Edgar Filing: BANNER CORP

BANR-6.30.2014-10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014.


[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ to ______________

Commission File Number 0-26584

BANNER CORPORATION

(Exact name of registrant as specified in its charter)





Washington		91-1691604
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

	10 South First Avenue, Walla Walla, Washington 99362
	(Address of principal executive offices and zip code)

	Registrant's telephone number, including area code: (509) 527-3636

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

[x]

[ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes

[x]

[ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ]

Accelerated filer [x]

Non-accelerated filer [ ]

Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes

[ ]

[x]

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Title of class:

As of July 31, 2014

Common Stock, $.01 par value per share

19,572,823 shares *

BANNER CORPORATION AND SUBSIDIARIES

Table of Contents



PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements. The Consolidated Financial Statements of Banner Corporation and Subsidiaries filed as a part of the report are as follows:

Consolidated Statements of Financial Condition as of June 30, 2014 and December 31, 2013	4

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013	5

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2014 and 2013	6

Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2014 and the Year Ended December 31, 2013	7

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013	9

Selected Notes to the Consolidated Financial Statements	11

Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations

Executive Overview	51

Comparison of Financial Condition at June 30, 2014 and December 31, 2013	57

Comparison of Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013	57

Asset Quality	63

Liquidity and Capital Resources	65

Capital Requirements	66

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

Market Risk and Asset/Liability Management	68

Sensitivity Analysis	68

Item 4 – Controls and Procedures	72

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings	73

Item 1A – Risk Factors	73

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	73

Item 3 – Defaults upon Senior Securities	73

Item 4 – Mine Safety Disclosures	73

Item 5 – Other Information	73

Item 6 – Exhibits	74

SIGNATURES	76

Special Note Regarding Forward-Looking Statements

Certain matters in this report on Form 10-Q contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, liquidity, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future economic performance and projections of financial items. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited to: the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets and may lead to increased losses and non-performing assets, and may result in our allowance for loan losses not being adequate to cover actual losses and require us to materially increase our reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates and the relative differences between short and long-term interest rates, loan and deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas; secondary market conditions for loans and our ability to sell loans in the secondary market; results of examinations of us by the Board of Governors of the Federal Reserve System (the Federal Reserve Board) and of our bank subsidiaries by the Federal Deposit Insurance Corporation (the FDIC), the Washington State Department of Financial Institutions, Division of Banks (the Washington DFI) or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, institute an informal or formal enforcement action against us or any of our bank subsidiaries which could require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds, or maintain or increase deposits, or impose additional requirements and restrictions on us, any of which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules including changes related to Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementing regulations; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining fair value of certain of our assets and liabilities, which estimates may prove to be incorrect and result in significant changes in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; the failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our business strategies; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; our ability to pay dividends on our common stock and interest or principal payments on our junior subordinated debentures; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and other risks detailed from time to time in our filings with the Securities and Exchange Commission. Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We do not undertake and specifically disclaim any obligation to update any forward-looking statements included in this report or the reasons why actual results could differ from those contained in such statements whether as a result of new information, future events or otherwise. These risks could cause our actual results to differ materially from those expressed in any forward-looking statements by, or on behalf of, us. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements.

As used throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to Banner Corporation and its consolidated subsidiaries, unless the context otherwise requires.

BANNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited) (In thousands, except shares)

June 30, 2014 and December 31, 2013



ASSETS	June 30 2014			December 31 2013
Cash and due from banks	$	146,561		$	137,349
Securities—trading, amortized cost $70,472 and $75,150, respectively	61,393			62,472
Securities—available-for-sale, amortized cost $455,232 and $474,960, respectively	455,353			470,280
Securities—held-to-maturity, fair value $138,065 and $103,610, respectively	133,186			102,513
Federal Home Loan Bank (FHLB) stock	31,191			35,390
Loans receivable:
Held for sale	7,322			2,734
Held for portfolio	3,755,277			3,415,711
Allowance for loan losses	(74,310		)	(74,258		)
	3,688,289			3,344,187
Accrued interest receivable	15,579			13,996
Real estate owned (REO), held for sale, net	4,388			4,044
Property and equipment, net	91,912			90,267
Intangible assets, net	3,892			2,449
Bank-owned life insurance (BOLI)	62,815			61,945
Deferred tax assets, net	22,065			27,479
Income tax receivable	166			9,728
Other assets	28,509			26,799
	$	4,745,299		$	4,388,898
LIABILITIES
Deposits:
Non-interest-bearing	$	1,210,068		$	1,115,346
Interest-bearing transaction and savings accounts	1,771,865			1,629,885
Interest-bearing certificates	936,986			872,695
	3,918,919			3,617,926
Advances from FHLB at fair value	45,251			27,250
Other borrowings	88,946			83,056
Junior subordinated debentures at fair value (issued in connection with Trust Preferred Securities)	77,313			73,928
Accrued expenses and other liabilities	35,619			31,324
Deferred compensation	16,238			16,442
	4,182,286			3,849,926
COMMITMENTS AND CONTINGENCIES (Note 15)
STOCKHOLDERS’ EQUITY
Common stock and paid in capital - $0.01 par value per share, 50,000,000 shares authorized, 19,568,704 shares issued and outstanding at June 30, 2014; 19,543,769 shares issued and 19,509,429 shares outstanding at December 31, 2013	567,483			569,028
Accumulated deficit	(4,541		)	(25,073		)
Accumulated other comprehensive income (loss)	71			(2,996		)
Unearned shares of common stock issued to Employee Stock Ownership Plan (ESOP) trust at cost: no shares outstanding at June 30, 2014 and 34,340 shares outstanding at December 31, 2013	—			(1,987		)
	563,013			538,972
	$	4,745,299		$	4,388,898

See Selected Notes to the Consolidated Financial Statements

BANNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited) (In thousands except for per share amounts)

For the Three and Six Months Ended June 30, 2014 and 2013



	Three Months Ended June 30						Six Months Ended June 30
	2014			2013			2014			2013
INTEREST INCOME:
Loans receivable	$	43,199		$	42,292		$	84,942		$	83,781
Mortgage-backed securities	1,446			1,394			2,917			2,566
Securities and cash equivalents	1,895			1,885			3,787			3,733
	46,540			45,571			91,646			90,080
INTEREST EXPENSE:
Deposits	1,910			2,490			3,874			5,210
FHLB advances	51			40			90			64
Other borrowings	45			51			89			107
Junior subordinated debentures	726			742			1,446			1,482
	2,732			3,323			5,499			6,863
Net interest income before provision for loan losses	43,808			42,248			86,147			83,217
PROVISION FOR LOAN LOSSES	—			—			—			—
Net interest income	43,808			42,248			86,147			83,217
OTHER OPERATING INCOME:
Deposit fees and other service charges	7,346			6,628			13,947			12,928
Mortgage banking operations	2,600			3,574			4,440			6,412
Miscellaneous	644			664			1,281			1,455
	10,590			10,866			19,668			20,795
Gain on sale of securities	—			12			35			1,018
Other-than-temporary impairment recovery	—			—			—			409
Net change in valuation of financial instruments carried at fair value	464			(255		)	209			(1,601		)
Acquisition bargain purchase gain	9,079			—			9,079			—
Total other operating income	20,133			10,623			28,991			20,621
OTHER OPERATING EXPENSES:
Salary and employee benefits	22,330			21,224			43,486			41,953
Less capitalized loan origination costs	(3,282		)	(3,070		)	(5,477		)	(5,941		)
Occupancy and equipment	5,540			5,415			11,236			10,744
Information/computer data services	1,918			1,923			3,853			3,643
Payment and card processing expenses	2,746			2,449			5,261			4,753
Professional services	1,109			820			2,115			1,726
Advertising and marketing	1,370			1,798			2,425			3,297
Deposit insurance	637			617			1,213			1,263
State/municipal business and use taxes	388			538			547			1,003
REO operations	(109		)	(195		)	(70		)	(446		)
Amortization of core deposit intangibles	450			477			929			982
Acquisition related costs	1,979			—			2,024			—
Miscellaneous	3,359			3,461			6,473			6,580
Total other operating expenses	38,435			35,457			74,015			69,557
Income before provision for income taxes	25,506			17,414			41,123			34,281
PROVISION FOR INCOME TAXES	8,499			5,661			13,545			10,945
NET INCOME	$	17,007		$	11,753		$	27,578		$	23,336
Earnings per common share:
Basic	$	0.88		$	0.61		$	1.43		$	1.21
Diluted	$	0.88		$	0.60		$	1.42		$	1.20
Cumulative dividends declared per common share	$	0.18		$	0.12		$	0.36		$	0.24

See Selected Notes to the Consolidated Financial Statements

BANNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited) (In thousands)

For the Three and Six Months Ended June 30, 2014 and 2013



	Three Months Ended June 30						Six Months Ended June 30
	2014			2013			2014			2013
NET INCOME	$	17,007		$	11,753		$	27,578		$	23,336
OTHER COMPREHENSIVE INCOME (LOSS), NET OF INCOME TAXES:
Unrealized holding gain (loss) on AFS securities arising during the period	2,330			(8,476		)	4,767			(8,854		)
Income tax benefit (expense) related to AFS unrealized holding gains (losses)	(845		)	3,043			(1,722		)	3,179
Reclassification for net (gains) losses on AFS securities realized in earnings	—			1			34			(116		)
Income tax benefit (expense) related to AFS realized gains (losses)	—			—			(12		)	42
Other comprehensive income (loss)	1,485			(5,432		)	3,067			(5,749		)
COMPREHENSIVE INCOME	$	18,492		$	6,321		$	30,645		$	17,587

See Selected Notes to the Consolidated Financial Statements

BANNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited) (In thousands, except for shares)

For the Six Months Ended June 30, 2014



	Common Stock and Paid in Capital					Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Unearned Restricted ESOP Shares			Stockholders’ Equity
	Shares		Amount			Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Unearned Restricted ESOP Shares			Stockholders’ Equity
Balance, January 1, 2014	19,509,429		$	569,028		$	(25,073	)	$	(2,996	)	$	(1,987	)	$	538,972
Net income						27,578									27,578
Other comprehensive income, net of income tax									3,067						3,067
Accrual of dividends on common stock ($0.36/share cumulative)						(7,046		)							(7,046		)
Redemption of unallocated shares upon termination of ESOP			(1,987		)							1,987			—
Repurchase of shares upon termination of ESOP	(13,550	)	(556		)										(556		)
Proceeds from issuance of common stock for stockholder reinvestment program	1,451		60												60
Issuance of restricted stock and amortization of related compensation	71,374		938												938
BALANCE, June 30, 2014	19,568,704		$	567,483		$	(4,541	)	$	71		$	—		$	563,013

See Selected Notes to the Consolidated Financial Statements

BANNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited) (In thousands, except for shares)

For the Year Ended December 31, 2013



	Common Stock and Paid in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Unearned Restricted ESOP Shares			Stockholders’ Equity
	Shares	Amount		Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Unearned Restricted ESOP Shares			Stockholders’ Equity
Balance, January 1, 2013	19,420,625	$	567,907	$	(61,102	)	$	2,101		$	(1,987	)	$	506,919
Net income				46,555									46,555
Other comprehensive loss, net of income tax							(5,097		)				(5,097		)
Accrual of dividends on common stock ($0.54/share cumulative)				(10,526		)							(10,526		)
Proceeds from issuance of common stock for stockholder reinvestment program	2,098	72											72
Issuance of restricted stock and amortization of related compensation	86,706	1,049											1,049
BALANCE, December 31, 2013	19,509,429	$	569,028	$	(25,073	)	$	(2,996	)	$	(1,987	)	$	538,972

See Selected Notes to the Consolidated Financial Statements

BANNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

For the Six Months Ended June 30, 2014 and 2013



	Six Months Ended June 30
	2014			2013
OPERATING ACTIVITIES:
Net income	$	27,578		$	23,336
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	4,053			3,679
Deferred income and expense, net of amortization	1,883			2,233
Amortization of core deposit intangibles	929			982
Gain on sale of securities	(35		)	(1,018		)
Other-than-temporary impairment recovery	—			(409		)
Net change in valuation of financial instruments carried at fair value	(209		)	1,601
Purchases of securities—trading	(2,387		)	(23,377		)
Proceeds from sales of securities—trading	2,387			25,267
Principal repayments and maturities of securities—trading	4,702			3,657
Bargain purchase gain on acquisition	(9,079		)	—
Decrease in deferred taxes	5,414			570
Increase (decrease) in current taxes payable	9,562			(4,245		)
Equity-based compensation	818			478
Increase in cash surrender value of BOLI	(858		)	(982		)
Gain on sale of loans, net of capitalized servicing rights	(2,528		)	(4,303		)
Gain on disposal of real estate held for sale and property and equipment	(453		)	(1,454		)
Provision for losses on real estate held for sale	37			299
Origination of loans held for sale	(160,625		)	(263,111		)
Proceeds from sales of loans held for sale	158,565			272,941
Net change in:
Other assets	(1,967		)	19,440
Other liabilities and equity	2,946			(5,019		)
Net cash provided from operating activities	40,733			50,565
INVESTING ACTIVITIES:
Purchases of securities—available-for-sale	(30,272		)	(179,555		)
Principal repayments and maturities of securities—available-for-sale	20,085			68,488
Proceeds from sales of securities—available-for-sale	28,207			103,274
Purchases of securities—held-to-maturity	(33,686		)	(9,029		)
Principal repayments and maturities of securities—held-to-maturity	2,603			987
Loan originations, net of principal repayments	(155,279		)	(66,066		)
Purchases of loans and participating interest in loans	(101,840		)	(91		)
Proceeds from sales of other loans	2,491			3,288
Net cash received from acquisition	127,557			—
Purchases of property and equipment	(2,617		)	(2,439		)
Proceeds from sale of real estate held for sale, net	2,672			11,787
Proceeds from FHLB stock repurchase program	4,199			665
Other	(2,054		)	120
Net cash used by investing activities	(137,934		)	(68,571		)
FINANCING ACTIVITIES:
Increase (decrease) in deposits, net	88,907			(97,480		)
Advances, net of repayments of FHLB borrowings	17,996			43,997
Increase in other borrowings, net	5,889			14,146
Cash dividends paid	(6,439		)	(2,530		)
Cash proceeds from issuance of stock for stockholder reinvestment plan	60			23
Net cash provided from (used by) financing activities	106,413			(41,844		)
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS	9,212			(59,850		)
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD	137,349			181,298
CASH AND DUE FROM BANKS, END OF PERIOD	$	146,561		$	121,448

(Continued on next page)

BANNER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited) (In thousands)

For the Six Months Ended June 30, 2014 and 2013



	Six Months Ended June 30
	2014		2013
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid in cash	$	5,527	$	7,087
Taxes paid, net of refunds received in cash	292		11,376
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
Loans, net of discounts, specific loss allowances and unearned income, transferred to real estate owned and other repossessed assets	2,885		1,770
ACQUISITIONS (Note 2):
Assets acquired	221,206		—
Liabilities assumed	212,127		—

See Selected Notes to the Consolidated Financial Statements

BANNER CORPORATION AND SUBSIDIARIES

SELECTED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 1: BASIS OF PRESENTATION AND CRITICAL ACCOUNTING POLICIES

The accompanying unaudited consolidated interim financial statements include the accounts of Banner Corporation (the Company or Banner), a bank holding company incorporated in the State of Washington and its wholly-owned subsidiaries, Banner Bank and Islanders Bank (the Banks).

These unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (SEC). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC. Certain reclassifications have been made to the 2013 Consolidated Financial Statements and/or schedules to conform to the 2014 presentation. These reclassifications may have affected certain ratios for the prior periods. The effect of these reclassifications is considered immaterial. All significant intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. Various elements of the Company’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of Banner’s financial statements. These policies relate to (i) the methodology for the recognition of interest income, (ii) determination of the provision and allowance for loan and lease losses, (iii) the valuation of financial assets and liabilities recorded at fair value, including other-than-temporary impairment (OTTI) losses, (iv) the valuation of intangibles, such as core deposit intangibles and mortgage servicing rights, (v) the valuation of real estate held for sale and (vi) the valuation of or recognition of deferred tax assets and liabilities. These policies and judgments, estimates and assumptions are described in greater detail in subsequent notes to the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations (Critical Accounting Policies) in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in the Company’s results of operations or financial condition. Further, subsequent changes in economic or market conditions could have a material impact on these estimates and the Company’s financial condition and operating results in future periods.

The information included in this Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013 as filed with the SEC (2013 Form 10-K). Interim results are not necessarily indicative of results for a full year.

Note 2: RECENT DEVELOPMENTS AND SIGNIFICANT EVENTS

Proposed Acquisition of Siuslaw Financial Group, Inc.

On August 7, 2014, the Company announced the execution of a definitive agreement to purchase Siuslaw Financial Group, Inc. (Siuslaw), the holding company of Siuslaw Bank, an Oregon state charted commercial bank. The consideration for the transaction is approximately 90% stock and 10% cash. Based on the Banner closing priced of $39.14 per share on August 7, 2014 the aggregate consideration would be $57.5 million. The purchase is subject to approval by Siuslaw shareholders, regulatory approval and other customary conditions of closing. Upon closing of the transaction, which is anticipated to take place in the latter part of the fourth quarter of 2014, Siuslaw will be merged into Banner and Siuslaw Bank will be merged into Banner Bank.

