Earlier this year, the banking sector experienced a significant but short-lived crisis. That crisis brought down shares of most every player in the industry. Some firms even collapsed entirely. Since then, many of the financial institutions that were hit experienced a nice recovery, though I have yet to see one that has posted a full recovery. Though not as rare as the nonexistent full recovery I seek, I have encountered some companies that have posted almost no recovery. One really good example of this can be seen by looking at Columbia Banking System (NASDAQ:COLB). At the bottom, shares of the bank holding company were down as much as 41% compared to where they were at the end of February. But even fast forward to today, and you see that shares are still down 34.6%. At first glance, this looks rather peculiar. This is especially true when you dig deeper and see exactly how cheap shares are on a pro forma basis. However, there are some legitimate issues regarding the institution that are offsetting the bullish arguments. And it’s the conflict between these two sides of the coin that leads me to take a more cautious approach to the company as an investment prospect.
A difficult picture
At its core, Columbia Banking System is an interesting financial institution. Compared to many of the other banks that I have seen, it has a rather short life, dating back to 1993. Just like many of the other banks that I have covered, it provides customers with a wide array of services, such as deposit services, various loans, and more. At the end of 2022, the bank had 152 different branches spread across four different states. Its largest presence was in Washington. However, earlier this year, management announced the completion of a merger with another bank called Umpqua Holdings, a deal that was originally announced in 2021. The $5.2 billion transaction was given regulatory approval in January of this year and it was completed as of March 1st.
Normally when I analyze a company like this, I would like to cover its historical financial results in depth. It gives good perspective on how a company might perform moving forward. However, in cases like this, that becomes rather challenging. A better approach is to look at the institution as it stands today and to see what kind of potential might exist moving forward. For instance, we do have a great deal of data when it comes to the value of deposits on the company’s books. As of the end of the second quarter, deposits totaled $40.83 billion. That represents a decline of $751.4 million compared to the $41.59 billion in deposits that the bank had at the end of the first quarter. However, it is a significant increase over the $27.07 billion that the company had at the end of last year. But once again, that massive increase can be chalked up to the aforementioned merger.
Given all that has gone on in the banking industry and the concerns around deposits, the continued drop from the first quarter to the second quarter proved to be somewhat worrisome for me. Another issue is the exposure that the bank has to uninsured deposits. That was the fuel for the fire that occurred in March of this year in the sector. $13.5 billion worth of deposits as of the end of the second quarter, accounting for 36.4% of total deposits, were classified as uninsured. Admittedly, this is down from the $14.8 billion, or 39.9%, that the bank had as of the end of the first quarter. But in an ideal world, we would have seen overall deposits increase while uninsured deposits fell. That, unfortunately, did not come to pass.
Loans, meanwhile, remained more or less unchanged. They dipped slightly from $37.09 billion in the first quarter to $37.05 billion in the second quarter. According to the data provided, the company’s loan distribution is fairly even. For instance, 21% of its loans are in the form of commercial and industrial loans. 17% falls under non owner occupied commercial real estate while another 17% falls under residential mortgages. 15% involves multifamily properties, while 14% includes owner occupied commercial real estate. I understand why investors might be concerned about the commercial side of things. In particular, the office category has proven to be problematic recently. This is because of high vacancy rates in office properties across the country. The good news is that, of the $17.3 billion of commercial real estate loans that the company has on its books, only 16.7%, amounting to $2.9 billion, or 7.8% of overall loans, fell under the office category. The picture on this front could be far worse.
It is worth noting that 21% of the company’s loans by value that are in the office category involve Southern California, while another 11% involve Northern California. This excludes 5% that is classified as being in the Bay Area. Add on top of this another 22% associated with Puget Sound, and add further the fact that 63% of its office loan portfolio is fixed rate, and I do think that there are concerns here that investors would not be wrong to have. Again, the overall lower exposure in the office category helps. But I would like to see further exposure mitigation on this side of things.
In the chart below, you can see financial data for the company for the second quarter of the current fiscal year compared to the same time last year, as well as for the first six months year over year. Once again, the merger involving the business complicates matters. But the good news is that management also provided pro forma figures that show what the financial picture of the company would look like had the merger been completed at the start of 2022. That data can be seen in the next image below.
One of the great things about this pro forma estimate is that it gives us a fairly decent idea of what the financial picture of the business might look like on an annualized basis. And this makes it fairly easy to value the enterprise. At the end of the day, I calculated that the bank is trading at a pro forma price to earnings multiple of about 5.4. That is quite low, even compared to many of the other banks that I have seen recently. Many of the cheaper ones trade at levels of between 6 and 9 at this time. However, I think that this discount is justified because of the uninsured deposit exposure, combined with the fact that debt on the company’s books is a rather hefty $6.67 billion as of this writing.
This does not mean that management is sitting by and doing nothing. The company most certainly does have a plan. For instance, management has already achieved significant cost savings following the completion of the merger. As of the end of the second quarter of this year, the business captured $105 million in annualized cost savings by cutting out inefficiencies. This included, amongst other things, consolidating 47 branches between the two separate banking systems. But this only accounts for roughly 20% of the $135 million worth of annualized cost savings that have been forecasted to be realized by the end of the third quarter this year.
As you can see in the image below, management is making sweeping changes in various parts of the enterprise. This has not stopped the company’s goal of growing its asset base though. As of the end of the second quarter, the average earning assets on the company’s books totaled about $43 billion. Management is pushing for this to grow to between $45 billion and $46 billion by the end of this year.
Truthfully, Columbia Banking System is a company that I feel somewhat conflicted about. There are some great positives such as a low trading multiple, cost cutting initiatives coming into play, a diverse loan portfolio, and more. However, negatives include a high uninsured deposit figure, high debt, and a continued drop in overall deposits. I truly am on the fence between a rather neutral rating and a bullish one for a firm like this. And due to lessons that I’ve learned in the past, when I do feel conflicted, I tend to opt for the more conservative of the two choices. So because of that, I have decided to rate the business a ‘hold’ for now. But it wouldn’t take much for me to bump this rating up.