Ron Farnsworth - Chief Financial Officer Ray Davis - President and Chief Executive Officer Cort O'Haver - President Dave Shotwell - Chief Credit Officer.

Steven Alexopoulos - JPMorgan Jeff Rulis - D.A. Davidson Jacque Bohlen - KBW Tyler Stafford - Stephens Inc Jared Shaw - Wells Fargo Securities.

Good day and welcome to the Umpqua Holdings Corporation Third Quarter Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Ron Farnsworth, Chief Financial Officer. Please go ahead, sir..

Excellent. Okay, thank you, Alan. And good morning, and thank you all for joining us today on our third-quarter 2016 earnings call. With me this morning are Ray Davis, the President and CEO of Umpqua Holdings Corporation; Cort O'Haver, our Bank President; and Dave Shotwell, our Chief Credit Officer.

Cort and Dave will join us as we take your questions after our prepared remarks. Yesterday afternoon, we issued an earnings release discussing our third quarter 2016 results. We have also prepared a slide presentation, which we will refer to during our remarks this morning.

Both of these materials can be found on our website at umpquabank.com, in the Investor Relations section. During today's call we may make forward-looking statements, which are subject to risks and uncertainties, and are intended to be covered by the Safe Harbor provisions of federal securities laws.

For a list of factors that may cause actual results to differ materially from expectations, please refer to Page 2 of our earnings conference call presentation as well as the disclosures contained within our SEC filings. And I will now turn the call over to Ray Davis..

our production is strong, and we expect stronger growth during the fourth quarter and into 2017. Over this past year, we have benefited from steady growth of over $1.1 billion, accomplished without bending or compromising our loan standards and underwriting, which will bode well for us in the future.

During the third quarter, we did experience an increased level of refinance activity and early payoffs, specifically within our owner-occupied and multifamily loan portfolios. A portion of these were multifamily construction projects that did not roll to permanent.

These early payoffs softened another good quarter of growth in our commercial real estate portfolio, as loan demand continues to be strong and our pipeline remains robust. Our commercial loan portfolio, which includes both traditional C&I lending and leasing, had another strong growth quarter, with an annualized growth rate of 13%.

Our leasing portfolio also continues to perform very well, with loan balances of $927 million, which we expect to cross over $1 billion in the next quarter or two. Once again, we are expecting stronger net loan growth in the fourth quarter.

As a reminder, and as stated on previous earnings calls, we continue to make good progress rebalancing our existing loan portfolio, which will provide us with a more diversified portfolio focused on relationship lending while increasing our balance sheet sensitivity.

This is being accomplished by growing traditional C&I and consumer loans at a much faster pace than commercial real estate loans, and by selected portfolio loan sales.

During last quarter's call, I mentioned that we expected strong deposit growth for this past quarter, as we put in place a number of initiatives to drive core deposit growth, both from our retail stores and our commercial banking teams across the footprint.

I am pleased to report those initiatives are producing good results, as indicated by deposit growth this quarter, all of which was core, of $660 million or 14% annualized. We continue to place a high value on these deposits, and expect to continue to see strong core deposit growth over the coming quarters.

Mortgage banking revenues remained strong during the quarter, driven by typical seasonal purchase activity and stronger refinance volume resulting from the low mortgage interest rate environment. For-sale mortgage originations increased by 7%, and our home lending margin increased by 6 basis points compared the prior quarter.

Disciplined expense management remains a top priority across the organization, as our operating efficiency ratio improved to 59% for the quarter. Operating expenses in the third quarter decreased by $3 million in total from the prior-quarter level.

Compensation-related expense, excluding home lending, has decreased $3.2 million or 4% from the third quarter of last year. We feel this proves that the organization-wide efficiency initiatives we have implemented are successfully lowering our core expense run rate.

Asset quality remained stable, with nonperforming assets decreasing to $62.3 million or 0.25% of total assets from $64.6 million or 0.27% of total assets in the prior quarter. Now, back to Ron..