Termination of Proposed Acquisition of Idaho Banking Company

On June 30, 2014, the Company announced it had terminated its agreement to acquire Idaho Banking Company (Idaho Banking) through the bidding process under Section 363 of Chapter 11 of the United States Bankruptcy Code in the U.S. Bankruptcy Court for the District of Idaho (Bankruptcy Court). Banner proposed to purchase all of the issued and outstanding shares of Idaho Banking Company pursuant to an Asset Purchase Agreement (Agreement) it had entered into with Idaho Bancorp, the bank holding company of Idaho Banking, on April 24, 2014. In connection with the June 26, 2014 Bankruptcy Court-supervised auction process, as contemplated by the Agreement, Idaho Banking received the highest offer from another bidder. Accordingly, the Agreement has been terminated. Pursuant to the Agreement, the Company will be reimbursed for its expenses in connection with the transaction.

Acquisition of Six Oregon Branches

Effective as of the close of business on June 20, 2014, Banner Bank completed the purchase of six branches from Umpqua Bank, successor to Sterling Savings Bank. Five of the six branches are located in Coos County, Oregon and the sixth branch is located in Douglas County, Oregon. The purchase provided $212 million in deposit accounts, $88 million in loans, and $3 million in branch properties. Banner Bank received $128 million in cash from the transaction.

The assets acquired and liabilities assumed in the purchase have been accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the acquisition date, and are subject to change for up to one year after the closing date of the acquisition. The application of the acquisition method of accounting resulted in recognition of a core deposit intangible asset of $2.4 million and an acquisition bargain purchase gain of $9.1 million. The bargain purchase gain represents the excess fair value of the net assets acquired over the purchase price, including fair value of liabilities assumed. The bargain purchase gain consisted primarily of a $7 million discount on the assets acquired in this required branch divestiture combined with a $2.4 million core deposit intangible, net of approximately $300,000 in fair value adjustments. The acquired core deposit intangible has been determined to have a useful life of approximately eight years and will be amortized on an accelerated basis.

The following table displays the fair value as of the acquisition date for each major class of assets acquired and liabilities assumed (in thousands):



	Fair Value at June 20, 2014
Assets:
Cash	$	127,557
Loans receivable, net (contractual amount of $88.3 million)	87,923
Property and equipment, net	3,079
Core deposit intangible	2,372
Other assets	275
Total assets	221,206

Liabilities:
Deposits	212,085
Other liabilities	42
Total liabilities	212,127
Acquisition bargain purchase gain	$	9,079

Amounts recorded are preliminary estimates of fair value. The primary reason for the acquisition was to continue the Company's growth strategy, including expanding our geographic footprint in markets throughout the Northwest. As of June 20, 2014 the transaction had no remaining contingencies. Pro forma results of operations for the three and six months ended June 30, 2014 and 2013, as if the branch acquisitions had occurred on January 1, 2013, have not been presented because historical financial information was not available.

The operating results of the Company include the operating results produced by the six acquired branches from June 21, 2014 to June 30, 2014. In connection with the acquisition, Banner recognized $2.0 million of acquisition-related expenses for the three and six months ended June 30, 2014 as follows (in thousands):



	Three Months Ended June 30, 2014		Six Months Ended June 30, 2014
Acquisition-related costs recognized in other operating expenses:
Non-capitalized equipment	$	29	$	29
Client communications	236		238
Information/computer data services	632		632
Payment and processing expenses	271		271
Professional services	587		619
Miscellaneous	224		235
	$	1,979	$	2,024

Stockholder Equity Transactions:

Omnibus Incentive Plan: On January 28, 2014, the Company's board of directors unanimously adopted, and on April 22, 2014 the Company's shareholders approved, the Banner Corporation 2014 Omnibus Incentive Plan. The purpose of the Plan is to promote the success and enhance the value of Banner by linking the personal interests of employees and directors with those of Banner's shareholders. The Plan is further intended to provide flexibility to Banner in its ability to motivate, attract, and retain the services of employees and directors upon whose judgment, interest and special effort Banner depends. The Plan also allows performance-based compensation to be provided in a manner that exempts such compensation from the deduction limits imposed by Section 162(m) of the Internal Revenue Code.

Note 3: ACCOUNTING STANDARDS RECENTLY ADOPTED

Unrecognized Tax Benefits

In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-11, Presentation of an Unrecognized Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU requires an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. An exception exists to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax of the applicable jurisdiction does not require the entity to use, and entity does not intend to use, the deferred tax asset for such a purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU No. 2013-11 is effective for fiscal years and interim periods beginning after December 15, 2013. The Company adopted the provisions of ASU No. 2013-11 effective January 1, 2014. The adoption of this guidance did not have a material effect on the Company's consolidated financial statements.

Investing in Qualified Affordable Housing Projects

In January 2014, FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. The objective of this ASU is to provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments in this ASU modify the conditions that a reporting entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. If the modified conditions are met, the amendments permit an entity to amortize the initial cost of the investment in proportion to the amount of tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). Additionally, the amendments introduce new recurring disclosures about all investments in qualified affordable housing projects irrespective of the method used to account for the investments. The amendments in this ASU should be applied retrospectively to all periods presented. ASU No. 2014-01 is effective beginning after December 15, 2014 and is not expected to have a material impact on the Company's consolidated financial statements.

Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure

In January 2014, FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendments in this ASU clarify that an in-substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. ASU No. 2014-04 is effective for fiscal years and interim periods beginning after December 15, 2014 and is not expected to have a material impact on the Company's consolidated financial statements.

Revenue from Contracts with Customers

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which creates Topic 606 and supersedes Topic 605, Revenue Recognition. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard is effective for public entities for interim and annual periods beginning after December 15, 2016; early adoption is not permitted. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company is currently evaluating the provisions of ASU No. 2014-09 to determine the potential impact the standard will have on the Company’s consolidated financial statements.

Note 4: BUSINESS SEGMENTS

The Company is managed by legal entity and not by lines of business. Each of the Banks is a community oriented commercial bank chartered in the State of Washington. Each of the Banks’ primary business is that of a traditional banking institution, gathering deposits and originating loans for its portfolios in its markets. The Banks offer a wide variety of deposit products to their consumer and commercial customers. Lending activities include the origination of real estate, commercial/agriculture business and consumer loans. Banner Bank is also an active participant in the secondary market, originating residential loans for sale on both a servicing released and servicing retained basis. In addition to interest income on loans and investment securities, the Banks receive other income from deposit service charges, loan servicing fees and from the sale of loans and investments. The performance of the Banks is reviewed by the Company’s executive management and Board of Directors on a monthly basis. All of the executive officers of the Company are members of Banner Bank’s management team.

Generally Accepted Accounting Principles, or GAAP, establish standards to report information about operating segments in annual financial statements and require reporting of selected information about operating segments in interim reports to stockholders. The Company has determined that its current business and operations consist of a single business segment.

Note 5: INTEREST-BEARING DEPOSITS AND SECURITIES

The following table sets forth additional detail regarding our interest-bearing deposits and securities at the dates indicated (includes securities—trading, available-for-sale and held-to-maturity, all at carrying value) (in thousands):



	June 30 2014		December 31 2013
Interest-bearing deposits included in cash and due from banks	$	62,990	$	67,638
U.S. Government and agency obligations	55,908		61,327
Municipal bonds:
Taxable	35,227		34,216
Tax exempt	138,859		119,588
Total municipal bonds	174,086		153,804
Corporate bonds	45,340		44,154
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	56,063		58,117
One- to four-family residential other	911		1,051
Multifamily agency guaranteed	281,421		281,319
Multifamily other	10,676		10,234
Total mortgage-backed or related securities	349,071		350,721
Asset-backed securities:
Student Loan Marketing Association (SLMA)	15,732		15,681
Other asset-backed securities	9,734		9,510
Total asset-backed securities	25,466		25,191
Equity securities (excludes FHLB stock)	61		68
Total securities	649,932		635,265
Total interest-bearing deposits and securities	$	712,922	$	702,903

Securities—Trading: The amortized cost and estimated fair value of securities—trading at June 30, 2014 and December 31, 2013 are summarized as follows (dollars in thousands):



	June 30, 2014						December 31, 2013
	Amortized Cost		Fair Value		Percent of Total		Amortized Cost		Fair Value		Percent of Total
U.S. Government and agency obligations	$	1,370	$	1,530	2.5	%	$	1,370	$	1,481	2.4	%
Municipal bonds:
Tax exempt	1,666		1,716		2.8		4,969		5,023		8.0
Corporate bonds	49,466		38,529		62.7		49,498		35,140		56.2
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	9,222		9,987		16.3		10,483		11,230		18.0
Multifamily agency guaranteed	8,734		9,570		15.6		8,816		9,530		15.3
Total mortgage-backed or related securities	17,956		19,557		31.9		19,299		20,760		33.3
Equity securities	14		61		0.1		14		68		0.1
	$	70,472	$	61,393	100.0	%	$	75,150	$	62,472	100.0	%

There were three sales of securities—trading totaling $2.4 million with a resulting net gain of $1,000 during the six months ended June 30, 2014. There were 37 sales of securities—trading totaling $25.3 million with a resulting net gain of $1.0 million during the six months ended June 30, 2013, including $1.0 million which represented recoveries on certain collateralized debt obligations that had previously been written off. In addition to the $1.0 million net gain, the Company also recognized a $409,000 OTTI recovery on sales of securities—trading during the six months ended June 30, 2013, which was related to the sale of certain equity securities issued by government-sponsored entities. The Company did not recognize any OTTI charges or recoveries on securities—trading during the six months ended June 30, 2014. No securities—trading were on nonaccrual status at June 30, 2014 and 2013.

The amortized cost and estimated fair value of securities—trading at June 30, 2014 and December 31, 2013, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or without call or prepayment penalties.



	June 30, 2014				December 31, 2013
	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Maturing in one year or less	$	11,759	$	11,763	$	260	$	263
Maturing after one year through five years	6,524		6,969		7,056		7,298
Maturing after five years through ten years	8,976		9,915		12,602		13,572
Maturing after ten years through twenty years	21,352		17,930		33,335		27,472
Maturing after twenty years	21,847		14,755		21,883		13,799
	70,458		61,332		75,136		62,404
Equity securities	14		61		14		68
	$	70,472	$	61,393	$	75,150	$	62,472

Securities—Available-for-Sale: The amortized cost and estimated fair value of securities—available-for-sale at June 30, 2014 and December 31, 2013 are summarized as follows (dollars in thousands):



	June 30, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Percent of Total
U.S. Government and agency obligations	$	52,424	$	41	$	(253	)	$	52,212	11.5	%
Municipal bonds:
Taxable	19,733		116		(40		)	19,809		4.4
Tax exempt	30,876		194		(78		)	30,992		6.8
Total municipal bonds	50,609		310		(118		)	50,801		11.2
Corporate bonds	5,000		11		—			5,011		1.1
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	43,883		839		(452		)	44,270		9.7
One- to four-family residential other	860		51		—			911		0.2
Multifamily agency guaranteed	266,339		877		(1,210		)	266,006		58.4
Multifamily other	10,554		122		—			10,676		2.3
Total mortgage-backed or related securities	321,636		1,889		(1,662		)	321,863		70.6
Asset-backed securities:
SLMA	15,508		224		—			15,732		3.5
Other asset-backed securities	10,055		—		(321		)	9,734		2.1
Total asset-backed securities	25,563		224		(321		)	25,466		5.6
	$	455,232	$	2,475	$	(2,354	)	$	455,353	100.0	%

	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Percent of Total
U.S. Government and agency obligations	$	59,178	$	117	$	(635	)	$	58,660	12.5	%
Municipal bonds:
Taxable	23,842		100		(278		)	23,664		5.0
Tax exempt	29,229		170		(208		)	29,191		6.2
Total municipal bonds	53,071		270		(486		)	52,855		11.2
Corporate bonds	7,001		2		(39		)	6,964		1.5
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	47,077		648		(838		)	46,887		10.0
One- to four-family residential other	988		63		—			1,051		0.2
Multifamily agency guaranteed	271,428		402		(3,392		)	268,438		57.1
Multifamily other	10,604		—		(370		)	10,234		2.2
Total mortgage-backed or related securities	330,097		1,113		(4,600		)	326,610		69.5
Asset-backed securities:
SLMA	15,553		128		—			15,681		3.3
Other asset-backed securities	10,060		—		(550		)	9,510		2.0
Total asset-backed securities	25,613		128		(550		)	25,191		5.3
	$	474,960	$	1,630	$	(6,310	)	$	470,280	100.0	%

At June 30, 2014 and December 31, 2013, an aging of unrealized losses and fair value of related securities—available-for-sale was as follows (in thousands):



	June 30, 2014
	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Government and agency obligations	$	6,691	$	(8	)	$	20,299	$	(245	)	$	26,990	$	(253	)
Municipal bonds:
Taxable	3,031		(6		)	3,829		(34		)	6,860		(40		)
Tax exempt	1,617		(3		)	3,757		(75		)	5,374		(78		)
Total municipal bonds	4,648		(9		)	7,586		(109		)	12,234		(118		)
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	10,338		(79		)	12,107		(373		)	22,445		(452		)
Multifamily agency guaranteed	21,224		(84		)	119,731		(1,126		)	140,955		(1,210		)
Total mortgage-backed or related securities	31,562		(163		)	131,838		(1,499		)	163,400		(1,662		)
Asset-backed securities:
Other asset-backed securities	—		—			9,734		(321		)	9,734		(321		)
	$	42,901	$	(180	)	$	169,457	$	(2,174	)	$	212,358	$	(2,354	)

	December 31, 2013
	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Government and agency obligations	$	39,621	$	(633	)	$	998	$	(2	)	$	40,619	$	(635	)
Municipal bonds:
Taxable	15,580		(261		)	413		(17		)	15,993		(278		)
Tax exempt	8,217		(205		)	487		(3		)	8,704		(208		)
Total municipal bonds	23,797		(466		)	900		(20		)	24,697		(486		)
Corporate bonds	4,961		(39		)	—		—			4,961		(39		)
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	14,972		(133		)	22,560		(705		)	37,532		(838		)
Multifamily agency guaranteed	199,407		(3,162		)	10,096		(230		)	209,503		(3,392		)
Multifamily other	10,234		(370		)	—		—			10,234		(370		)
Total mortgage-backed or related securities	224,613		(3,665		)	32,656		(935		)	257,269		(4,600		)
Asset-backed securities:
Other asset-backed securities	—		—			9,510		(550		)	9,510		(550		)
	$	292,992	$	(4,803	)	$	44,064	$	(1,507	)	$	337,056	$	(6,310	)

There were six sales of securities—available-for-sale totaling $28.2 million with a resulting net gain of $34,000 during the six months ended June 30, 2014. There were 35 sales of securities—available-for-sale totaling $103.3 million with a resulting net loss of $116,000 during the six months ended June 30, 2013. At June 30, 2014, there were 64 securities—available for sale with unrealized losses, compared to 114 securities at December 31, 2013. Management does not believe that any individual unrealized loss as of June 30, 2014 represents OTTI. The decline in fair market values of these securities was generally due to changes in interest rates and changes in market-desired spreads subsequent to their purchase. There were no securities—available-for-sale on nonaccrual status at June 30, 2014 or 2013.

The amortized cost and estimated fair value of securities—available-for-sale at June 30, 2014 and December 31, 2013, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or without call or prepayment penalties.



	June 30, 2014				December 31, 2013
	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Maturing in one year or less	$	20,198	$	20,248	$	25,136	$	25,256
Maturing after one year through five years	314,605		314,067		322,493		319,489
Maturing after five years through ten years	56,558		56,708		58,468		57,782
Maturing after ten years through twenty years	5,923		5,819		15,535		15,135
Maturing after twenty years	57,948		58,511		53,328		52,618
	$	455,232	$	455,353	$	474,960	$	470,280

Securities—Held-to-Maturity: The amortized cost and estimated fair value of securities—held-to-maturity at June 30, 2014 and December 31, 2013 are summarized as follows (dollars in thousands):



	June 30, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Percent of Total Amortized Cost
U.S. Government and agency obligations	$	2,166	$	—	$	(29	)	$	2,137	1.6	%
Municipal bonds:
Taxable	15,418		287		(38		)	15,667		11.6
Tax exempt	106,151		4,970		(361		)	110,760		79.7
Total municipal bonds	121,569		5,257		(399		)	126,427		91.3
Corporate bonds	1,800		—		—			1,800		1.4
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	1,806		—		(10		)	1,796		1.4
Multifamily agency guaranteed	5,845		60		—			5,905		4.3
Total mortgage-backed or related securities	7,651		60		(10		)	7,701		5.7
	$	133,186	$	5,317	$	(438	)	$	138,065	100.0	%

	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Percent of Total Amortized Cost
U.S. Government and agency obligations	$	1,186	$	—	$	(80	)	$	1,106	1.2	%
Municipal bonds:
Taxable	10,552		193		(204		)	10,541		10.3
Tax exempt	85,374		2,545		(1,299		)	86,620		83.3
Total municipal bonds	95,926		2,738		(1,503		)	97,161		93.6
Corporate bonds	2,050		—		—			2,050		2.0
Mortgage-backed or related securities:
Multifamily agency guaranteed	3,351		—		(58		)	3,293		3.2
	$	102,513	$	2,738	$	(1,641	)	$	103,610	100.0	%

At June 30, 2014 and December 31, 2013, an age analysis of unrealized losses and fair value of related securities—held-to-maturity was as follows (in thousands):



	June 30, 2014
	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Government and agency obligations	$	1,000	$	(1	)	$	1,137	$	(28	)	$	2,137	$	(29	)
Municipal bonds:
Taxable	2,222		(8		)	2,837		(30		)	5,059		(38		)
Tax exempt	7,499		(82		)	9,080		(279		)	16,579		(361		)
Total municipal bonds	9,721		(90		)	11,917		(309		)	21,638		(399		)
Mortgage-backed or related securities:
One- to four-family residential agency guaranteed	1,796		(10		)	—		—			1,796		(10		)
	$	12,517	$	(101	)	$	13,054	$	(337	)	$	25,571	$	(438	)

	December 31, 2013
	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Government and agency obligations	$	1,106	$	(80	)	$	—	$	—		$	1,106	$	(80	)
Municipal bonds:
Taxable	3,344		(110		)	2,964		(94		)	6,308		(204		)
Tax exempt	31,234		(1,282		)	303		(17		)	31,537		(1,299		)
Total municipal bonds	34,578		(1,392		)	3,267		(111		)	37,845		(1,503		)
Mortgage-backed or related securities:
Multifamily agency guaranteed	3,293		(58		)	—		—			3,293		(58		)
	$	38,977	$	(1,530	)	$	3,267	$	(111	)	$	42,244	$	(1,641	)

There were no sales of securities—held-to-maturity during the six months ended June 30, 2014 and 2013. At June 30, 2014, there were 37 securities—held-to-maturity with unrealized losses, compared to 36 securities at December 31, 2013. Management does not believe that any individual unrealized loss as of June 30, 2014 represents OTTI. The decline in fair market value of these securities was generally due to changes in interest rates and changes in market-desired spreads subsequent to their purchase. There were no securities—held-to-maturity on nonaccrual status at June 30, 2014 or 2013.

