Columbia Banking System, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Columbia Banking System, Inc., is a regional bank operating primarily in the Pacific Northwest. It offers commercial banking, retail banking, and wealth management services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Columbia Banking System (COLB) has a narrow moat. This is mainly due to their community focus, established regional presence, and moderately high customer stickiness which is somewhat enhanced by brand reputation. However, the competitive landscape is intense and regulations are a big headwind that they face.

Moat Analysis

Moat Rating: 2/5

Justification:

  • Established Regional Presence: Columbia Bank is a well-known regional bank that has had a long track record of providing financial services in the Pacific Northwest. This gives them a certain level of local brand recognition and customer loyalty. They have numerous branches across Oregon, Washington, California, Idaho, Nevada, Arizona, and Colorado which has made its moat somewhat resilient. They also mention being committed to community and building relationships and it helps create switching costs on the customers.
  • Switching Costs: Moving from a bank is tedious for most customers, particularly if they have any long-term accounts or other commitments. It’s very hard for the average customer to completely switch over to another bank and for that reason banks tend to retain a good amount of customers. In addition, customer relationships which are a core focus for the bank, and the convenience of many branches in their operating area enhances customer stickiness.
  • Regulatory Burden: While regulation acts as a barrier to entry for new banks, it is not really creating any kind of competitive advantage for the incumbents, they must comply with these regulations which results in lower margins and earnings. Also, they need to spend a lot on regulatory compliance.
  • Competition: Banks are constantly battling for customer deposits, and when rates for loans rise the banks will face competition from other banks or non bank lenders, which may have better terms. The banking industry overall is a very intensely competitive one, with many banks trying to offer more or similar services to customers. This results in pricing pressures, thereby lowering profitability for each company.
  • Limited Differentiation: There is only limited differentiation of services in the banking industry. The services that they provide are commoditized, therefore, their prices are highly competitive. Hence, any competitive advantage will most likely be short-lived.

Legitimate Risks to Moat and Resilience

Risks:

  • Interest Rate Sensitivity: Changes in the Fed funds rate and overall changes in interest rate structure directly influence both their funding and profitability. They also mentioned seeing significant reduction in NIM in the latest earnings call.
  • Credit Risk: The risk of loan defaults is high during a recession or a high-interest rate environment. Their most recent risk analysis was particularly focused on those loans in commercial real estate. A large portion of their loan portfolio is in commercial real estate as well which is more prone to fluctuations during downturns. Also they are a regional bank, which means they might have high geographic exposure and their loans are not diversified that well.
  • Economic Sensitivity: Banks are directly tied to the economy. During a recession or economic downturn, their returns on assets usually fall, and their defaults increase, and as a consequence they might have lower stock value.
  • Regulatory Changes: Banks face a significant regulatory burden, and increasing regulations may hamper profitability. There are also many factors affecting regulatory environment like government policy, which the company cannot control and may negatively affect them.
  • Technology Disruption: New technology startups in the FinTech space are increasingly taking customers away from traditional banks.
  • Merger Integration: There are always risks associated with mergers and acquisitions. It can take a toll on employee morale, or it might cost more and synergies can fail to materialize.

Resilience:

  • Regional Focus: They seem to be an integral part of the community in their regions, thus having good relations with customers and being able to withstand some level of adversity.
  • Well-Established: As a long time operator in the region, they have built a strong brand name which may lead to customer stickiness and some loyalties.
  • High Customer Retention: Banks typically have high customer retention as a result of switching costs.

Business Details

  • Revenue Distribution:
    • Columbia Bank’s revenue primarily comes from interest income. They earn through their loans. Other sources of revenue are non-interest income such as deposit account services, customer services, mortgage banking fees and gains on sales of loans. The company is heavily dependent on interest rates.
  • Industry Trends:
    • The banking industry is facing challenges with interest rate uncertainty, tech innovations, increasing regulations and risks.
  • Margins:
    • They have been experiencing pressure on net interest margins (NIM) due to higher interest rates on deposits and a slow increase in interest rates on loans. They reported NIM of 3.58% for the third quarter of 2023 which was a large decrease from prior quarters.
    • Non-interest expense and operating expenses have also been slightly increasing which might reduce margins even further.
  • Competitive Landscape:
    • The banking industry is becoming more and more competitive. Banks face competition from credit unions, other banks, non-bank lenders, and FinTech companies.
  • What Makes the Company Different:
    • They are a well-established local bank in the pacific northwest, and are dedicated to serving their community, their employees, and shareholders.