Okay. Thanks, Ray, and I will be referring to certain page numbers from our earnings presentation. Starting first with the P&L, as noted on Page 5 of the slide deck, for the third quarter we reported $0.32 per share in our non-GAAP operating earnings measure, up from $0.31 in the second quarter.

GAAP earnings per share were $0.28, up from $0.25 in the second quarter, driven by lower charge related to the fair value of the MSR and expected lower level of merger-related expenses. In addition to the presentation, we also show the reconciliation for non-GAAP measures on noninterest income and expense on Page 8 of the earnings release.

Adjusting out the non-operating items, we saw a $3 million decrease in noninterest expense and a slight increase in net interest income. This was offset by a $1.6 million decline in noninterest income, mostly from lower gain on portfolio loan sales and an increase in the provision for loan loss.

Turning to net interest income and margin on Slide 6, net interest income increased by $700,000 from the prior-quarter level. We benefited from higher average interest earning assets, given the strong growth in deposits Ray discussed. The deposit growth was held for the short-term in interest-bearing cash.

Higher cash balances were partially offset by lower average yields in both the loan and lease portfolio and our investment portfolio, which is predominantly agency mortgage-backed securities.

The decline in taxable investment income this quarter related primarily to increased premium amortization with the decline in long-term interest rates this year. Credit discount accretion from the Sterling portfolio was $9.1 million in the third quarter, down from $10.1 million in the prior quarter.

As noted on prior quarterly calls, this accretion is expected to continue to decline modestly on a quarterly basis. The total net interest margin was 3.95% for the third quarter. Excluding the credit discount accretion, the margin was 3.77%, a decline of 9 basis points from the second quarter.

This decline – and I want to emphasize this – related almost entirely to the average higher interest-bearing cash balances, at 6 basis points of impact; and higher investment premium amortization, at 2 basis points of impact.

Regardless, based on the current interest rate environment and competition for quality loans, we do expect continued modest quarterly pressure on the net interest margin, both with and excluding credit discount accretion. Our asset sensitivity has increased now to the highest level since we closed the Sterling deal, 2.5 years ago.

We estimate the next 25 basis points increase from the Fed to add approximately $10 million to annual revenue. We will continue to increase our asset sensitivity over the coming quarters with balanced loan and deposit growth, as we anticipate interest rate increases in 2017.

On Slide 7, the provision for loan and lease losses increased this quarter to $13.1 million, driven primarily by continued strong growth in the lease and equipment finance portfolio and the slight increase in net charge-offs to $10.4 million. Now moving to noninterest income on Slide 8.

We saw an increase of $6.1 million from the second-quarter level, driven by higher residential mortgage banking revenue, but partially offset by lower gains related to portfolio loan sales. The largest component of our noninterest income is mortgage banking revenue.

The total GAAP figure this quarter included a $7.8 million loss on the change in fair value of the MSR, which was lower than the $13.9 million charge in the second quarter, driven by the change in long-term interest rates during the quarter.

The MSR asset is now valued at 82 basis points of the service portfolio, down from 83 basis points in the second quarter and 101 basis points last December, reflective of the decline in mortgage interest rates this year. Excluding the MSR fair value change, mortgage production revenue was $45.6 million, up 8% from the second quarter.

Servicing revenue continues to grow, now at $9.4 million for the quarter, up 9% from the second quarter and 30% from the same period a year ago. On Page 9, you will see for-sale mortgage originations increased 7% to $1.1 billion.

Our gain on sale margin increased to 4.08%, up from 4.02% last quarter, as we did a good job of managing volume through pricing and the lock pipeline increased slightly to $820 million this quarter. As for the fourth quarter, we expect a modest seasonal decline in for-sale originations with the gain on sale margin in the mid to upper 3% range.

Turning to noninterest expense on Slide 10. Our operating expense was $177.4 million, a decrease of $3 million or 1.6% from the prior quarter. Recall last quarter we had an OREO gain of $1.5 million.

Adjusting for this, our third quarter operating expense declined $4.5 million, with $4 million coming primarily from lower compensation and services expense, and another $0.5 million from a decline in home lending expense. A portion of the compensation decline also came from the store consolidations we completed in the middle of the third quarter.