The amortized cost and estimated fair value of securities—held-to-maturity at June 30, 2014 and December 31, 2013, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because some securities may be called or prepaid with or without call or prepayment penalties.



	June 30, 2014				December 31, 2013
	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Maturing in one year or less	$	1,365	$	1,377	$	1,270	$	1,281
Maturing after one year through five years	14,447		14,774		10,834		11,206
Maturing after five years through ten years	26,912		27,231		17,948		17,908
Maturing after ten years through twenty years	64,444		68,049		59,643		60,791
Maturing after twenty years	26,018		26,634		12,818		12,424
	$	133,186	$	138,065	$	102,513	$	103,610

Pledged Securities: The following table presents, as of June 30, 2014, investment securities and interest-bearing deposits which were pledged to secure borrowings, public deposits or other obligations as permitted or required by law (in thousands):



	Carrying Value		Amortized Cost		Fair Value
Purpose or beneficiary:
State and local governments public deposits	$	131,022	$	130,863	$	135,798
Interest rate swap counterparties	9,902		9,468		9,902
Retail repurchase agreements	102,175		101,574		102,175
Other	248		248		248
Total pledged securities and interest-bearing deposits	$	243,347	$	242,153	$	248,123

Note 6: FHLB STOCK

The Banks’ investments in Federal Home Loan Bank of Seattle stock are carried at cost, which is its par value ($100 per share), and which reasonably approximates its fair value. As members of the FHLB system, the Banks are required to maintain a minimum level of investment in FHLB stock based on specific percentages of their outstanding FHLB advances. At June 30, 2014 and December 31, 2013, respectively, the Company had recorded $31.2 million and $35.4 million in investments in FHLB stock. This stock is generally viewed as a long-term investment and it does not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member institutions and can only be purchased and redeemed at par. For the six months ended June 30, 2014, the Banks received dividend income of $18,000 on FHLB stock. For the six months ended June 30, 2013, the Banks did not receive any dividend income on FHLB stock.

Management periodically evaluates FHLB stock for impairment. Management’s determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position of the FHLB.

Previously, the Federal Housing Finance Agency (the FHFA), the FHLB of Seattle's primary regulator, determined that the FHLB of Seattle had a risk-based capital deficiency as of December 31, 2008, and required the FHLB to suspend future dividends and the repurchase and redemption of outstanding common stock. Subsequent improvement in the FHLB's operating performance and financial condition, however, led to a September 7, 2012 announcement by the FHLB that the FHFA now considers the FHLB of Seattle to be adequately capitalized. Dividends on, or repurchases of, the FHLB of Seattle stock continue to require the consent of the FHFA. Since the third quarter of 2012, the FHFA has approved the repurchase of portions of FHLB of Seattle stock in each subsequent quarter and since the third quarter of 2013 has approved the payment of cash dividends by the FHLB of Seattle in each subsequent quarter. The FHLB repurchased $2.1 million of the Banks' stock during the quarter ending June 30, 2014. The FHLB of Seattle announced on July 29, 2014 that, based on second quarter 2014 financial results, its Board of Directors had declared a $0.025 per share cash dividend. This is the fourth dividend received since dividends recommenced in the third quarter of 2013. Even though the payment of dividends and stock repurchases have resumed, the Company will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of Banner's investment. Based on the above, the Company has determined there is no impairment on the FHLB stock investment as of June 30, 2014.

Note 7: LOANS RECEIVABLE AND THE ALLOWANCE FOR LOAN LOSSES

The Banks originate residential mortgage loans for both portfolio investment and sale in the secondary market. At the time of origination, mortgage loans are designated as held for sale or held for investment. Loans held for sale are stated at the lower of cost or estimated market value determined on an aggregate basis. Net unrealized losses on loans held for sale are recognized through a valuation allowance by charges to income. The Banks also originate construction, land and land development, commercial and multifamily real estate, commercial business, agricultural business and consumer loans for portfolio investment. Loans receivable not designated as held for sale are recorded at the principal amount outstanding, net of deferred fees and origination costs, and discounts and premiums. Premiums, discounts and deferred loan fees and origination costs are amortized to maturity using the level-yield methodology.

Interest is accrued as earned unless management doubts the collectability of the loan or the unpaid interest. Interest accruals are generally discontinued when loans become 90 days past due for scheduled interest payments. All previously accrued but uncollected interest is deducted from interest income upon transfer to nonaccrual status. Future collection of interest is included in interest income based upon an assessment of the likelihood that the loans will be repaid or recovered. A loan may be put on nonaccrual status sooner than this policy would dictate if, in management’s judgment, the loan may be uncollectable. Such interest is then recognized as income only if it is ultimately collected.

Loans receivable, including loans held for sale, at June 30, 2014, December 31, 2013 and June 30, 2013 are summarized as follows (dollars in thousands):



	June 30, 2014					December 31, 2013					June 30, 2013
	Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
Commercial real estate:
Owner-occupied	$	541,558		14.4	%	$	502,601		14.7	%	$	500,812		15.2	%
Investment properties	807,499			21.5		692,457			20.3		595,896			18.1
Multifamily real estate	188,792			5.0		137,153			4.0		137,027			4.2
Commercial construction	12,638			0.3		12,168			0.4		25,629			0.8
Multifamily construction	39,864			1.1		52,081			1.5		39,787			1.2
One- to four-family construction	213,414			5.7		200,864			5.8		191,003			5.8
Land and land development:
Residential	73,030			1.9		75,695			2.2		86,037			2.6
Commercial	10,679			0.3		10,450			0.3		11,228			0.3
Commercial business	735,128			19.5		682,169			20.0		639,840			19.5
Agricultural business, including secured by farmland	245,742			6.5		228,291			6.7		233,967			7.1
One- to four-family residential	558,744			14.9		529,494			15.5		552,698			16.8
Consumer:
Consumer secured by one- to four-family	209,511			5.6		173,188			5.1		163,339			5.0
Consumer-other	126,000			3.3		121,834			3.5		112,938			3.4
Total loans outstanding	3,762,599			100.0	%	3,418,445			100.0	%	3,290,201			100.0	%
Less allowance for loan losses	(74,310		)			(74,258		)			(76,121		)
Net loans	$	3,688,289				$	3,344,187				$	3,214,080

Loan amounts are net of unearned loan fees in excess of unamortized costs of $8.4 million as of June 30, 2014, $8.3 million as of December 31, 2013 and $8.9 million as of June 30, 2013.

The Company’s total loans by geographic concentration at June 30, 2014 were as follows (dollars in thousands):



	Washington			Oregon			Idaho			Other			Total
Commercial real estate:
Owner-occupied	$	388,662		$	85,787		$	54,529		$	12,580		$	541,558
Investment properties	535,393			116,493			59,700			95,913			807,499
Multifamily real estate	146,291			27,175			14,932			394			188,792
Commercial construction	11,770			—			868			—			12,638
Multifamily construction	33,454			6,410			—			—			39,864
One- to four-family construction	127,627			83,832			1,955			—			213,414
Land and land development:
Residential	40,492			31,358			1,180			—			73,030
Commercial	5,163			2,605			2,911			—			10,679
Commercial business	397,570			120,286			66,940			150,332			735,128
Agricultural business, including secured by farmland	134,477			59,120			52,145			—			245,742
One- to four-family residential	332,850			202,853			22,025			1,016			558,744
Consumer:
Consumer secured by one- to four-family	125,888			68,272			14,314			1,037			209,511
Consumer—other	81,884			37,708			6,000			408			126,000
Total loans	$	2,361,521		$	841,899		$	297,499		$	261,680		$	3,762,599
Percent of total loans	62.7		%	22.4		%	7.9		%	7.0		%	100.0		%

The geographic concentrations of the Company’s land and land development loans by state at June 30, 2014 were as follows (dollars in thousands):



	Washington			Oregon			Idaho			Total
Residential:
Acquisition and development	$	15,752		$	13,457		$	983		$	30,192
Improved land and lots	19,261			17,289			197			36,747
Unimproved land	5,479			612			—			6,091
Commercial:
Acquisition and development	—			—			—			—
Improved land and lots	2,913			500			1,785			5,198
Unimproved land	2,250			2,105			1,126			5,481
Total land and land development loans	$	45,655		$	33,963		$	4,091		$	83,709
Percent of land and land development loans	54.5		%	40.6		%	4.9		%	100.0		%

The Company originates both adjustable- and fixed-rate loans. The maturity and repricing composition of those loans, less undisbursed amounts and deferred fees and origination costs, at June 30, 2014, December 31, 2013 and June 30, 2013 were as follows (in thousands):



	June 30, 2014		December 31, 2013		June 30, 2013
Fixed-rate (term to maturity):
Maturing in one year or less	$	122,304	$	122,313	$	145,221
Maturing after one year through three years	148,398		143,322		167,187
Maturing after three years through five years	195,309		187,279		201,672
Maturing after five years through ten years	222,369		209,869		192,594
Maturing after ten years	511,972		439,004		425,603
Total fixed-rate loans	1,200,352		1,101,787		1,132,277
Adjustable-rate (term to rate adjustment):
Maturing or repricing in one year or less	1,510,684		1,390,579		1,292,387
Maturing or repricing after one year through three years	372,477		279,791		266,841
Maturing or repricing after three years through five years	568,997		541,529		526,563
Maturing or repricing after five years through ten years	108,989		99,503		69,797
Maturing or repricing after ten years	1,100		5,256		2,336
Total adjustable-rate loans	2,562,247		2,316,658		2,157,924
Total loans	$	3,762,599	$	3,418,445	$	3,290,201

The adjustable-rate loans have interest rate adjustment limitations and are generally indexed to various prime or London Inter-bank Offering Rate (LIBOR) rates, One to Five Year Constant Maturity Treasury Indices or FHLB advance rates. Future market factors may affect the correlation of the interest rate adjustment with the rates the Banks pay on the short-term deposits that were primarily utilized to fund these loans.

Impaired Loans and the Allowance for Loan Losses. A loan is considered impaired when, based on current information and circumstances, the Company determines it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. Impaired loans are comprised of loans on nonaccrual, troubled debt restructurings (TDRs) that are performing under their restructured terms, and loans that are 90 days or more past due, but are still on accrual.

Troubled Debt Restructures. Some of the Company’s loans are reported as TDRs. Loans are reported as TDRs when the bank grants one or more concessions to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. Our TDRs have generally not involved forgiveness of amounts due, but almost always include a modification of multiple factors; the most common combination includes interest rate, payment amount and maturity date. As a result of these concessions, restructured loans are impaired as the Company will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement. Loans identified as TDRs are accounted for in accordance with the Company's impaired loan accounting policies.

The amount of impaired loans and the related allocated reserve for loan losses as of June 30, 2014 and December 31, 2013 were as follows (in thousands):



	June 30, 2014				December 31, 2013
	Loan Amount		Allocated Reserves		Loan Amount		Allocated Reserves
Impaired loans:
Nonaccrual loans
Commercial real estate:
Owner-occupied	$	2,381	$	36	$	2,466	$	31
Investment properties	311		62		3,821		89
Multifamily real estate	422		60		—		—
One- to four-family construction	—		—		269		—
Land and land development:
Residential	1,296		176		924		6
Commercial business	925		69		724		104
Agricultural business, including secured by farmland	104		6		—		—
One- to four-family residential	9,354		53		12,532		250
Consumer:
Consumer secured by one- to four-family	1,024		49		903		13
Consumer—other	181		—		269		1
Total nonaccrual loans	15,998		511		21,908		494

Loans 90 days or more past due and still accruing
Commercial real estate:
Owner-occupied	993		1		—		—
Commercial business	280		6		—		—
Agricultural business, including secured by farmland	—		—		105		8
One- to four-family residential	2,181		11		2,611		16
Consumer:
Consumer secured by one- to four-family	6		—		13		—
Consumer—other	287		—		131		1
Total loans past due and still accruing	3,747		18		2,860		25

Troubled debt restructuring on accrual status:
Commercial real estate:
Owner-occupied	184		4		186		4
Investment properties	6,101		747		5,367		415
Multifamily real estate	5,705		850		5,744		1,139
One- to four-family construction	4,831		656		6,864		1,002
Land and land development:
Residential	1,638		459		4,061		754
Commercial business	989		163		1,299		222
One- to four-family residential	17,521		1,131		23,302		1,355
Consumer:
Consumer secured by one- to four-family	259		28		360		33
Consumer—other	233		33		245		34
Total troubled debt restructurings on accrual status	37,461		4,071		47,428		4,958
Total impaired loans	$	57,206	$	4,600	$	72,196	$	5,477

As of June 30, 2014 and December 31, 2013, the Company had commitments to advance funds up to an additional amount of $731,000 and $225,000, respectively, related to TDRs.

The following tables provide additional information on impaired loans with and without specific allowance reserves at or for the six months ended June 30, 2014 and at or for the year ended December 31, 2013 (in thousands):



	At or For the Six Months Ended June 30, 2014
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Without a specific allowance reserve ⁽¹⁾
Commercial real estate:
Owner-occupied	$	1,599	$	1,649	$	37	$	1,604	$	18
Investment properties	311		857		62		334		—
Multifamily real estate	422		422		60		433		—
Commercial business	1,205		1,571		75		1,299		5
Agricultural business/farmland	104		104		6		104		—
One- to four-family residential	7,923		8,395		26		7,804		13
Consumer:
Consumer secured by one- to four-family	663		676		11		672		—
Consumer—other	348		352		—		354		4
	12,575		14,026		277		12,604		40
With a specific allowance reserve ⁽²⁾
Commercial real estate:
Owner-occupied	1,959		1,959		4		2,070		6
Investment properties	6,101		6,506		747		6,147		160
Multifamily real estate	5,705		5,705		850		5,719		127
One- to-four family construction	4,831		4,831		656		4,592		103
Land and land development:
Residential	2,934		4,089		635		2,943		46
Commercial business	989		989		162		1,035		28
One- to four-family residential	21,133		21,892		1,170		21,870		453
Consumer:
Consumer secured by one- to four-family	627		627		66		677		9
Consumer—other	352		369		33		360		11
	44,631		46,967		4,323		45,413		943
Total
Commercial real estate:
Owner-occupied	3,558		3,608		41		3,674		24
Investment properties	6,412		7,363		809		6,481		160
Multifamily real estate	6,127		6,127		910		6,152		127
One- to four-family construction	4,831		4,831		656		4,592		103
Land and land development:
Residential	2,934		4,089		635		2,943		46
Commercial business	2,194		2,560		237		2,334		33
Agricultural business/farmland	104		104		6		104		—
One- to four-family residential	29,056		30,287		1,196		29,674		466
Consumer:
Consumer secured by one- to four-family	1,290		1,303		77		1,349		9
Consumer—other	700		721		33		714		15
	$	57,206	$	60,993	$	4,600	$	58,017	$	983



	At or For the Year Ended December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Without a specific allowance reserve ⁽¹⁾
Commercial real estate:
Owner-occupied	$	534	$	584	$	31	$	569	$	—
Investment properties	429		974		89		624		—
Commercial business	724		1,040		104		896		—
Agricultural business/farmland	105		105		8		110		8
One- to four-family residential	8,611		9,229		42		8,889		31
Consumer:
Consumer secured by one- to four-family	870		1,013		13		900		1
Consumer—other	276		285		2		287		8
	11,549		13,230		289		12,275		48
With a specific allowance reserve ⁽²⁾
Commercial real estate:
Owner-occupied	2,118		2,118		4		2,192		12
Investment properties	8,759		10,395		415		8,353		241
Multifamily real estate	5,744		5,744		1,139		5,705		298
One- to-four family construction	7,133		7,213		1,002		5,870		239
Land and land development:
Residential	4,985		6,140		760		6,053		221
Commercial business	1,298		1,298		222		1,340		59
One- to four-family residential	29,834		31,440		1,579		31,668		1,032
Consumer:
Consumer secured by one- to four-family	406		407		33		503		24
Consumer—other	370		386		34		390		21
	60,647		65,141		5,188		62,074		2,147
Total
Commercial real estate
Owner-occupied	2,652		2,702		35		2,761		12
Investment properties	9,188		11,369		504		8,977		241
Multifamily real estate	5,744		5,744		1,139		5,705		298
One- to four-family construction	7,133		7,213		1,002		5,870		239
Land and land development
Residential	4,985		6,140		760		6,053		221
Commercial business	2,022		2,338		326		2,236		59
Agricultural business/farmland	105		105		8		110		8
One- to four-family residential	38,445		40,669		1,621		40,557		1,063
Consumer
Consumer secured by one- to four-family	1,276		1,420		46		1,403		25
Consumer—other	646		671		36		677		29
	$	72,196	$	78,371	$	5,477	$	74,349	$	2,195


⁽¹⁾	Loans without a specific allowance reserve have not been individually evaluated for impairment, but have been included in pools of homogeneous loans for evaluation of related allowance reserves.

