable time in the current market environment: strengthening credit quality, an economic lift-off, rising interest rates, market share opportunity, and a chance to pursue a one-of-a-kind business. PCBK's complementary assets have tremendous value to COLB, especially as COLB can use its strong stock currency to complete the deal, reducing the hit to its own TBV. 

COLB expects the deal to be 8-10% accretive to 2018 / 2019 EPS, respectively with 6% TBV dilution earned back in 3.7 years. Transaction multiples look a little rich relative to others but the deal makes sense strategically, culturally and is complementary from a product & geographic perspective within the Pacific Northwest. PCBK has #1 market share in Eugene, OR (17.1%) with $2.5B in assets including $1.8B in loans & fully funded with $2.2B in deposits (42% noninterest) averaging $155M per branch (14). 

The cost savings target (34%) seems reasonable given the overlap. COLB expects 8% EPS accretion in 2018E and 10% in 2019E. Since the election, deal multiples would have been more reasonable with P/TBV of 2.34x, P/2017E EPS of 16.2x, core deposit premium of 13.8% & a market premium of 28.6%. Lastly, COLB expects 8% EPS accretion and only a modest TBV dilution.

3Q16 Highlights
COLB posted 3Q16 operating EPS of $0.47 (reported: $0.48), in-line with consensus ($0.47) and better than the forecast ($0.45) as higher revenues & a lighter provision was offset by higher expenses. This was another solid quarter from COLB with unexpected core margin expansion (+3 bps to 4.03% ex PAA), stronger than expected loan growth (+10% LQA) on record production, a lighter provision on higher recoveries, and its 11th consecutive special dividend ($0.19) on top of its regular cash dividend ($0.20) that implies a 4.9% adjusted yield.

Positives for the quarter included reported margin expanded 3 bps to 4.13% (consensus 4.07%) including a core margin (ex PAA) that was also up 3 bps to 4.03% due to higher core loan yields (+6 bps to 4.76%). Second, loan growth of 10% LQA or $153M was above consensus (+3%) due to record production (+11% LQ to $375M) primarily driven by C&I, (3) Provision ($1.9M) was below consensus ($3.5M) with NPAs down 7 bps to 0.48%.

On the other hand, expenses ($67M) were above consensus estimate ($64.4M) due to a higher comp & advertising. In addition, operating expense-to-asset ratio deteriorated to 2.76% (+5 bps) but was still below its guidance range of 2.79-2.89%. This was another solid quarter for COLB with good loan growth, unexpected margin expansion and even better credit metrics.

What has the stock done lately?
COLB is down 8.62% MTD, QTD, and YTD so far in 2017. While COLB missed eps 5/8 and revenue 6/8 quarters, they have been preparing for the acquisition of PCBK, which is expected to drive COLB’s bottom-line going forward. As of 3Q16, COLB’s ROIC was 7.49% and ROE was 7.86% with a NIM of 4.13%. Loan/Deposit Ratio was down to 77.69% and Tier 1 Capital Ratio was strong at 11.44%. Total Debt/Total Capital was at 9.61%.

Past Year Performance
Over the past 12 months, COLB is up nearly 41%, primarily driven from the bounce in the market after the election of Trump. The regional environment continues to show strength in COLB’s core areas. During the third quarter, Washington's unemployment rate improved to 5.6% and 20,000 new jobs were added. Idaho's unemployment rate held steady at 3.8% in September and the state ranks third in the nation for year-over-year job growth. Oregon has been outpacing in the country in their job growth rate since 2013. 

The state posted a rate of 3.5% for job growth in September compared to the nationwide average of 1.7%. The Northwest Seaport Alliance, the consolidated container operation at the Port of Seattle and Port of Tacoma is the fourth-largest container gateway in North America. Year-to-date full imports are up 3% and full exports increased 12%.

Source: FactSet

My Takeaway
COLB was originally pitched in September 2012 at 18.50 with a target of 23.47, of which is has obviously shown significant returns, currently trading at $41. P/B is 1.49x and P/E is 18.80 as of 3Q16.

Drivers of continued expansion, solid loan growth and the Northwest banking economy continue to hold in place. The interest rate environment is more favorable for banks than it was in 2012 and the risk of its loan portfolio continues to be mitigated with complementary acquisitions. 

I believe that we should HOLD this name to track its performance through the next few quarters to see how the integration of the most recent acquisition goes in order to evaluate management’s effectiveness to deliver on promises. Indexed to the date it was pitched, COLB has outperformed the Russell 2000 by 1.5x.

Source: FactSet

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