Looking forward to Q4, we expect a continued decline in operating expense both in our home lending group, from the expected seasonal decline in production, and in the core bank operations.

For the non-GAAP adjustment items, we expect merger expense to be around this level in Q4 and tail down to zero in 2017, and we expect exit disposal costs to decline in Q4. With that, I will turn to the balance sheet, beginning on Slide 11. As I indicated, interest-bearing cash was up to $1.1 billion at quarter end.

We expect to hold the higher level of cash through the fourth quarter and keep the investment portfolio around recent levels. On Slides 12 and 13, you'll see details on our loan and deposit portfolios. I will not go into great detail here, as Ray already discussed these during his comments.

Our loan to deposit ratio ended the quarter at 92%, down from 95% in the prior quarter. We expect near-term we'll remain in this range, with future balanced loan and deposit growth. Slide 14 shows the continued improvements in the overall credit quality of the company, noting the nonperforming asset ratio declined to 0.25%.

Also of note, OREO on the balance sheet was cut in half this past quarter and is now under $10 million. Lastly, on Slide 15, I want to highlight capital. Noting that all of our regulatory ratios remain in excess of well capitalized levels, with our Tier 1 common at 11.1% and total risk-based capital at 14.4%.

With the $5 million share repurchase this quarter, our total payout ratio was strong, at 58% of operating earnings. We are focused on creating long-term value for our shareholders and we recognize that tangible book value per share, plus dividend growth, is a metric that some investors use to measure that.

Umpqua's tangible book value per common share increased to $9.51 in the third quarter compared to $9.08 per share in the same period of the prior year. Factoring in the $0.64 of dividends paid over that time, our yearly growth in tangible book value per share, plus dividends, was very strong at 12%.

Our excess capital was approximately $250 million as of the third quarter. As we have discussed for the last few years, we plan to continue to employ excess capital in a prudent and thoughtful manner.

And, finally, earlier this week we published results from our 2016 Dodd-Frank stress test exercise to the Investor Relations section of our website, under financial information. This includes projected results under a nine-quarter hypothetical severely adverse scenario.

Our projected capital ratios under that scenario remain above our internal thresholds, which are also above regulatory-defined well capitalized levels. And with that, I'll now turn the call back to Ray to wrap up our prepared remarks..

Okay, just a couple of more comments. First on our subsidiary, Pivotus. As a quick reminder, Pivotus was formed to provide the product, tools, and roadmap to pivot Umpqua into digital banking with a differentiated digital banking platform. Our progress to date, considering we've been fully operational for only eight months, is impressive.

So much so that we are scheduled to be in pilot with phase 1 of our digital program by the end of January. As previously announced, one aspect of our strategy was to introduce a collaborative effort to help leverage the capital and brand of Umpqua with other like-minded institutions.

Our collaboration with Nationwide Bank, headquartered in the United Kingdom, has proven this concept can and does work very well. We are extremely pleased to work alongside Nationwide's talented professionals, as we together are building a very unique digital banking strategy. We are now convinced this new technology will work.

Accordingly, as we head to pilot, we are diligently working on the work paths for integration into our institutions. Both companies have each established integration teams from within our institutions, working together to accomplish this.

Finally, over the next several quarters, we will be considering adding new collaborating companies to our structure that embrace the digital direction we have embarked on.

As previously announced, on January 1, 2017, I will be stepping down from my position as CEO of Umpqua Holdings, Umpqua Bank, and become the Executive Chairman of the Board, and will remain CEO of Pivotus. Cort O'Haver, who many of you have had a chance to meet, will step into the CEO position at that time for the Bank and the holding company.

I have had the privilege to hold the CEO title here at Umpqua for over 22 years.

And as I look back over my career here, I can tell you that I'm most proud of the strength of our company culture, the strength of recognition of our brand throughout our industry, and having worked with some of the finest people within the industry, my fellow associates. Thanks to all of you on the call for the years of support.

Now, we will take your questions..