⁽²⁾

Loans with a specific allowance reserve have been individually evaluated for impairment using either a discounted cash flow analysis or, for collateral dependent loans, current appraisals to establish realizable value. These analyses may identify a specific impairment amount needed or may conclude that no reserve is needed. Any specific impairment that is identified is included in the category’s Related Allowance column.

The following tables present TDRs at June 30, 2014 and December 31, 2013 (in thousands):



	June 30, 2014
	Accrual Status		Nonaccrual Status		Total TDRs
Commercial real estate:
Owner-occupied	$	184	$	710	$	894
Investment properties	6,101		45		6,146
Multifamily real estate	5,705		—		5,705
One- to four-family construction	4,831		—		4,831
Land and land development:
Residential	1,638		546		2,184
Commercial business	989		123		1,112
One- to four-family residential	17,521		2,211		19,732
Consumer:
Consumer secured by one- to four-family	259		168		427
Consumer—other	233		119		352
	$	37,461	$	3,922	$	41,383



	December 31, 2013
	Accrual Status		Nonaccrual Status		Total TDRs
Commercial real estate:
Owner-occupied	$	186	$	613	$	799
Investment properties	5,367		1,630		6,997
Multifamily real estate	5,744		—		5,744
One- to four-family construction	6,864		269		7,133
Land and land development:
Residential	4,061		174		4,235
Commercial business	1,299		164		1,463
One- to four-family residential	23,302		2,474		25,776
Consumer:
Consumer secured by one- to four-family	360		252		612
Consumer—other	245		123		368
	$	47,428	$	5,699	$	53,127

The following tables present new TDRs that occurred during the three and six months ended June 30, 2014 and 2013 (dollars in thousands):



	Three Months Ended June 30, 2014					Six Months Ended June 30, 2014
	Number of Contracts	Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Contracts	Pre- modification Outstanding Recorded Investment		Post- modification Outstanding Recorded Investment
Recorded Investment ^{(1) (2)}
Commercial real estate
Owner occupied	—	$	—	$	—	1	$	94	$	94
One- to four-family construction	4	980		980		4	980		980
Commercial business	—	—		—		1	100		100
	4	$	980	$	980	6	$	1,174	$	1,174

	Three Months Ended June 30, 2013					Six Months Ended June 30, 2013
	Number of Contracts	Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Contracts	Pre- modification Outstanding Recorded Investment		Post- modification Outstanding Recorded Investment
Recorded Investment ^{(1) (2)}
Commercial real estate
Investment properties	1	$	900	$	781	1	$	900	$	781
Multifamily real estate	1	378		378		1	378		378
Land and land development—residential	5	521		521		9	1,597		1,597
One- to four-family residential	—	—		—		9	3,115		3,115
	7	$	1,799	$	1,680	20	$	5,990	$	5,871


⁽¹⁾	Since most loans were already considered classified and/or on nonaccrual status prior to restructuring, the modifications did not have a material effect on the Company’s determination of the allowance for loan losses.


⁽²⁾	The majority of these modifications do not fit into one separate type, such as rate, term, amount, interest-only or payment, but instead are a combination of multiple types of modifications; therefore, they are disclosed in aggregate.

The following table presents TDRs which incurred a payment default within twelve months of the restructure date during the three and six month periods ended June 30, 2014 and 2013 (in thousands). A default on a TDR results in either a transfer to nonaccrual status or a partial charge-off:



	Three Months Ended June 30				Six Months Ended June 30
	2014		2013		2014		2013
Commercial business	$	—	$	—	$	—	$	343
Total	$	—	$	—	$	—	$	343

Credit Quality Indicators: To appropriately and effectively manage the ongoing credit quality of the Company’s loan portfolio, management has implemented a risk-rating or loan grading system for its loans. The system is a tool to evaluate portfolio asset quality throughout each applicable loan’s life as an asset of the Company. Generally, loans and leases are risk rated on an aggregate borrower/relationship basis with individual loans sharing similar ratings. There are some instances when specific situations relating to individual loans will provide the basis for different risk ratings within the aggregate relationship. Loans are graded on a scale of 1 to 9. A description of the general characteristics of these categories is shown below:

Overall Risk Rating Definitions: Risk-ratings contain both qualitative and quantitative measurements and take into account the financial strength of a borrower and the structure of the loan or lease. Consequently, the definitions are to be applied in the context of each lending transaction and judgment must also be used to determine the appropriate risk rating, as it is not unusual for a loan or lease to exhibit characteristics of more than one risk-rating category. Consideration for the final rating is centered in the borrower’s ability to repay, in a timely fashion, both principal and interest. There were no material changes in the risk-rating or loan grading system in the six months ended June 30, 2014.

Risk Rating 1: Exceptional

A credit supported by exceptional financial strength, stability, and liquidity. The risk rating of 1 is reserved for the Company’s top quality loans, generally reserved for investment grade credits underwritten to the standards of institutional credit providers.

Risk Rating 2: Excellent

A credit supported by excellent financial strength, stability and liquidity. The risk rating of 2 is reserved for very strong and highly stable customers with ready access to alternative financing sources.

Risk Rating 3: Strong

A credit supported by good overall financial strength and stability. Collateral margins are strong; cash flow is stable although susceptible to cyclical market changes.

Risk Rating 4: Acceptable

A credit supported by the borrower’s adequate financial strength and stability. Assets and cash flow are reasonably sound and provide for orderly debt reduction. Access to alternative financing sources will be more difficult to obtain.

Risk Rating 5: Watch

A credit with the characteristics of an acceptable credit which requires, however, more than the normal level of supervision and warrants formal quarterly management reporting. Credits in this category are not yet criticized or classified, but due to adverse events or aspects of underwriting require closer than normal supervision. Generally, credits should be watch credits in most cases for six months or less as the impact of stress factors are analyzed.

Risk Rating 6: Special Mention

A credit with potential weaknesses that deserves management’s close attention is risk rated a 6. If left uncorrected, these potential weaknesses will result in deterioration in the capacity to repay debt. A key distinction between Special Mention and Substandard is that in a Special Mention credit, there are identified weaknesses that pose potential risk(s) to the repayment sources, versus well defined weaknesses that pose risk(s) to the repayment sources. Assets in this category are expected to be in this category no more than 9-12 months as the potential weaknesses in the credit are resolved.

Risk Rating 7: Substandard

A credit with well defined weaknesses that jeopardize the ability to repay in full is risk rated a 7. These credits are inadequately protected by either the sound net worth and payment capacity of the borrower or the value of pledged collateral. These are credits with a distinct possibility of loss. Loans headed for foreclosure and/or legal action due to deterioration are rated 7 or worse.

Risk Rating 8: Doubtful

A credit with an extremely high probability of loss is risk rated 8. These credits have all the same critical weaknesses that are found in a substandard loan; however, the weaknesses are elevated to the point that based upon current information, collection or liquidation in full is improbable. While some loss on doubtful credits is expected, pending events may strengthen a credit making the amount and timing of any loss indeterminable. In these situations taking the loss is inappropriate until it is clear that the pending event has failed to strengthen the credit and improve the capacity to repay debt.

Risk Rating 9: Loss

A credit that is considered to be currently uncollectible or of such little value that it is no longer a viable Bank asset is risk rated 9. Losses should be taken in the accounting period in which the credit is determined to be uncollectible. Taking a loss does not mean that a credit has absolutely no recovery or salvage value but, rather, it is not practical or desirable to defer writing off the credit, even though partial recovery may occur in the future.

The following table shows the Company’s portfolio of risk-rated loans and non-risk-rated loans by grade or other characteristics as of June 30, 2014 and December 31, 2013 (in thousands):



	June 30, 2014
	Commercial Real Estate		Multifamily		Construction and Land		Commercial Business		Agricultural Business		One- to Four-Family		Consumer		Total Loans
Risk-rated loans:
Pass (Risk Ratings 1-5) ⁽¹⁾	$	1,316,537	$	182,634	$	331,354	$	717,421	$	244,510	$	545,231	$	332,059	$	3,669,746
Special mention	5,623		—		—		8,188		578		64		134		14,587
Substandard	26,453		6,158		18,271		9,511		654		13,449		3,306		77,802
Doubtful	444		—		—		8		—		—		12		464
Loss	—		—		—		—		—		—		—		—
Total loans	$	1,349,057	$	188,792	$	349,625	$	735,128	$	245,742	$	558,744	$	335,511	$	3,762,599

Performing loans	$	1,345,372	$	188,370	$	348,329	$	733,923	$	245,638	$	547,209	$	334,013	$	3,742,854
Non-performing loans ⁽²⁾	3,685		422		1,296		1,205		104		11,535		1,498		19,745
Total loans	$	1,349,057	$	188,792	$	349,625	$	735,128	$	245,742	$	558,744	$	335,511	$	3,762,599

	December 31, 2013
	Commercial Real Estate		Multifamily		Construction and Land		Commercial Business		Agricultural Business		One- to Four-Family		Consumer		Total Loans
Risk-rated loans:
Pass (Risk Ratings 1-5) ⁽¹⁾	$	1,160,921	$	131,523	$	332,150	$	655,007	$	225,329	$	511,967	$	291,992	$	3,308,889
Special mention	6,614		—		350		10,484		561		—		106		18,115
Substandard	26,979		5,630		18,758		16,669		2,401		17,527		2,924		90,888
Doubtful	544		—		—		9		—		—		—		553
Loss	—		—		—		—		—		—		—		—
Total loans	$	1,195,058	$	137,153	$	351,258	$	682,169	$	228,291	$	529,494	$	295,022	$	3,418,445

Performing loans	$	1,188,771	$	137,153	$	350,065	$	681,445	$	228,187	$	514,351	$	293,705	$	3,393,677
Non-performing loans ⁽²⁾	6,287		—		1,193		724		104		15,143		1,317		24,768
Total loans	$	1,195,058	$	137,153	$	351,258	$	682,169	$	228,291	$	529,494	$	295,022	$	3,418,445

⁽¹⁾

The Pass category includes some performing loans that are part of homogenous pools which are not individually risk-rated. This includes all consumer loans, all one- to four-family residential loans and, as of June 30, 2014 and December 31, 2013, in the commercial business category, $103 million and $94 million, respectively, of credit-scored small business loans. As loans in these pools become non-performing, they are individually risk-rated.


⁽²⁾	Non-performing loans include non-accrual loans and loans past due greater than 90 days and on accrual status.

The following tables provide additional detail on the age analysis of the Company’s past due loans as of June 30, 2014 and December 31, 2013 (in thousands):



	June 30, 2014
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Loans 90 Days or More Past Due and Accruing
Commercial real estate:
Owner-occupied	$	2,896	$	18	$	1,437	$	4,351	$	537,207	$	541,558	$	993
Investment properties	—		—		—		—		807,499		807,499		—
Multifamily real estate	423		—		—		423		188,369		188,792		—
Commercial construction	—		—		—		—		12,638		12,638		—
Multifamily construction	—		—		—		—		39,864		39,864		—
One-to-four-family construction	—		—		—		—		213,414		213,414		—
Land and land development:
Residential	—		—		—		—		73,030		73,030		—
Commercial	—		—		—		—		10,679		10,679		—
Commercial business	673		209		1,622		2,504		732,624		735,128		280
Agricultural business, including secured by farmland	12		250		104		366		245,376		245,742		—
One- to four-family residential	484		2,720		7,552		10,756		547,988		558,744		2,181
Consumer:
Consumer secured by one- to four-family	182		757		474		1,413		208,098		209,511		6
Consumer—other	545		75		287		907		125,093		126,000		287
Total	$	5,215	$	4,029	$	11,476	$	20,720	$	3,741,879	$	3,762,599	$	3,747



	December 31, 2013
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Loans 90 Days or More Past Due and Accruing
Commercial real estate:
Owner-occupied	$	883	$	550	$	813	$	2,246	$	500,355	$	502,601	$	—
Investment properties	—		—		—		—		692,457		692,457		—
Multifamily real estate	1,845		785		—		2,630		134,523		137,153		—
Commercial construction	—		—		—		—		12,168		12,168		—
Multifamily construction	—		—		—		—		52,081		52,081		—
One-to-four-family construction	9		7		4		20		200,844		200,864		—
Land and land development:
Residential	—		—		251		251		75,444		75,695		—
Commercial	—		—		—		—		10,450		10,450		—
Commercial business	2,001		2		299		2,302		679,867		682,169		—
Agricultural business, including secured by farmland	—		—		—		—		228,291		228,291		105
One-to four-family residential	521		2,550		9,142		12,213		517,281		529,494		2,611
Consumer:
Consumer secured by one- to four-family	723		93		918		1,734		171,454		173,188		13
Consumer—other	384		99		131		614		121,220		121,834		131
Total	$	6,366	$	4,086	$	11,558	$	22,010	$	3,396,435	$	3,418,445	$	2,860

The following tables provide additional information on the allowance for loan losses and loan balances individually and collectively evaluated for impairment at or for the three and six months ended June 30, 2014 and 2013 (in thousands):



	For the Three Months Ended June 30, 2014
	Commercial Real Estate			Multifamily		Construction and Land			Commercial Business			Agricultural Business			One- to Four-Family			Consumer			Unallocated			Total
Allowance for loan losses:
Beginning balance	$	17,412		$	5,652	$	18,620		$	11,363		$	2,636		$	10,913		$	912		$	6,863		$	74,371
Provision for loan losses	2,199			113		(1,048		)	625			(123		)	(1,833		)	(38		)	105			—
Recoveries	274			—		472			286			311			204			58			—			1,605
Charge-offs	(1,001		)	—		(207		)	(260		)	—			(14		)	(184		)	—			(1,666		)
Ending balance	$	18,884		$	5,765	$	17,837		$	12,014		$	2,824		$	9,270		$	748		$	6,968		$	74,310

	For the Six Months Ended June 30, 2014
	Commercial Real Estate			Multifamily		Construction and Land			Commercial Business			Agricultural business			One- to Four- Family			Consumer			Unallocated			Total
Allowance for loan losses:
Beginning balance	$	16,759		$	5,306	$	17,640		$	11,773		$	2,841		$	11,486		$	1,335		$	7,118		$	74,258
Provision for loan losses	2,794			459		(300		)	660			(678		)	(2,215		)	(570		)	(150		)	—
Recoveries	570			—		704			579			661			392			340			—			3,246
Charge-offs	(1,239		)	—		(207		)	(998		)	—			(393		)	(357		)	—			(3,194		)
Ending balance	$	18,884		$	5,765	$	17,837		$	12,014		$	2,824		$	9,270		$	748		$	6,968		$	74,310



	At June 30, 2014
	Commercial Real Estate		Multifamily		Construction and Land		Commercial Business		Agricultural Business		One- to Four-Family		Consumer		Unallocated		Total
Allowance individually evaluated for impairment	$	751	$	850	$	1,291	$	162	$	—	$	1,170	$	99	$	—	$	4,323
Allowance collectively evaluated for impairment	18,133		4,915		16,546		11,852		2,824		8,100		649		6,968		69,987
Total allowance for loan losses	$	18,884	$	5,765	$	17,837	$	12,014	$	2,824	$	9,270	$	748	$	6,968	$	74,310



	At June 30, 2014
	Commercial Real Estate		Multifamily		Construction and Land		Commercial Business		Agricultural Business		One- to Four-Family		Consumer		Unallocated		Total
Loan balances:
Loans individually evaluated for impairment	$	8,060	$	5,705	$	7,765	$	989	$	—	$	21,133	$	979	$	—	$	44,631
Loans collectively evaluated for impairment	1,340,997		183,087		341,860		734,139		245,742		537,611		334,532		—		3,717,968
Total loans	$	1,349,057	$	188,792	$	349,625	$	735,128	$	245,742	$	558,744	$	335,511	$	—	$	3,762,599



	For the Three Months Ended June 30, 2013
	Commercial Real Estate			Multifamily			Construction and Land			Commercial Business			Agricultural Business		One- to Four-Family			Consumer			Unallocated			Total
Allowance for loan losses:
Beginning balance	$	14,776		$	5,075		$	15,214		$	10,011		$	2,282	$	15,930		$	1,238		$	11,870		$	76,396
Provision for loan losses	162			(102		)	1,493			527			1,213		(557		)	105			(2,841		)	—
Recoveries	378			—			337			666			310		3			117			—			1,811
Charge-offs	(418		)	—			(419		)	(398		)	—		(402		)	(449		)	—			(2,086		)
Ending balance	$	14,898		$	4,973		$	16,625		$	10,806		$	3,805	$	14,974		$	1,011		$	9,029		$	76,121