Financials (In-depth)

Based on Form 10-Q for the period ended September 30th 2023:

  • Assets:
    • Total assets: $19.65 Billion, indicating a substantial financial base. The bulk is made up of loans, investments, and cash.
    • Available-for-sale securities and held-to-maturity securities add up to ~$7 billion
    • Cash and due from banks ~$690 million. Cash is readily available for use.
    • Loans and leases net of unearned income is at ~$12.5 billion. A big source of revenue is interest from those loans.
  • Liabilities and Shareholders’ Equity:
    • Total liabilities are at $17.89 Billion, mostly made up of deposits, borrowings, and other liabilities.
    • Shareholder Equity is at $1.76 Billion, showcasing the company’s ownership base.
    • They are highly leveraged, which is common in banking, but means that the health of their loans is very important.
  • Income Statement (9 month ended, Sep 30th, 2023):
    • Net interest income increased to $476 Million due to higher interest rates, and loans growing at a high rate in the market.
      • But at the same time interest expenses on deposits and other liabilities also increased by a substantial amount.
    • Noninterest income is at $132.2 Million. The company is dependent on interest income more than fees.
    • The provision for credit losses increased by a large margin, which indicates a risk of higher defaults in the future.
    • Overall net income was $210.3 million.
*   **Cash Flow:**
     *   Net cash from operating activities was $221.3 million, which is less than the net income, as it also includes some noncash items that increase net income but does not have any cash transactions.
     * Cash outflow from investing was at about $100 million, and mostly from purchase of investment securities. 
     *  Net cash provided by financing was $130 million, largely driven by deposits from their customers.
  • Key Ratios:
    • Their interest coverage is around 2 to 4 times.
    • Price-to-earnings is at 10x.
    • Price-to-book ratio is around 0.7 to 0.8.
  • Controversies and Concerns:
    • The biggest concern is the high amount of interest expenses from deposits and the increasing probability of defaults.
      • Their net interest income has suffered in the recent quarter due to increasing costs of deposits.
    • They are a regional bank with large exposure to the local economies, so if a recession hits those areas, then it can severely impact the bank.
      • A large portion of their loan portfolio is in commercial real estate, which also has high risk.
    • Management is Trying To:
      • They have talked about raising the interest rates on new loans in order to keep their net interest margins healthy.
      • They have also acknowledged that the credit costs might increase if the economy does decline and their borrowers are facing trouble, but they are trying to assess the loans prudently and not extending credit where the borrower looks risky.

Understandability Rating

Understandability Rating: 2/5

Justification:

  • While the basic principles of banking are easy to understand, the complexity stems from the number of financial instruments involved and the multiple moving factors that affect profitability and growth.
  • Understanding bank financial statements and regulatory filings requires a higher-than-average level of understanding.
  • There are many outside factors that influence the financial performance of a bank, so it’s relatively harder to determine if they can perform well in the future.

Balance Sheet Health Rating

Balance Sheet Health: 3/5

Justification:

  • They have a reasonable amount of assets as compared to the liabilities.
  • Their tangible equity to assets ratio is good, but their leverage is high. So they have to continue to focus on good asset quality, or they could be heavily hurt by any major defaults.
  • Their loan portfolio is primarily in commercial real estate, which can be troublesome in case of a recession.
  • The bank is reliant on deposits, which means they are heavily affected by interest rates, and can lose customers if the interest rates offered are not competitive.

Conclusion

In conclusion, COLB has a narrow moat that is not strong enough to give them a high level of predictability for the future. They are primarily a bank whose fate depends on macroeconomic conditions, interest rates, and regulations. Their financials are a bit complicated and they require a good financial understanding to interpret correctly. They have an average balance sheet, and their recent financials have been quite weak.