Thank you, sir. [Operator Instructions] We’ll take our first question from Steven Alexopoulos with JPMorgan..

Good morning, everybody..

Hey, good morning..

I wanted to start first on loan growth.

So, if we look at the low-single-digit loan growth in the quarter adjusting for the loan sales, and you guys consider the headwinds from remixing the loan book, do you think given Ray's comments you could do better than the low-single-digit growth moving forward?.

Yes, absolutely. We do feel that way. One comment on that. I might as well make this because I know it will probably come up and let me make the comment.

I don't think it's any great secret that a lot of these institutions have been reporting these unsustainable growth rates, in our opinion, are going to unfortunately – and we certainly hope not, but it's obviously there's some trends out there that they are going to unfortunately suffer probably some consequences for growth, too fast of growth, unsustainable growth rates and perhaps in some areas where they don't have the expertise to handle it.

And I think, Steve, you know Umpqua, have followed us long enough to know, we're not going to do that. We are not going to sacrifice our underwriting standards. We are not going to sacrifice a general policy here that we've established within the credit culture of this company for the sake of growth or for posting a 10% versus a 7.5% loan growth.

We're not going to do it. It's steady as she goes with us. This rebalance of the portfolio, let's face it, that's going to take a long time. That's not a one-year, two-year, three-year project. That's an ongoing process. As soon as we get portions of it balanced, it will probably fall out of balance again, depending on what's going on within the market.

But we are, I believe, being very diligent and thoughtful on the loans that we are making, obviously. And I think obviously everybody else says that as well. But I think you can see by the results and as well as the – Steve as well as the loan sales we've had in the past, that we are not growing just for the sake of growth.

If we were, we wouldn't have sold loans at all. So, the answer to your question is yes but we're going to be very thoughtful..

That's helpful. And maybe following up on that, when you think about, Ron, the margin guidance you gave which is calling for some modest pressure, you had 6 basis points of pressure this quarter from holding excess liquidity.

How come you are not expecting to get some of that back at least near term, following up on Ray's comments that loan growth should be a little bit better here? I would think you would use some of that excess liquidity..

There is a potential for that. It obviously depends on how much of that is utilized and we are obviously focused on balanced loan and deposit growth, but over the last two quarters we have talked about net new businesses coming on in the mid-3s. And here's the margin, ex- the credit discount accretion in the high 3.7 range.

So, if net new is coming on, let's call it, 3.6 to 3.7 and rates don't change, chances are over time it's just mathematically going to drift to that level. But yes, we put some of that cash to work over the coming quarters and we will see a little bounce related to that.

I do expect the premium amortization to slow down as we head into the winter months. This is really more of a tail off of the Q2 movement in rates..

Steve, this is Ray. One other comment on that. I do also believe – first of all, Ron is absolutely correct on his comments. The other aspect of it is we're going to continue to grow deposits.

We believe with rate environment changing here, it appears that deposits which we all know is the blood that runs through the veins of every financial institution are going to become even more critical, even more critical.

So, we're beefing up a little bit on our deposit base intentionally to make sure that we can have the liquidity or sustain the liquidity we need to continue with that loan growth..

Got you. Okay. Maybe if I could just ask one final one. Thank you for that. Given the upward bias in provision this quarter, is there anything unusual driving that? Or is this just what you consider normalization of credit? Thanks..

I don't think there's anything – no, there's nothing normal – nothing abnormal in it whatsoever. Our leasing portfolio, the provision was a little bit higher this quarter over last quarter. But other than that, I think, as Ron I think I mentioned in his comments, our provision is going to run in the last two or three quarters on average..

Okay, got you. Okay. I appreciate all the color. Thanks, guys..

Thank you..

Next, we’ll go to Jeff Rulis with D.A. Davidson..

Thanks. Good morning. Just following up a little bit on the credit side, those net charge-offs have been elevated the last couple of quarters. I thought you had mentioned in the past maybe just confirming this is that working through some legacy Sterling credits.

Is that correct?.