	For the Six Months Ended June 30, 2013
	Commercial Real Estate			Multifamily			Construction and Land			Commercial Business			Agricultural business		One- to Four- Family			Consumer			Unallocated			Total
Allowance for loan losses:
Beginning balance	$	15,322		$	4,506		$	14,991		$	9,957		$	2,295	$	16,475		$	1,348		$	11,865		$	76,759
Provision for loan losses	(1,622		)	467			2,050			1,124			1,163		(567		)	221			(2,836		)	—
Recoveries	1,964			—			438			1,052			347		119			219			—			4,139
Charge-offs	(766		)	—			(854		)	(1,327		)	—		(1,053		)	(777		)	—			(4,777		)
Ending balance	$	14,898		$	4,973		$	16,625		$	10,806		$	3,805	$	14,974		$	1,011		$	9,029		$	76,121



	At June 30, 2013
	Commercial Real Estate		Multifamily		Construction and Land		Commercial Business		Agricultural Business		One- to Four-Family		Consumer		Unallocated		Total
Allowance individually evaluated for impairment	$	750	$	1,326	$	1,955	$	216	$	—	$	1,923	$	84	$	—	$	6,254
Allowance collectively evaluated for impairment	14,148		3,647		14,670		10,590		3,805		13,051		927		9,029		69,867
Total allowance for loan losses	$	14,898	$	4,973	$	16,625	$	10,806	$	3,805	$	14,974	$	1,011	$	9,029	$	76,121



	At June 30, 2013
	Commercial Real Estate		Multifamily		Construction and Land		Commercial Business		Agricultural Business		One- to Four-Family		Consumer		Unallocated		Total
Loan balances:
Loans individually evaluated for impairment	$	10,647	$	5,815	$	12,723	$	2,818	$	—	$	29,419	$	1,066	$	—	$	62,488
Loans collectively evaluated for impairment	1,086,061		131,212		340,961		637,022		233,967		523,279		275,211		—		3,227,713
Total loans	$	1,096,708	$	137,027	$	353,684	$	639,840	$	233,967	$	552,698	$	276,277	$	—	$	3,290,201

Note 8: REAL ESTATE OWNED, NET

The following table presents the changes in REO for the three and six months ended June 30, 2014 and 2013 (in thousands):



	Three Months Ended June 30						Six Months Ended June 30
	2014			2013			2014			2013
Balance, beginning of the period	$	3,236		$	11,160		$	4,044		$	15,778
Additions from loan foreclosures	1,996			418			2,703			1,504
Additions from capitalized costs	33			—			37			46
Proceeds from dispositions of REO	(1,034		)	(5,305		)	(2,675		)	(11,787		)
Gain on sale of REO	157			667			316			1,472
Valuation adjustments in the period	—			(226		)	(37		)	(299		)
Balance, end of the period	$	4,388		$	6,714		$	4,388		$	6,714

The following table shows REO by type and geographic location by state as of June 30, 2014 (in thousands):



	Washington		Oregon		Idaho		Total
Commercial real estate	$	—	$	—	$	175	$	175
Land development—residential	614		1,637		32		2,283
One- to four-family real estate	1,187		743		—		1,930
Balance, end of period	$	1,801	$	2,380	$	207	$	4,388

REO properties are recorded at the lower of the estimated fair value of the property, less expected selling costs, or the carrying value of the defaulted loan, establishing a new cost basis. Subsequently, REO properties are carried at the lower of the new cost basis or updated fair market values, based on updated appraisals of the underlying properties, as received. Valuation allowances on the carrying value of REO may be recognized based on updated appraisals or on management’s authorization to reduce the selling price of a property.

Note 9: INTANGIBLE ASSETS AND MORTGAGE SERVICING RIGHTS

Intangible Assets: At June 30, 2014, intangible assets consisted primarily of core deposit intangibles (CDI), which are amounts recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the customer relationships associated with the deposits.

The Company amortizes CDI over their estimated useful life and reviews them at least annually for events or circumstances that could impair their value. The CDI assets shown in the table below represent the value ascribed to the long-term deposit relationships acquired in three separate bank acquisitions during 2007, a single branch acquisition in the quarter ended September 30, 2013, and the acquisition of six branches in the quarter ended June 30, 2014. These intangible assets are being amortized using an accelerated method over estimated useful lives of three to eight years. The CDI assets are not estimated to have a significant residual value.

The following table summarizes the changes in the Company’s core deposit intangibles for the six months ended June 30, 2014 and the year ended December 31, 2013 (in thousands):



	CDI
Balance, December 31, 2013	$	2,449
Additions through acquisitions	2,372
Amortization	(929		)
Balance, June 30, 2014	$	3,892



	CDI
Balance, December 31, 2012	$	4,230
Additions through acquisitions	160
Amortization	(1,941		)
Balance, December 31, 2013	$	2,449

The following table presents the estimated amortization expense with respect to intangibles for the periods indicated (in thousands):



	CDI
Remainder of 2014	$	1,061
2015	1,007
2016	353
2017	321
2018	296
Thereafter	854
	$	3,892

Mortgage Servicing Rights: Mortgage servicing rights are reported in other assets. Mortgage servicing rights are initially recorded at fair value and are amortized in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Mortgage servicing rights are subsequently evaluated for impairment based upon the fair value of the rights compared to the amortized cost (remaining unamortized initial fair value). If the fair value is less than the amortized cost, a valuation allowance is created through an impairment charge to servicing fee income. However, if the fair value is greater than the amortized cost, the amount above the amortized cost is not recognized in the carrying value. During the six months ended June 30, 2014, the Company did not record an impairment charge. During the six months ended June 30, 2013, the Company reversed $600,000 of valuation allowance for previously recorded impairment charges. Loans serviced for others totaled $1.190 billion and $1.116 billion at June 30, 2014 and December 31, 2013, respectively. Custodial accounts maintained in connection with this servicing totaled $6.3 million and $5.4 million at June 30, 2014 and December 31, 2013, respectively.

An analysis of our mortgage servicing rights, net of valuation allowances, for the three and six months ended June 30, 2014 and 2013 is presented below (in thousands):



	Three Months Ended June 30						Six Months Ended June 30
	2014			2013			2014			2013
Balance, beginning of the period	$	8,199		$	6,335		$	8,086		$	6,244
Amounts capitalized	794			807			1,369			1,583
Amortization ⁽¹⁾	(512		)	(706		)	(974		)	(1,391		)
Valuation adjustments in the period	—			600			—			600
Balance, end of the period ⁽²⁾	$	8,481		$	7,036		$	8,481		$	7,036


⁽¹⁾	Amortization of mortgage servicing rights is recorded as a reduction of loan servicing income and any unamortized balance is fully written off if the loan repays in full.


⁽²⁾	There was no valuation allowance as of June 30, 2014 and a $700,000 valuation allowance as of June 30, 2013.

Note 10: DEPOSITS AND RETAIL REPURCHASE AGREEMENTS

Deposits consisted of the following at June 30, 2014 and December 31, 2013 (dollars in thousands):



	June 30, 2014				December 31, 2013
	Amount		Percent of Total		Amount		Percent of Total
Non-interest-bearing accounts	$	1,210,068	30.9	%	$	1,115,346	30.8	%
Interest-bearing checking	437,810		11.2		422,910		11.7
Regular savings accounts	843,950		21.5		798,764		22.1
Money market accounts	490,105		12.5		408,211		11.3
Total transaction and saving accounts	2,981,933		76.1		2,745,231		75.9
Certificates of deposit	936,986		23.9		872,695		24.1
Total deposits	$	3,918,919	100.0	%	$	3,617,926	100.0	%
Included in total deposits:
Public fund transaction accounts	$	93,550	2.4	%	$	87,521	2.4	%
Public fund interest-bearing certificates	48,180		1.2		51,465		1.4
Total public deposits	$	141,730	3.6	%	$	138,986	3.8	%
Total brokered deposits	$	88,209	2.3	%	$	4,291	0.1	%

Certificate of deposit accounts by total balance at June 30, 2014 and December 31, 2013 were as follows (in thousands):



	June 30, 2014		December 31, 2013
Certificates of deposit less than $100,000	$	467,058	$	386,745
Certificates of deposit $100,000 through $250,000	301,075		308,130
Certificates of deposit more than $250,000	168,853		177,820
Total certificates of deposit	$	936,986	$	872,695

Scheduled maturities and repricing of certificate accounts at June 30, 2014 and December 31, 2013 (in thousands):



	June 30, 2014		December 31, 2013
Certificates which mature or reprice:
Within one year or less	$	709,335	$	660,394
After one year through two years	135,677		117,789
After two years through three years	45,403		47,362
After three years through four years	24,414		26,443
After four years through five years	16,991		17,075
After five years	5,166		3,632
Total certificates of deposit	$	936,986	$	872,695

The following table presents the geographic concentration of deposits at June 30, 2014 (dollars in thousands):



	Washington			Oregon			Idaho			Total
Total deposits	$	2,835,383		$	848,991		$	234,545		$	3,918,919
Percent of total deposits	72.3		%	21.7		%	6.0		%	100.0		%

In addition to deposits, the banks also offer retail repurchase agreements which are customer funds that are primarily associated with sweep account arrangements tied to transaction deposit accounts. While the banks include these collateralized borrowings in other borrowings reported in our Consolidated Statements of Financial Condition, these accounts primarily represent customer utilization of our cash management services and related deposit accounts.

The following table presents retail repurchase agreement balances as of June 30, 2014, December 31, 2013 and June 30, 2013 (in thousands):



	June 30, 2014		December 31, 2013		June 30, 2013
Retail repurchase agreements	$	88,946	$	83,056	$	90,779

Note 11: FAIR VALUE ACCOUNTING AND MEASUREMENT

The Company measures and discloses certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (that is, not a forced liquidation or distressed sale). GAAP (ASC 820, Fair Value Measurements) establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the accounting standard requires the reporting entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy:


•	Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.


•	Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data.

•

Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs from non-binding single dealer quotes not corroborated by observable market data.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for certain financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Transfers between levels of the fair value hierarchy are deemed to occur at the end of the reporting period.

Items Measured at Fair Value on a Recurring Basis:

Banner records trading account securities, securities available-for-sale, FHLB advances, junior subordinated debentures and certain derivative transactions at fair value on a recurring basis.


•	The securities assets primarily consist of U.S. Government and agency obligations, municipal bonds, corporate bonds, single issue trust preferred securities (TPS), pooled trust preferred collateralized debt obligation securities (TRUP CDO), mortgage-backed securities, asset-backed securities, equity securities and certain other financial instruments.

From mid-2008 through the current quarter, the lack of active markets and market participants for certain securities resulted in an increase in Level 3 measurements. In particular, the market for our TRUP CDO securities has been generally inactive during this period. This was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which TRUP CDOs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market also has been inactive as almost no new TRUP CDOs have been issued since 2007. There are still very few market participants who are willing and/or able to transact for these securities. Thus, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issuer or of the fair value of the security. As of June 30, 2014, Banner owned $31 million in par value of these securities.

Given these conditions in the debt markets and the absence of observable transactions in the secondary and new issue markets, management determined that for the TRUP CDOs at June 30, 2014 and December 31, 2013:


•	The few observable transactions and market quotations that were available were not reliable for purposes of determining fair value,


•	An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs was equally or more representative of fair value than the market approach valuation technique, and


•	The Company’s TRUP CDOs should be classified exclusively within Level 3 of the fair value hierarchy because of the significant assumptions required to determine fair value at the measurement date.

The TRUP CDO valuations were derived using input from independent third parties who used proprietary cash flow models for analyzing collateralized debt obligations. Their approaches to determining fair value involve considering the credit quality of the collateral, assuming a level of defaults based on the probability of default of each underlying trust preferred security, creating expected cash flows for each TRUP CDO security and discounting that cash flow at an appropriate risk-adjusted rate plus a liquidity premium.

Where appropriate, management reviewed the valuation methodologies and assumptions used by the independent third party providers and determined that the fair value estimates were reasonable and utilized those estimates in the Company’s reported financial statements. For one TRUP CDO, management became aware that a marketplace auction occurred one day after quarter-end that would payoff this security at par in the subsequent quarter. That successful auction caused management to increase the fair value of this security at June 30, 2014 to par and resulted in the recognition of a fair value gain on this security of $2.9 million. The aggregate result of the fair value analysis of all the Level 3 TRUP CDO measurements was a fair value gain of $2.9 million in the quarter ended June 30, 2014.

At June 30, 2014, Banner also owned approximately $19 million in amortized cost of single issuer TPS securities for which no direct market data or independent valuation source is available. Similar to the TRUP CDOs above, there were too few, if any, issuances of new TPS securities or sales of existing TPS securities to provide Level 1 or even Level 2 fair value measurements for these securities. Management, therefore, utilized a discounted cash-flow model to calculate the present value of each security’s expected future cash flows to determine their respective fair values. Management took into consideration the limited market data that was available regarding similar securities and assessed the performance of the three individual issuers of TPS securities owned by the Company. In the current quarter, the Company again sought input from independent third parties to help it establish an appropriate set of parameters to identify a reasonable range of discount rates for use in its fair value model. Management concluded that the indicated spreads and implied yields for non-investment grade securities as well as the yields associated with individual issuers in the third party analyst reports indicated that spreads have tightened in the six months ended June 30, 2014 and that the previous spread of 525 basis points over the three-month LIBOR index was no longer appropriate. At June 30, 2014, the spread to three-month LIBOR used to estimate the fair value analysis of these securities was decreased by 25 basis points to 500 basis points. The result of this Level 3 fair value measurement was a fair value gain of $518,000 in the quarter ended June 30, 2014. The Company has and will continue to assess the appropriate fair value hierarchy for determination of fair values on TRUP CDO and TPS securities on a quarterly basis. For all other trading securities and securities available-for-sale we used matrix pricing models from investment reporting and valuation services. Management considers this to be a Level 2 input method.


•	Fair valuations for FHLB advances are estimated using fair market values provided by the lender, the FHLB of Seattle. The FHLB of Seattle prices advances by discounting the future contractual cash flows for individual advances using its current cost of funds curve to provide the discount rate. Management considers this to be a Level 2 input method.

•

The fair valuations of junior subordinated debentures (TPS-related debt that the Company has issued) were also valued using discounted cash flows. These debentures carry interest rates that reset quarterly, using the three-month LIBOR index plus spreads of 1.38% to 3.35%. While the quarterly reset of the index on this debt would seemingly keep its fair value reasonably close to book value, the disparity in the fixed spreads above the index and the inability to determine realistic current market spreads, due to lack of new issuances and trades, resulted in having to rely more heavily on assumptions about what spread would be appropriate if market transactions were to take place. In periods prior to the third quarter of 2008, the discount rate used was based on recent issuances or quotes from brokers on the date of valuation for comparable bank holding companies and was considered to be a Level 2 input method. However, as noted above in the discussions of TPS and TRUP CDOs, due to the unprecedented disruption of certain financial markets, management concluded that there were insufficient transactions or other indicators to continue to reflect these measurements as Level 2 inputs. Due to this reliance on assumptions and not on directly observable transactions, management believes fair value for these instruments should follow a Level 3 input methodology. Since the discount rate used in the fair value modeling is the most sensitive unobservable estimate in the calculation, the Company again utilized input from the same independent third party noted above to help it establish an appropriate set of parameters to identify a reasonable range of discount rates for use in its fair value model. In valuing the debentures at June 30, 2014, management evaluated the general market for credit spreads as noted above and for the discount rate used the period-ending three-month LIBOR plus 500 basis points. As noted above in the discussion about single-issuer TPS securities, since market spreads have tightened in the six months ended June 30, 2014, management also decreased the spread on the debentures by 25 basis points, resulting in a fair value loss on these instruments of $3.2 million for the quarter ended June 30, 2014. The fair value adjustment in the current period was primarily the result of the decreased spread with a minor amount attributed to the passage of time on the years to maturity in the discounted present value calculation used to estimate the fair value.

•

Derivative instruments include interest rate commitments related to one- to four-family loans and residential mortgage-backed securities and interest rate swaps. The fair value of interest rate lock commitments and forward sales commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical trends, where appropriate. The fair value of interest rate swaps is determined by using current market quotes on similar instruments provided by active broker/dealers in the swap market. Management considers these to be Level 2 input methods. The changes in the fair value of all of these derivative instruments are primarily attributable to changes in the level of market interest rates. The Company has elected to record the fair value of these derivative instruments on a net basis.

The following tables present financial assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy of the fair value measurements for those assets as of June 30, 2014 and December 31, 2013 (in thousands):



	June 30, 2014
	Level 1		Level 2		Level 3		Total
Assets:
Securities—available-for-sale
U.S. Government and agency	$	—	$	52,212	$	—	$	52,212
Municipal bonds	—		50,801		—		50,801
Corporate bonds	—		5,011		—		5,011
Mortgage-backed or related securities	—		321,863		—		321,863
Asset-backed securities	—		25,466		—		25,466
	—		455,353		—		455,353
Securities—trading
U.S. Government and agency	—		1,530		—		1,530
Municipal bonds	—		1,716		—		1,716
TPS and TRUP CDOs	—		—		38,529		38,529
Mortgage-backed or related securities	—		19,557		—		19,557
Equity securities and other	—		61		—		61
	—		22,864		38,529		61,393
Derivatives
Interest rate lock commitments	—		563		—		563
Interest rate swaps	—		5,650		—		5,650
	$	—	$	484,430	$	38,529	$	522,959

Liabilities:
Advances from FHLB at fair value	$	—	$	45,251	$	—	$	45,251
Junior subordinated debentures net of unamortized deferred issuance costs at fair value	—		—		77,313		77,313
Derivatives
Interest rate sales forward commitments, net	—		351		—		351
Interest rate swaps	—		5,650		—		5,650
	$	—	$	51,252	$	77,313	$	128,565



	December 31, 2013
	Level 1		Level 2		Level 3		Total
Assets:
Securities—available-for-sale
U.S. Government and agency	$	—	$	58,660	$	—	$	58,660
Municipal bonds	—		52,855		—		52,855
Corporate bonds	—		6,964		—		6,964
Mortgage-backed or related securities	—		326,610		—		326,610
Asset-backed securities	—		25,191		—		25,191
	—		470,280		—		470,280
Securities—trading
U.S. Government and agency	—		1,481		—		1,481
Municipal bonds	—		5,023		—		5,023
TPS and TRUP CDOs	—		—		35,140		35,140
Mortgage-backed or related securities	—		20,760		—		20,760
Equity securities and other	—		68		—		68
	—		27,332		35,140		62,472
Derivatives
Interest rate lock commitments	—		130		—		130
Interest rate swaps	—		4,946		—		4,946
	$	—	$	502,688	$	35,140	$	537,828

Liabilities:
Advances from FHLB at fair value	$	—	$	27,250	$	—	$	27,250
Junior subordinated debentures net of unamortized deferred issuance costs at fair value	—		—		73,928		73,928
Derivatives
Interest rate sales forward commitments, net	—		43		—		43
Interest rate swaps	—		4,946		—		4,946
	$	—	$	32,239	$	73,928	$	106,167

The following table provides a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and six months ended June 30, 2014 and 2013 (in thousands):



	Three Months Ended				Six Months Ended
	June 30, 2014				June 30, 2014
	Level 3 Fair Value Inputs				Level 3 Fair Value Inputs
	TPS and TRUP CDOs		Borrowings—Junior Subordinated Debentures		TPS and TRUP CDOs			Borrowings— Junior Subordinated Debentures
Beginning balance	$	35,062	$	74,135	$	35,140		$	73,928
Total gains or losses recognized
Assets gains, including OTTI	3,464		—		3,420			—
Liabilities losses	—		3,178		—			3,385
Maturities and paydowns net of discount amortization	3		—		(31		)	—
Ending balance at June 30, 2014	$	38,529	$	77,313	$	38,529		$	77,313

	Three Months Ended				Six Months Ended
	June 30, 2013				June 30, 2013
	Level 3 Fair Value Inputs				Level 3 Fair Value Inputs
	TPS and TRUP CDOs		Borrowings—Junior Subordinated Debentures		TPS and TRUP CDOs			Borrowings— Junior Subordinated Debentures
Beginning balance	$	34,520	$	73,220	$	35,741		$	73,063
Total gains or losses recognized
Assets gains (losses), including OTTI	585		—		(636		)	—
Liabilities losses	—		251		—			408
Ending balance at June 30, 2013	$	35,105	$	73,471	$	35,105		$	73,471

The Company has elected to continue to recognize the interest income and dividends from the securities reclassified to fair value as a component of interest income as was done in prior years when they were classified as available-for-sale. Interest expense related to the FHLB advances and junior subordinated debentures continues to be measured based on contractual interest rates and reported in interest expense. The change in fair market value of these financial instruments has been recorded as a component of other operating income.

Items Measured at Fair Value on a Non-recurring Basis:

Carrying values of certain impaired loans are periodically evaluated to determine if valuation adjustments, or partial write-downs, should be recorded. These non-recurring fair value adjustments are recorded when observable market prices or current appraised values of collateral indicate a shortfall in collateral value or discounted cash flows indicate a shortfall compared to current carrying values of the related loan. If the Company determines that the value of the impaired loan is less than the carrying value of the loan, the Company either establishes an impairment reserve as a specific component of the allowance for loan and lease losses (ALLL) or charges off the impaired amount. The remaining impaired loans are evaluated for reserve needs in homogenous pools within the Company’s ALLL methodology. As of June 30, 2014, the Company reviewed all of its adversely classified loans totaling $78 million and identified $57 million which were considered impaired. Of those $57 million in impaired loans, $45 million were individually evaluated to determine if valuation adjustments, or partial write-downs, should be recorded, or if specific impairment reserves should be established. The $45 million had original carrying values of $47 million which have been reduced by partial write-downs totaling $2 million. In addition to these write-downs, in order to bring the impaired loan balances to fair value, Banner has also established $4 million in specific reserves on these impaired loans. Impaired loans that were collectively evaluated for reserve purposes within homogenous pools totaled $13 million and were found to require allowances totaling $277,000. The valuation inputs for impaired loans are considered to be Level 3 inputs.

The Company records REO (acquired through a lending relationship) at fair value on a non-recurring basis. All REO properties are recorded at the lower of the estimated fair value of the properties, less expected selling costs, or the carrying amount of the defaulted loans. From time to time, non-recurring fair value adjustments to REO are recorded to reflect partial write-downs based on an observable market price or current appraised value of property. Banner considers any valuation inputs related to REO to be Level 3 inputs. The individual carrying values of these assets are reviewed for impairment at least annually and any additional impairment charges are expensed to operations. For the three months ended June 30, 2014, the Company recognized no impairment charges related to REO assets, compared to $226,000 for the same quarter one year earlier.

The following tables present financial assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy of the fair value measurements for those assets as of June 30, 2014 and December 31, 2013 (in thousands):



	At or For the Six Months Ended June 30, 2014
	Level 1		Level 2		Level 3		Total		Net Gains/(Losses) Recognized During the Period
Impaired loans	$	—	$	—	$	5,046	$	5,046	$	(2,678	)
REO	—		—		4,388		4,388		(433		)

	At or For the Year Ended December 31, 2013
	Level 1		Level 2		Level 3		Total		Net Gains/(Losses) Recognized During the Period
Impaired loans	$	—	$	—	$	10,627	$	10,627	$	(4,890	)
REO	—		—		4,044		4,044		(853		)

The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring and nonrecurring basis at June 30, 2014 and December 31, 2013:



			Weighted Average Rate
Financial Instruments	Valuation Techniques	Unobservable Inputs	June 30, 2014		December 31, 2013
TPS securities	Discounted cash flows	Discount rate	5.23	%	5.50	%
TRUP CDOs	Discounted cash flows	Discount rate	3.30		3.85
Junior subordinated debentures	Discounted cash flows	Discount rate	5.23		5.50
Impaired loans	Discounted cash flows	Discount rate	Various		Various
	Collateral Valuations	Market values	n/a		n/a
REO	Appraisals	Market values	n/a		n/a

TPS and TRUP CDOs: Management believes that the credit risk-adjusted spread used to develop the discount rate utilized in the fair value measurement of TPS and TRUP CDOs is indicative of the risk premium a willing market participant would require under current market conditions for instruments with similar contractual rates and terms and conditions and issuers with similar credit risk profiles and with similar expected probability of default. Management attributes the change in fair value of these instruments, compared to their par value, primarily to perceived general market adjustments to the risk premiums for these types of assets subsequent to their issuance.

Junior subordinated debentures: Similar to the TPS and TRUP CDOs discussed above, management believes that the credit risk-adjusted spread utilized in the fair value measurement of the junior subordinated debentures is indicative of the risk premium a willing market participant would require under current market conditions for an issuer with Banner's credit risk profile. Management attributes the change in fair value of the junior subordinated debentures, compared to their par value, primarily to perceived general market adjustments to the risk premiums for these types of liabilities subsequent to their issuance. Future contractions in the risk adjusted spread relative to the spread currently utilized to measure the Company's junior subordinated debentures at fair value as of June 30, 2014, or the passage of time, will result in negative fair value adjustments. At June 30, 2014, the discount rate utilized was based on a credit spread of 500 basis points and three-month LIBOR of 23 basis points.

Impaired loans: Loans are considered impaired when, based on current information and events, management determines that it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, the value of the underlying collateral and the current status of the economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. If this practical expedient is used, the impaired loans are considered to be held at fair value. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported.

REO: Fair value adjustments on REO are based on updated real estate appraisals which are based on current market conditions. In many of our markets real estate sales are still slow and prices are negatively affected by an over-supply of properties for sale. These market conditions decrease the amount of comparable sales data and increase the reliance on estimates and assumptions about current and future market conditions and could negatively affect our operating results.

Fair Values of Financial Instruments:

The following table presents estimated fair values of the Company’s financial instruments as of June 30, 2014 and December 31, 2013, whether or not measured at fair value in the consolidated Statements of Financial Condition. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data in the development of the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The carrying value and estimated fair value of financial instruments are as follows (in thousands):



	June 30, 2014				December 31, 2013
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Assets:
Cash and due from banks	$	146,561	$	146,561	$	137,349	$	137,349
Securities—trading	61,393		61,393		62,472		62,472
Securities—available-for-sale	455,353		455,353		470,280		470,280
Securities—held-to-maturity	133,186		138,065		102,513		103,610
Loans receivable held for sale	7,322		7,350		2,734		2,751
Loans receivable	3,755,277		3,642,023		3,415,711		3,297,936
FHLB stock	31,191		31,191		35,390		35,390
Bank-owned life insurance	62,815		62,815		61,945		61,945
Mortgage servicing rights	8,481		12,287		8,086		11,529
Derivatives	6,213		6,213		5,076		5,076
Liabilities:
Demand, interest checking and money market accounts	2,137,983		1,909,240		1,946,467		1,697,095
Regular savings	843,950		747,164		798,764		695,863
Certificates of deposit	936,986		931,701		872,695		867,904
FHLB advances at fair value	45,251		45,251		27,250		27,250
Junior subordinated debentures at fair value	77,313		77,313		73,928		73,928
Other borrowings	88,946		88,946		83,056		83,056
Derivatives	6,001		6,001		4,989		4,989

Fair value estimates, methods, assumptions and the level within the fair value hierarchy of the fair value measurements are set forth below for the Company’s financial and off-balance-sheet instruments:

Cash and Due from Banks: The carrying amount of these items is a reasonable estimate of their fair value. These values are considered Level 1 measures.

Securities: The estimated fair values of investment securities and mortgaged-backed securities are priced using current active market quotes, if available, which are considered Level 1 measurements. For most of the portfolio, matrix pricing based on the securities’ relationship to other benchmark quoted prices is used to establish the fair value. These measurements are considered Level 2. Due to the continued credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads for some of the Company’s TPS and TRUP CDO securities (see earlier discussion above in determining the securities’ fair market value), management has classified these securities as a Level 3 fair value measure.

Loans Receivable: Fair values are estimated first by stratifying the portfolios of loans with similar financial characteristics. Loans are segregated by type such as multifamily real estate, residential mortgage, nonresidential mortgage, commercial/agricultural, consumer and other. Each loan category is further segmented into fixed- and adjustable-rate interest terms and by performing and non-performing categories. A preliminary estimate of fair value is then calculated based on discounted cash flows using as a discount rate the current rate offered on similar products, plus an adjustment for liquidity to reflect the non-homogeneous nature of the loans. The preliminary estimate is then further reduced by the amount of the allowance for loan losses to arrive at a final estimate of fair value. Fair value for significant non-performing loans is also based on recent appraisals or estimated cash flows discounted using rates commensurate with risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information. Management considers this to be a Level 2 measure.

FHLB Stock: The fair value is based upon the redemption value of the stock which equates to its carrying value. This fair value is considered a Level 3 measure.

Mortgage Servicing Rights: Fair values are estimated based on current pricing for sales of servicing for new loans adjusted up or down based on the serviced loan’s interest rate versus current new loan rates. Management considers this to be a Level 3 measure.

Deposit Liabilities: The fair value of deposits with no stated maturity, such as savings and checking accounts, is estimated by applying decay rate assumptions to segregated portfolios of similar deposit types to generate cash flows which are then discounted using short-term market interest rates. The market value of certificates of deposit is based upon the discounted value of contractual cash flows. The discount rate is determined using the rates currently offered on comparable instruments. Fair value estimates for deposits are considered Level 3 measures.

FHLB Advances and Other Borrowings: Fair valuations for Banner’s FHLB advances are estimated using fair market values provided by the lender, the FHLB of Seattle. The FHLB of Seattle prices advances by discounting the future contractual cash flows for individual advances using its current cost of funds curve to provide the discount rate. This is considered to be a Level 2 input method. Other borrowings are priced using discounted cash flows to the date of maturity based on using current rates at which such borrowings can currently be obtained. This fair value is considered to be a Level 3 measure.

Junior Subordinated Debentures: Due to continued credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads (see earlier discussion above in determining the junior subordinated debentures’ fair market value), junior subordinated debentures have been classified as a Level 3 fair value measure. Management believes that the credit risk adjusted spread and resulting discount rate utilized is indicative of those that would be used by market participants.

Derivatives: Derivatives include interest rate swap agreements, interest rate lock commitments to originate loans held for sale and forward sales contracts to sell loans and securities related to mortgage banking activities. Fair values for these instruments, which generally change as a result of changes in the level of market interest rates, are estimated based on dealer quotes and secondary market sources. Management considers these to be Level 2 inputs.

Off-Balance Sheet Items: Off-balance sheet financial instruments include unfunded commitments to extend credit, including standby letters of credit, and commitments to purchase investment securities. The fair value of these instruments is not considered to be material. Other commitments to fund loans totaled $1.182 billion and $1.097 billion at June 30, 2014 and December 31, 2013, respectively, and have no carrying value at both dates, representing the cost of such commitments. There were no commitments to purchase securities at June 30, 2014 or at December 31, 2013.

Limitations: The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2014 and December 31, 2013. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not financial instruments include the deferred tax assets/liabilities; land, buildings and equipment; costs in excess of net assets acquired; and real estate held for sale.

Note 12: INCOME TAXES AND DEFERRED TAXES

The Company files a consolidated income tax return including all of its wholly-owned subsidiaries on a calendar year basis. Income taxes are accounted for using the asset and liability method. Under this method, a deferred tax asset or liability is determined based on the enacted tax rates which will be in effect when the differences between the financial statement carrying amounts and tax bases of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change. A valuation allowance is recognized as a reduction to deferred tax assets when management determines it is more likely than not that deferred tax assets will not be available to offset future income tax liabilities.

Accounting standards for income taxes prescribe a recognition threshold and measurement process for financial statement recognition and measurement of uncertain tax positions taken or expected to be taken in a tax return, and also provide guidance on the de-recognition of previously recorded benefits and their classification, as well as the proper recording of interest and penalties, accounting in interim periods, disclosures and transition. The Company periodically reviews its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities’ examinations of the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment.

As of June 30, 2014, the Company had an insignificant amount of unrecognized tax benefits for uncertain tax positions, none of which would materially affect the effective tax rate if recognized. The Company does not anticipate that the amount of unrecognized tax benefits will significantly increase or decrease in the next twelve months. The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in the income tax expense. The Company files consolidated income tax returns in U.S. federal jurisdiction and in the Oregon and Idaho state jurisdictions. The tax years which remain subject to examination by the taxing authorities are the years ended December 31, 2013, 2012, 2011, and 2010. Tax years 2006 - 2009 are not open for assessment of additional tax, but remain open for adjustments to the amount of NOLs, credit, and other carryforwards utilized in open years or to be utilized in the future.

Note 13: CALCULATION OF WEIGHTED AVERAGE SHARES OUTSTANDING FOR EARNINGS PER SHARE (EPS)

The following table reconciles basic to diluted weighted shares outstanding used to calculate earnings per share data dollars and shares (in thousands, except per share data):



	Three Months Ended June 30				Six Months Ended June 30
	2014		2013		2014		2013
Net income	$	17,007	$	11,753	$	27,578	$	23,336

Basic weighted average shares outstanding	19,342		19,333		19,344		19,323
Plus unvested restricted stock	68		64		62		62
Diluted weighted shares outstanding	19,410		19,397		19,406		19,385
Earnings per common share
Basic	$	0.88	$	0.61	$	1.43	$	1.21
Diluted	$	0.88	$	0.60	$	1.42	$	1.20

Options to purchase an additional 19,964 shares of common stock as of June 30, 2014 were not included in the computation of diluted earnings per share because their exercise price resulted in them being anti-dilutive. Also, as of June 30, 2014, the warrants originally issued to the U.S. Treasury in the fourth quarter of 2008 to purchase up to $18.6 million (243,998 shares, post reverse-split) of common stock were not included in the computation of diluted EPS for the quarters ended June 30, 2014 and 2013 because the exercise price of the warrants was greater than the average market price of common shares. In June 2013, the Treasury sold the warrants in a public auction. That sale did not change the Company's capital position and did not have any impact on the financial accounting and reporting for these securities.