This is Ron. No, I'd say the legacy Sterling, at least the impaired loans, were all in the 3-, 10-, 30- space. That hasn't been what we've seen here over the past two quarters. But I'd characterize the past two quarters as bouncing along the bottom, just like the previous two quarters were. We don't see any noticeable trends in that space..

All right. But in terms of net charge-off rate, it has kind of doubled where you had been the previous two quarters..

Right, but it's doubled off of 8 basis points to 16 basis points still relatively low by historical standards..

So a 10 basis point to 30 basis point range on net charge-off to average loans is bouncing along the bottom I guess..

Versus long-term historical averages? Yes..

Okay. And then on the expenses, last quarter you broke out the variable mortgage cost quarter-to-quarter, but didn't do it this quarter.

Is that because the production was similar on the mortgage side?.

I want to break out the moving parts for you every quarter, so I think we've shown that historically on a quarterly basis. Obviously it moves up and down with mortgage volumes. This quarter, though, it was nice to see that the expense was down $0.5 million even with the slight uptick in production..

Got you. And Ron, you talked about maybe some room for further improvement on the operating cost base of $177 million.

Any additional color as to where that gets to or put it in a different way of improvement?.

Yes, this is Ray. Well, first, one of the biggest things, obviously is we are as of the weekend of November 4 or 5 whatever day that weekend is, that will be the final conversion that we'll have on technology with the – from the Sterling acquisition.

And that puts all of that to bed, which enables us to take advantage of some additional cost saves obviously in a go-forward basis. So I think you will see, we should realize some of that and we'd like to see some more of our expense in consulting and services to help us get through integration and conversions start to ramp down..

So, Ray, just to make sure I got you that would be – through that final conversion, you expect the end of merger costs and then additional cost savings on the core run rate..

Yes, we're going to have – we will probably have some merger costs in fourth quarter. But as we go into 2017, that's when it will go to zero. Yes..

Okay. Thank you. .

Yes. You’re right..

Next, we’ll go to Jacque Bohlen with KBW. .

Hi, good morning guys..

Hi, Jacque..

I wondered if you could give some added color on the payoffs in the quarter, the payoffs and refinances that you spoke about. How much did they impact the organic growth that was booked in the quarter? And I guess assuming that – since you think loan growth will be more, I'm assuming that you expect them to slow next quarter.

And so what drives that view?.

Jacque, it's Cort. The largest category of paths [ph] we took in the quarter was multifamily. It was a little under $175 million. And the real reason that that was higher than normal primarily is just the aggressive underwriting terms being offered by both – yes, both non-banks and banks.

And we've chosen that stick to Ray's point in the opening comments – to stick to our knitting. So we saw some higher payoffs than we had seen in prior quarters in that particular category. And then investor real estate, same thing, just very aggressive terms being offered by competitive banks.

And as you noticed in the detail, all our other loan categories have grown in double digits. It's those two particular categories, where we have a higher concentration, where we're a lot more selective about what types of assets we'll put on the books..

Okay.

Was there any geographic skew to the payoffs or to the aggression that you're seeing in the market?.

No. We've got commercial real estate and multifamily all up and down the West Coast, and it's pretty much spread out. .

Okay. Maybe just some color on the pipelines that you're seeing, where they stood last quarter, where they are now.

Do you expect continue similar growth in the leasing buckets to continue through the next several quarters?.

So, pipelines haven't moved an iota, to be quite honest, since the beginning of the year. We've been sitting in a commercial bank about $3 billion to $3.1 billion since the beginning of the year. So it's not a production; it's more of a payoff, more of a payoff issue that we've got.

On the leasing side, that pipeline is still robust, and we're still on a pretty good growth tangent there. And we are approaching that $1 billion mark, which we could hit by the end of the year, but it will probably happen after the first of the year..

Okay. And then just one last quick housekeeping one. The disposal costs that were mentioned, I'm guessing, Ron, those are related to store closures..

That's correct. .

And I missed part of the prepared remarks.

You said they would trend downward next quarter, or they would remain next quarter?.

They will be there next quarter related to some excess back-office facility consolidation, but it will be a lower amount..