Note 14: STOCK-BASED COMPENSATION PLANS

The Company operates the following stock-based compensation plans as approved by the shareholders: the 1998 Stock Option Plan, and 2001 Stock Option Plan (collectively the SOPs), the 2012 Restricted Stock and Incentive Bonus Plan, and the 2014 Omnibus Incentive Plan. In addition, the Board approved in 2006 the Long Term Incentive Plan. The purpose of these plans is to promote the success and enhance the value of the Company by providing a means for attracting and retaining highly skilled employees, officers and directors of Banner Corporation and its affiliates and linking their personal interests with those of the Company's shareholders. Under these plans the Company currently has outstanding restricted stock grants, stock options and stock appreciation rights.

Restricted Stock Grants. Under the 2012 Restricted Stock and Incentive Bonus Plan, which was initially approved on April 24, 2012, the Company is authorized to issue up to 300,000 shares of its common stock to provide a means for attracting and retaining highly skilled officers of Banner Corporation and its affiliates. Shares granted under the Plan have a minimum vesting period of three years. The Plan will continue in effect for a term of ten years, after which no further awards may be granted. The 2012 Restricted Stock Plan was amended on April 23, 2013 to provide for the ability to grant (1) cash-denominated incentive-based awards payable in cash or common stock, including those that are eligible to qualify as qualified performance-based compensation for the purposes of Section 162(m) of the Code and (2) restricted stock awards that qualify as qualified performance-based compensation for the purposes of Section 162(m) of the Code. Vesting requirements may include time-based conditions, performance-based conditions, or market-based conditions. As of June 30, 2014, the Company had granted 267,827 shares of restricted stock from the 2012 Restricted Stock and Incentive Bonus Plan, of which 57,243 shares had vested and 210,584 shares remain unvested.

The expense associated with all restricted stock grants was $610,000 and $1.1 million, respectively, for the three and six month period ended June 30, 2014 and was $315,000 and $522,000, respectively, for the three and six month period ended June 30, 2013. Unrecognized compensation expense for these awards as of June 30, 2014 was $5.0 million and will be amortized over the next 36 months.

Stock Options. Under the SOPs, Banner reserved 2,284,186 shares for issuance pursuant to the exercise of stock options to be granted to directors and employees. Authority to grant additional options under the 1998 Stock Option Plan terminated on July 24, 2008. Authority to grant additional options under the 2001 Stock Option Plan terminated on April 20, 2011. The exercise price of the stock options is set at 100% of the fair market value of the stock price on the date of grant. Options granted vest at a rate of 20% per year from the date of grant and any unexercised incentive stock options will expire ten years after date of grant or 90 days after employment or service ends.

During the six months ended June 30, 2014 and 2013, the Company did not grant any stock options. Additionally, there were no significant modifications made to any stock option grants during the period. The fair values of stock options granted are amortized as compensation expense on a straight-line basis over the vesting period of the grant.

There were no stock-based compensation costs related to the SOPs for the quarters ended June 30, 2014 or June 30, 2013. The SOPs’ stock option grant compensation costs are generally based on the fair value calculated from the Black-Scholes option pricing on the date of the grant award. The Black-Scholes model assumes an expected stock price volatility based on the historical volatility at the date of the grant and an expected term based on the remaining contractual life of the vesting period. The Company bases the estimate of risk-free interest rate on the

U.S. Treasury Constant Maturities Indices in effect at the time of the grant. The dividend yield is based on the current quarterly dividend in effect at the time of the grant.

During the three and six months ended June 30, 2014 and 2013, there were no exercises of stock options. Cash was not used to settle any equity instruments previously granted. The Company issues shares from authorized but unissued shares upon the exercise of stock options. The Company does not currently expect to repurchase shares from any source to satisfy such obligations under the SOPs.

Banner Corporation Long-Term Incentive Plan: In June 2006, the Board of Directors adopted the Banner Corporation Long-Term Incentive Plan effective July 1, 2006. The Plan is an account-based type of benefit, the value of which is directly related to changes in the value of Company common stock, dividends declared on Company common stock and changes in Banner Bank’s average earnings rate, and is considered a stock appreciation right (SAR). Each SAR entitles the holder to receive cash upon vesting, equal to the excess of the fair market value of a share of the Company’s common stock on the date of maturity of the SAR over the fair market value of such share on the date granted plus, for some grants, the dividends declared on the stock from the date of grant to the date of vesting. The primary objective of the Plan is to create a retention incentive by allowing officers who remain with the Company or the Banks for a sufficient period of time to share in the increases in the value of Company stock. The Company re-measures the fair value of SARs each reporting period until the award is settled and recognizes changes in fair value and vesting in compensation expense. The Company recognized compensation expense of $11,000 for the three months ended June 30, 2014 and a net reversal of compensation expense of $137,000 for the six months ended June 30, 2014 due to variations in market value of the underlying stock, compared to compensation expense of $150,000 for the three months ended June 30, 2013 and a compensation expense of $239,000 for the six months ended June 30, 2013. At June 30, 2014, the aggregate liability related to SARs was $858,000 and was included in deferred compensation.

Banner Corporation 2014 Omnibus Incentive Plan: The Banner Corporation 2014 Omnibus Incentive Plan (2014 Plan) was approved by shareholders on April 22, 2014. The 2014 Plan provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, other stock-based awards and other cash awards, and provides for vesting requirements which may include time-based or performance-based conditions. The Company has reserved 900,000 shares of its common stock for issuance under the 2014 Plan in connection with exercise of awards. As of June 30, 2014, no awards had been granted under the 2014 Omnibus Plan.

Note 15: COMMITMENTS AND CONTINGENCIES

Lease Commitments — The Company leases 64 sites under non-cancelable operating leases. The leases contain various provisions for increases in rental rates, based either on changes in the published Consumer Price Index or a predetermined escalation schedule. Substantially all of the leases provide the Company with the option to extend the lease term one or more times following expiration of the initial term.

Financial Instruments with Off-Balance-Sheet Risk—The Company has financial instruments with off-balance-sheet risk generated in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, commitments related to standby letters of credit, commitments to originate loans, commitments to sell loans, commitments to buy and sell securities. These instruments involve, to varying degrees, elements of credit and interest rate risk similar to the risk involved in on-balance sheet items recognized in our Consolidated Statements of Financial Condition.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument from commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments.

Outstanding commitments for which no asset or liability for the notional amount has been recorded consisted of the following at the dates indicated (in thousands):



	Contract or Notional Amount
	June 30, 2014		December 31, 2013
Commitments to extend credit	$	1,140,644	$	1,073,897
Standby letters of credit and financial guarantees	8,392		6,990
Commitments to originate loans	32,525		15,776

Derivatives also included in Note 16:
Commitments to originate loans held for sale	43,639		21,434
Commitments to sell loans secured by one- to four-family residential properties	17,714		9,378
Commitments to sell securities related to mortgage banking activities	29,166		15,200

Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments may expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of

credit, is based on management’s credit evaluation of the customer. The type of collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties.

Standby letters of credit are conditional commitments issued to guarantee a customer’s performance or payment to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Interest rates on residential one- to four-family mortgage loan applications are typically rate locked (committed) to customers during the application stage for periods ranging from 30 to 60 days, the most typical period being 45 days. Traditionally these loan applications with rate lock commitments had the pricing for the sale of these loans locked with various qualified investors under a best-efforts delivery program at or near the time the interest rate is locked with the customer. The Company then attempts to deliver these loans before their rate locks expired. This arrangement generally required delivery of the loans prior to the expiration of the rate lock. Delays in funding the loans required a lock extension. The cost of a lock extension at times was borne by the customer and at times by the Bank. These lock extension costs have not had a material impact to our operations. In 2012, the Company also began entering into forward commitments at specific prices and settlement dates to deliver either: (1) residential mortgage loans for purchase by secondary market investors (i.e., Freddie Mac or Fannie Mae), or (2) mortgage-backed securities to broker/dealers. The purpose of these forward commitments is to offset the movement in interest rates between the execution of its residential mortgage rate lock commitments with borrowers and the sale of those loans to the secondary market investor. There were no counterparty default losses on forward contracts in the six months ended June 30, 2014 or June 30, 2013. Market risk with respect to forward contracts arises principally from changes in the value of contractual positions due to changes in interest rates. We limit our exposure to market risk by monitoring differences between commitments to customers and forward contracts with market investors and securities broker/dealers. In the event we have forward delivery contract commitments in excess of available mortgage loans, the transaction is completed by either paying or receiving a fee to or from the investor or broker/dealer equal to the increase or decrease in the market value of the forward contract.

Legal Proceedings—In the normal course of business, the Company and/or its subsidiaries have various legal proceedings and other contingent matters outstanding. These proceedings and the associated legal claims are often contested and the outcome of individual matters is not always predictable. The claims and counter-claims typically arise during the course of collection efforts on problem loans or with respect to action to enforce liens on properties in which the Company holds a security interest. Based on information known to management at this time, the Company is not a party to any legal proceedings that management believes would have a material adverse effect on the Company's results of operations or consolidated financial position at June 30, 2014.

NOTE 16: DERIVATIVES AND HEDGING

The Company, through its Banner Bank subsidiary, is party to various derivative instruments that are used for asset and liability management and customer financing needs. Derivative instruments are contracts between two or more parties that have a notional amount and an underlying variable, require no net investment and allow for the net settlement of positions. The notional amount serves as the basis for the payment provision of the contract and takes the form of units, such as shares or dollars. The underlying variable represents a specified interest rate, index, or other component. The interaction between the notional amount and the underlying variable determines the number of units to be exchanged between the parties and influences the market value of the derivative contract. The Company obtains dealer quotations to value its derivative contracts.

The Company's predominant derivative and hedging activities involve interest rate swaps related to certain term loans and forward sales contracts associated with mortgage banking activities. Generally, these instruments help the Company manage exposure to market risk and meet customer financing needs. Market risk represents the possibility that economic value or net interest income will be adversely affected by fluctuations in external factors such as market-driven interest rates and prices or other economic factors.

Derivatives Designated in Hedge Relationships

The Company's fixed rate loans result in exposure to losses in value or net interest income as interest rates change. The risk management objective for hedging fixed rate loans is to effectively convert the fixed rate received to a floating rate. The Company has hedged exposure to changes in the fair value of certain fixed rate loans through the use of interest rate swaps. For a qualifying fair value hedge, changes in the value of the derivatives are recognized in current period earnings along with the corresponding changes in the fair value of the designated hedged item attributable to the risk being hedged.

In a program brought to Banner Bank through its merger with F&M Bank in 2007, customers received fixed interest rate commercial loans and the Bank subsequently hedged that fixed rate loan by entering into an interest rate swap with a dealer counterparty. The Bank receives fixed rate payments from the customers on the loans and makes similar fixed rate payments to the dealer counterparty on the swaps in exchange for variable rate payments based on the one-month LIBOR index. Some of these interest rate swaps are designated as fair value hedges. Through application of the “short cut method of accounting,” there is an assumption that the hedges are effective. The Bank discontinued originating interest rate swaps under this program in 2008.

As of June 30, 2014 and December 31, 2013, the notional values or contractual amounts and fair values of the Company's derivatives designated in hedge relationships were as follows (in thousands):



	Asset Derivatives								Liability Derivatives
	June 30, 2014				December 31, 2013				June 30, 2014				December 31, 2013
	Notional/ Contract Amount		Fair Value ⁽¹⁾		Notional/ Contract Amount		Fair Value ⁽¹⁾		Notional/ Contract Amount		Fair Value ⁽²⁾		Notional/ Contract Amount		Fair Value ⁽²⁾
Interest rate swaps	$	7,257	$	1,263	$	7,420	$	1,295	$	7,257	$	1,263	$	7,420	$	1,295


⁽¹⁾	Included in Loans receivable on the Consolidated Statements of Financial Condition.


⁽²⁾	Included in Other liabilities on the Consolidated Statements of Financial Condition.

Derivatives Not Designated in Hedge Relationships

Interest Rate Swaps. Banner Bank has been using an interest rate swap program for commercial loan customers, termed the Back-to-Back Program, since 2010. In the Back-to-Back Program, the Bank provides the client with a variable rate loan and enters into an interest rate swap in which the client receives a variable rate payment in exchange for a fixed rate payment. The Bank offsets its risk exposure by entering into an offsetting interest rate swap with a dealer counterparty for the same notional amount and length of term as the client interest rate swap providing the dealer counterparty with a fixed rate payment in exchange for a variable rate payment. There are also a few interest rate swaps from prior to 2009 that were not designated in hedge relationships that are included in these totals. These swaps do not qualify as designated hedges; therefore, each swap is accounted for as a free standing derivative.

Mortgage Banking. In the normal course of business, the Company sells originated mortgage loans into the secondary mortgage loan markets. During the period of loan origination and prior to the sale of the loans in the secondary market, the Company has exposure to movements in interest rates associated with written rate lock commitments with potential borrowers to originate loans that are intended to be sold and for closed loans that are awaiting sale and delivery into the secondary market.

Written loan commitments that relate to the origination of mortgage loans that will be held for resale are considered free-standing derivatives and do not qualify for hedge accounting. Written loan commitments generally have a term of up to 60 days before the closing of the loan. The loan commitment does not bind the potential borrower to enter into the loan, nor does it guarantee that the Company will approve the potential borrower for the loan. Therefore, when determining fair value, the Company makes estimates of expected “fallout” (loan commitments not expected to close), using models which consider cumulative historical fallout rates, current market interest rates and other factors.

Written loan commitments in which the borrower has locked in an interest rate results in market risk to the Company to the extent market interest rates change from the rate quoted to the borrower. The Company economically hedges the risk of changing interest rates associated with its interest rate lock commitments by entering into forward sales contracts.

Mortgage loans which are held for sale are subject to changes in fair value due to fluctuations in interest rates from the loan's closing date through the date of sale of the loans into the secondary market. Typically, the fair value of these loans declines when interest rates increase and rises when interest rates decrease. To mitigate this risk, the Company enters into forward sales contracts on a significant portion of these loans to provide an economic hedge against those changes in fair value. Mortgage loans held for sale and the forward sales contracts are recorded at fair value with ineffective changes in value recorded in current earnings as loan sales and servicing income.

As of June 30, 2014 and December 31, 2013, the notional values or contractual amounts and fair values of the Company's derivatives not designated in hedge relationships were as follows (in thousands):



	Asset Derivatives								Liability Derivatives
	June 30, 2014				December 31, 2013				June 30, 2014				December 31, 2013
	Notional/ Contract Amount		Fair Value ⁽¹⁾		Notional/ Contract Amount		Fair Value ⁽¹⁾		Notional/ Contract Amount		Fair Value ⁽²⁾		Notional/ Contract Amount		Fair Value ⁽²⁾
Interest rate swaps	$	138,345	$	4,387	$	135,122	$	3,651	$	138,345	$	4,387	$	135,122	$	3,651
Mortgage loan commitments	28,254		448		14,107		57		15,177		115		7,326		43
Forward sales contracts	15,177		115		22,526		73		29,166		236		—		—
	$	181,776	$	4,950	$	171,755	$	3,781	$	182,688	$	4,738	$	142,448	$	3,694


⁽¹⁾	Included in Other assets on the Consolidated Statement of Financial Condition, with the exception of those interest rate swaps from prior to 2009 that were not designated in hedge relationships (with a fair value of $689,000 at June 30, 2014 and $791,000 at December 31, 2013), which are included in Loans receivable.


⁽²⁾	Included in Other liabilities on the Consolidated Statement of Financial Condition.

Gains (losses) recognized in income on non-designated hedging instruments for the three and six months ended June 30, 2014 and 2013 were as follows (in thousands):



		Three Months Ended June 30						Six Months Ended June 30
	Location on Income Statement	2014			2013			2014			2013
Mortgage loan commitments	Mortgage banking operations	$	321		$	(878	)	$	391		$	(816	)
Forward sales contracts	Mortgage banking operations	(199		)	878			(265		)	823
		$	122		$	—		$	126		$	7

The Company is exposed to credit-related losses in the event of nonperformance by the counterparty to these agreements. Credit risk of the financial contract is controlled through the credit approval, limits, and monitoring procedures and management does not expect the counterparties to fail their obligations.

In connection with the interest rate swaps between Banner Bank and the dealer counterparties, the agreements contain a provision where if Banner Bank fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions and Banner Bank would be required to settle its obligations. Similarly, Banner Bank could be required to settle its obligations under certain of its agreements if specific regulatory events occur, such as a publicly issued prompt corrective action directive, cease and desist order, or a capital maintenance agreement that required Banner Bank to maintain a specific capital level. If Banner Bank had breached any of these provisions at June 30, 2014 or December 31, 2013, it could have been required to settle its obligations under the agreements at the termination value. As of June 30, 2014 and December 31, 2013, the termination value of derivatives in a net liability position related to these agreements was $5.4 million and $2.7 million, respectively. The Company generally posts collateral against derivative liabilities in the form of government agency-issued bonds, mortgage-backed securities, or commercial mortgage-backed securities. Collateral posted against derivative liabilities was $9.9 million and $8.9 million as of June 30, 2014 and December 31, 2013, respectively.

Derivative assets and liabilities are recorded at fair value on the balance sheet and do not take into account the effects of master netting agreements. Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis and to offset net derivative positions with related collateral where applicable.