Okay.

And then mostly gone in 1Q?.

Correct. .

Okay. Great. Thank you guys for all the color. .

You bet. Thanks..

Next we go to Tyler Stafford with Stephens Inc..

Hi, good afternoon guys. Just a question first on the mortgage business.

Can you talk about the changes or initiatives you are making behind the scenes to allow for that mortgage compensation expense to actually decline $0.5 million, given it's such a strong origination quarter?.

I think – and part of that too, it's a combination of a number of factors, including the product, the geography. Also you have ramp-ups over the course of the year in terms of some of the benefit-related costs. So all that really factored into it. But again, the key with it is we're working to obviously maintain, retain the conventional side.

We've had some reductions on the portfolio side, for obvious reasons we've discussed over the past few quarters, so that also is a bit of a mix..

Okay. And then do you have the dollar amount of gain from SBA sales this quarter, and what it was last quarter? And in line with that, the gain on sale income this quarter was clearly down from 2Q.

Any outlook on how much you expect to sell and the revenue contribution as we think about next year from that?.

Yes. So, in terms of that gain on sale line, that in essence is SBA on a quarterly basis, and it's been around that level here over the last several quarters, ex- the portfolio sales..

So SBA has been essentially flat? Am I understanding that --?.

[indiscernible], but off of a small base. So, for example, this quarter the $1.3 million, that's roughly – that's basically SBA. .

Okay.

And then just lastly, do you have the PCI versus non-PCI breakdown on the accretion, that $9.1 million?.

Of the $9.1 million, it was – roughly $2 million was non-PCI..

Okay. Great. Thanks, guys. .

And next, we’ll go to Jared Shaw with Wells Fargo Securities..

This is actually Timur Braziler filling in for Jared. I guess my first question is a little bit more of a hypothetical one. Again, strong deposit growth this quarter, which resulted in some build in excess liquidity position. I'm just wondering if loan payoffs remain elevated in Q4, and even into 2017.

Deposit growth remains strong; excess liquidity continues to build.

Would there be a strategic shift on deposit gathering activities or maybe a strategic shift within the securities book?.

if something was hypothetically, since you said it was hypothetic – hypothetically, if something happened dramatic in the economy which stopped the credit machines around here, that certainly could have an impact on the way we look at how we go forward with loans, and what that means to the investment portfolio. But that's awful hypothetical. .

This is Cort. Let me add one more little piece of detail that might be helpful to you. So, we have a group that does construction finance. They do multifamily construction. And those, obviously, as they come to term, there is a construction period, and those deals come to term in chunks.

And as those come to term, and we get bid on by other banks and we choose not to compete, they kind of come in waves. And we hit a wave of that in the third quarter, where we had some multifamily production – construction loan production that was done probably 18 to 24 months ago that hit its term.

There is a very aggressive multifamily market out there. And there was a chunk of payoffs out of that construction portfolio. That's not a reocurring event, every quarter. That kind of comes in waves..

Okay. No, that's very good color. Appreciate that, thank you.

And then just looking at potential opportunity for additional loan sales here in the fourth quarter, or did you see something special in Q3 that made you pull the trigger on that?.

On the Q3 side, it was just a continuation of the long-term fixed residential. We're assessing that now for the fourth quarter, but we're not expecting anything significant..

Okay. And then last one for me, just circling back to the comments that you made about further increasing the asset sensitivity of the balance sheet.

Internally speaking, what's the expectation for rate hikes that you guys are budgeting in?.

I think the market is factoring in 25 basis points in December, above 50%, in terms of that estimate; and probably 50-50 in terms of another one next year. So that was the one I was referring to. With that first, or the next 25 basis points, we do expect roughly $10 million increase to net interest income on an annualized basis..

Okay, great. Thank you. .

You bet. Thank you..

And there are no further questions..

Okay. Well, I want to thank everyone for their interest in Umpqua Holdings and attendance on the call today. This will conclude the call. Goodbye..

And that does conclude today's conference. We thank everyone for their participation..