The following table illustrates the potential effect of the Company's derivative master netting arrangements, by type of financial instrument, on the Company's Statements of Financial Condition as of June 30, 2014 and December 31, 2013 (in thousands):



	June 30, 2014
							Gross Amounts of Financial Instruments Not Offset in the Statement of Financial Condition
	Gross Amounts Recognized		Amounts offset in the Statement of Financial Condition		Net Amounts in the Statement of Financial Condition		Netting Adjustment Per Applicable Master Netting Agreements			Fair Value of Financial Collateral in the Statement of Financial Condition			Net Amount
Derivative assets
Interest rate swaps	$	5,650	$	—	$	5,650	$	(148	)	$	—		$	5,502
	$	5,650	$	—	$	5,650	$	(148	)	$	—		$	5,502

Derivative liabilities
Interest rate swaps	$	5,650	$	—	$	5,650	$	(148	)	$	—		$	5,502
	$	5,650	$	—	$	5,650	$	(148	)	$	—		$	5,502

	December 31, 2013
							Gross Amounts of Financial Instruments Not Offset in the Statement of Financial Condition
	Gross Amounts Recognized		Amounts offset in the Statement of Financial Condition		Net Amounts in the Statement of Financial Condition		Netting Adjustment Per Applicable Master Netting Agreements			Fair Value of Financial Collateral in the Statement of Financial Condition			Net Amount
Derivative assets
Interest rate swaps	$	4,946	$	—	$	4,946	$	(554	)	$	—		$	4,392
	$	4,946	$	—	$	4,946	$	(554	)	$	—		$	4,392

Derivative liabilities
Interest rate swaps	$	4,946	$	—	$	4,946	$	(554	)	$	(2,657	)	$	1,735
	$	4,946	$	—	$	4,946	$	(554	)	$	(2,657	)	$	1,735

ITEM 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Overview

We are a bank holding company incorporated in the State of Washington which owns two subsidiary banks, Banner Bank and Islanders Bank. Banner Bank is a Washington-chartered commercial bank that conducts business from its main office in Walla Walla, Washington and, as of June 30, 2014, its 90 branch offices and ten loan production offices located in Washington, Oregon and Idaho. Islanders Bank is also a Washington-chartered commercial bank and conducts its business from three locations in San Juan County, Washington. Banner Corporation is subject to regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board). Banner Bank and Islanders Bank (the Banks) are subject to regulation by the Washington State Department of Financial Institutions, Division of Banks and the Federal Deposit Insurance Corporation (the FDIC). As of June 30, 2014, we had total consolidated assets of $4.7 billion, total loans of $3.8 billion, total deposits of $3.9 billion and total stockholders’ equity of $563 million.

Banner Bank is a regional bank which offers a wide variety of commercial banking services and financial products to individuals, businesses and public sector entities in its primary market areas. Islanders Bank is a community bank which offers similar banking services to individuals, businesses and public entities located in the San Juan Islands. The Banks’ primary business is that of traditional banking institutions, accepting deposits and originating loans in locations surrounding their offices in portions of Washington, Oregon and Idaho. Banner Bank is also an active participant in the secondary market, engaging in mortgage banking operations largely through the origination and sale of one- to four-family residential loans. Lending activities include commercial business and commercial real estate loans, agriculture business loans, construction and land development loans, one- to four-family residential loans and consumer loans.

Banner Corporation's successful execution of its strategic plan and operating initiatives continued in the second quarter of 2014, as evidenced by our solid operating results and profitability. Highlights for the quarter included significant loan growth, increased core deposits, additional client acquisition, further improvement in our asset quality and solid revenues from core operations. The quarter was also highlighted by the acquisition of six branches in southwestern Oregon (the Branch Acquisition). In connection with the Branch Acquisition, as of June 20, 2014, the Company acquired approximately $211 million in deposits, $88 million in loans and 10,500 new customer relationships. In addition, the Company recognized a $9.1 million bargain purchase gain related to the Branch Acquisition, which net of related expenses added $0.23 per diluted share to the quarter and year-to-date earnings.

In spite of persistently weak economic conditions and exceptionally low interest rates which have created an unusually challenging banking environment for an extended period, the Company experienced marked improvement and consistent profitability in 2012 and 2013 which continued in the first half of 2014. For the quarter ended June 30, 2014, our net income was $17.0 million, or $0.88 per diluted share, compared to a net income of $11.8 million, or $0.60 per diluted share, for the quarter ended June 30, 2013. For the six months ended June 30, 2014, our net income was $27.6 million, or $1.42 per diluted share, compared to net income of $23.3 million, or $1.20 per diluted share for the same period a year earlier. Although there continue to be indications that economic conditions are improving, the pace of expansion has been modest and uneven and ongoing uncertainty in the economy will likely continue to be challenging going forward. As a result, our future operating results and financial performance will be significantly affected by the course of economic activity. However, over the past three years we have significantly added to our client relationships and account base, as well as substantially improved our risk profile by aggressively managing and reducing our problem assets, which has resulted in stronger and sustainable revenues and lower credit costs, and which we believe has positioned the Company well to meet this challenging environment with continued success.

Our operating results depend primarily on our net interest income, which is the difference between interest income on interest-earning assets, consisting of loans and investment securities, and interest expense on interest-bearing liabilities, composed primarily of customer deposits and borrowings. Net interest income is primarily a function of our interest rate spread, which is the difference between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, as well as a function of the average balances of interest-earning assets and interest-bearing liabilities. Our net interest income before provision for loan losses increased $1.6 million, or 4%, to $43.8 million for the quarter ended June 30, 2014, compared to $42.2 million for the same quarter one year earlier. During the same period, our interest rate spread decreased to 4.03% from 4.17% and our net interest margin decreased to 4.06% in the current quarter compared to 4.20% in the same quarter a year earlier. This increase in net interest income reflects the significant growth in earning assets and occurred despite the decrease in interest rate spread as a result of declining yields on earning assets, which were only partially offset by continuing reductions in deposit and other funding costs.

Our net income also is affected by the level of our other operating income, including deposit fees and service charges, loan origination and servicing fees, and gains and losses on the sale of loans and securities, as well as credit costs and our non-interest operating expenses and income tax provisions. In addition, our net income is affected by the net change in the valuation of certain financial instruments carried at fair value and in certain periods by other-than-temporary impairment (OTTI) charges or recoveries, and in the current quarter by the Branch Acquisition bargain purchase gain. (See Note 11 of the Selected Notes to the Consolidated Financial Statements.)

As a result of substantial reserves already in place representing 1.97% of total loans outstanding at June 30, 2014, we did not record a provision for loan losses in the three months ended June 30, 2014. Our reserves at March 31, 2014 and June 30, 2013 were 2.11% and 2.31%, respectively, of total loans outstanding and, similar to the current quarter, no provisions for loan losses were recorded in the quarters ended March 31, 2014 or June 30, 2013. The allowance for loan losses at June 30, 2014 was $74.3 million, representing 376% of non-performing loans. Non-performing loans decreased by 14% to $19.7 million at June 30, 2014, compared to $22.9 million three months earlier, and decreased 24% when compared to $26.1 million a year earlier. (See Note 7, Loans Receivable and the Allowance for Loan Losses, as well as “Asset Quality” below in this Form 10-Q.)

Our total other operating income, which includes the gain on sale of securities, changes in the value of financial instruments carried at fair value, and the bargain purchase gain, was $20.1 million for the quarter ended June 30, 2014, compared to $10.6 million for the quarter ended June 30, 2013. For the quarter ended June 30, 2014, we recorded the bargain purchase gain (pre-tax) of $9.1 million and a net fair value gain of $464,000 in fair value adjustments. In comparison, for the quarter ended June 30, 2013, we recorded a net fair value loss of $255,000, partially offset by $12,000 in gains on the sale of securities. However, other operating income excluding the gain on sale of securities, changes in the fair value of financial instruments and the bargain purchase gain, which we believe is more indicative of our core operations, decreased 3% to $10.6 million for the quarter ended June 30, 2014, compared to $10.9 million for the same quarter a year earlier, as a result of substantially decreased revenues from our mortgage banking operations and despite meaningfully increased deposit fees and service charges fueled by growth in non-interest-bearing deposit accounts.

Our total revenues (net interest income before the provision for loan losses plus total other operating income) for the second quarter of 2014 increased $11.1 million to $63.9 million, compared to $52.9 million for the same period a year earlier, as a result of the Branch Acquisition bargain purchase gain, increased net interest income and deposit fees and service charges, as well as positive changes in fair value adjustments, which were only partially offset by decreased mortgage banking revenues and gain on sale of securities. Our total revenues, excluding fair value, gain on sale of securities, and the Branch Acquisition bargain purchase gain, which we believe are more indicative of our core operations, also remained strong at $54.4 million for the quarter ended June 30, 2014, a $1.3 million, or 2% increase, compared to $53.1 million for the same period a year earlier.

Our other operating expenses increased in the second quarter of 2014 compared to a year earlier largely as a result of acquisition-related costs, increased salary and employee benefits, payment and card processing and professional services expenses, which were partially offset by decreased advertising and marketing expense and state/municipal business and use taxes as well as an increase in the credit for capitalized loan origination costs. Other operating expenses were $38.4 million for the quarter ended June 30, 2014, compared to $35.5 million for the same quarter a year earlier. In the quarter ended June 30, 2014, expenses related to the Branch Acquisition contributed $2.0 million to other operating expense.

Other operating income, revenues and other earnings information excluding fair value adjustments, OTTI losses or recoveries, gains or losses on sale of securities and the bargain purchase gain are non-GAAP financial measures. Management has presented these and other non-GAAP financial measures in this discussion and analysis because it believes that they provide useful and comparative information to assess trends in our core operations. However, these non-GAAP financial measures are supplemental and are not a substitute for any analysis based on GAAP. Where applicable, we have also presented comparable earnings information using GAAP financial measures. For a reconciliation of these non-GAAP financial measures, see the tables below. Because not all companies use the same calculations, our presentation may not be comparable to other similarly titled measures as calculated by other companies. See “Comparison of Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013” for more detailed information about our financial performance.

The following tables set forth reconciliations of non-GAAP financial measures discussed in this report (in thousands):



	For the Three Months Ended June 30						For the Six Months Ended June 30
	2014			2013			2014			2013

Total other operating income	$	20,133		$	10,623		$	28,991		$	20,621
Exclude gain on sale of securities	—			(12		)	(35		)	(1,018		)
Exclude other-than-temporary impairment (recovery) loss	—			—			—			(409		)
Exclude change in valuation of financial instruments carried at fair value	(464		)	255			(209		)	1,601
Exclude acquisition bargain purchase gain	(9,079		)	—			(9,079		)	—
Total other operating income, excluding fair value adjustments, OTTI, gain on sale of securities and bargain purchase gain	$	10,590		$	10,866		$	19,668		$	20,795

Net interest income before provision for loan losses	$	43,808		$	42,248		$	86,147		$	83,217
Total other operating income	20,133			10,623			28,991			20,621
Total revenue	63,941			52,871			115,138			103,838
Exclude gain on sale of securities	—			(12		)	(35		)	(1,018		)
Exclude other-than-temporary impairment (recovery) loss	—			—			—			(409		)
Exclude change in valuation of financial instruments carried at fair value	(464		)	255			(209		)	1,601
Exclude acquisition bargain purchase gain	(9,079		)	—			(9,079		)	—
Total revenue, excluding fair value adjustments, OTTI, gain on sale of securities and bargain purchase gain	$	54,398		$	53,114		$	105,815		$	104,012

Income before provision for taxes	$	25,506		$	17,414		$	41,123		$	34,281
Exclude gain on sale of securities	—			(12		)	(35		)	(1,018		)
Exclude other-than-temporary impairment (recovery) loss	—			—			—			(409		)
Exclude change in valuation of financial instruments carried at fair value	(464		)	255			(209		)	1,601
Exclude acquisition bargain purchase gain	(9,079		)	—			(9,079		)	—
Income before provision for taxes, excluding fair value adjustments, OTTI, gain on sale of securities and bargain purchase gain	$	15,963		$	17,657		$	31,800		$	34,455

Net income	$	17,007		$	11,753		$	27,578		$	23,336
Exclude gain on sale of securities	—			(12		)	(35		)	(1,018		)
Exclude other-than-temporary impairment (recovery) loss	—			—			—			(409		)
Exclude change in valuation of financial instruments carried at fair value	(464		)	255			(209		)	1,601
Exclude acquisition bargain purchase gain	(9,079		)	—			(9,079		)	—
Exclude related tax expense (benefit)	3,435			(87		)	3,356			(63		)
Total earnings, excluding fair value adjustments, OTTI, gain on sale of securities and bargain purchase gain, net of related tax effects	$	10,899		$	11,909		$	21,611		$	23,447

Acquisition bargain purchase gain	$	9,079		$	—		$	9,079		$	—
Acquisition related costs	(1,979		)	—			(2,024		)	—
Related tax expense	(2,556		)	—			(2,540		)	—
Total net effect of acquisition on earnings	$	4,544		$	—		$	4,515		$	—
Diluted weighted shares outstanding	19,409,601			19,397,171			19,406,215			19,385,389
Total net effect of acquisition on diluted earnings per share	$	0.23		$	—		$	0.23		$	—

The ratio of tangible common stockholders’ equity to tangible assets is also a non-GAAP financial measure. We calculate tangible common equity by excluding other intangible assets from stockholders’ equity. We calculate tangible assets by excluding the balance of other intangible assets from total assets. We believe that this is consistent with the treatment by our bank regulatory agencies, which exclude goodwill and other intangible assets from the calculation of risk-based capital ratios. Management believes that this non-GAAP financial measure provides information to investors that is useful in understanding the basis of our capital position (dollars in thousands).



	June 30, 2014			December 31, 2013			June 30, 2013
Stockholders’ equity	$	563,013		$	538,972		$	520,333
Other intangible assets, net	3,892			2,449			3,247
Tangible common stockholders’ equity	$	559,121		$	536,523		$	517,086
Total assets	$	4,745,299		$	4,388,898		$	4,236,290
Other intangible assets, net	3,892			2,449			3,247
Tangible assets	$	4,741,407		$	4,386,449		$	4,233,043
Tangible common stockholders’ equity to tangible assets	11.79		%	12.23		%	12.22		%

Loans are our most significant and generally highest yielding earning assets. We attempt to maintain a portfolio of loans in a range of 90% to 95% of total deposits while adhering to sound underwriting practices and appropriate diversification guidelines in order to achieve and maintain a moderate risk profile. We had solid loan growth in the current quarter and at June 30, 2014 our net loan portfolio totaled $3.688 billion compared to $3.344 billion at December 31, 2013 and $3.213 billion at June 30, 2013.

We offer a wide range of loan products to meet the demands of our customers. Our lending activities are primarily directed toward the origination of real estate and commercial loans. Commercial real estate loans for both owner-occupied and investment properties, including construction and development loans for these types of properties, totaled $1.372 billion, or approximately 36% of our loan portfolio at June 30, 2014. In addition, multifamily residential real estate loans, including construction and development loans, totaled $229 million and comprise approximately 6% of our loan portfolio. While our level of activity and investment in commercial and multifamily real estate loans has been relatively stable for many years, we have experienced an increase in new originations in recent periods resulting in growth in these loan balances. Commercial real estate loans increased by $155 million during the first six months of 2014 and multifamily loans increased by $39 million. We also originate residential construction and development loans and, although our portfolio balances are well below the peak levels before the financial crisis, beginning in 2011 and continuing since then we have experienced increased demand for one- to four-family construction loans. Outstanding residential construction and development balances increased $10 million, or 4%, to $286 million at June 30, 2014 compared to $276 million at December 31, 2013 and increased $9 million, or 3%, compared to $277 million at June 30, 2013. Still, residential construction and development loans represent only approximately 8% of our total loan portfolio at June 30, 2014. Our commercial business lending is directed toward meeting the credit and related deposit needs of various small- to medium-sized business and agribusiness borrowers operating in our primary market areas. Reflecting the slowly recovering economy, demand for these types of commercial business loans has been modest although our production levels have increased in recent periods. In recent years, our commercial business lending has also included participation in certain national syndicated loans, including shared national credits , which totaled $117 million at June 30, 2014. Commercial and agricultural business loans increased $70 million, or 8%, to $981 million at June 30, 2014, compared to $910 million at December 31, 2013, and have increased $107 million, or 12%, compared to $874 million at June 30, 2013. Commercial and agricultural business loans represented approximately 26% of our portfolio at June 30, 2014. Total loans increased $88 million at June 30, 2014 due to the Branch Acquisition. At June 30, 2014, these acquired loans consisted of $37 million in commercial real estate loans, $22 million in consumer loans, $13 million in commercial business loans, $11 million in one- to four-family real estate loans, $3 million in agricultural business loans and $2 million in multifamily real estate loans.

Our residential mortgage loan originations have been relatively strong in recent years, as exceptionally low interest rates have supported demand for loans to refinance existing debt as well as loans to finance home purchases. Refinancing activity was particularly significant in 2012 and in the first six months of 2013, leading to meaningful increases in residential mortgage originations during those periods; however, the rise in mortgage interest rates that began in the second quarter of 2013 has slowed origination activity and has resulted in much lower refinancing activity in the current period. Nevertheless, after several quarters of declining balances, at June 30, 2014, our outstanding balances for residential mortgages increased $29 million, or 6%, to $559 million, compared to $529 million at December 31, 2013, and have increased $6 million, or 1%, compared to $553 million at June 30, 2013. One- to four-family residential real estate loans represent nearly 15% of our loan portfolio at June 30, 2014.

Our consumer loan activity is primarily directed at meeting demand from our existing deposit customers and, while we have increased our emphasis on consumer lending in recent years, demand for consumer loans has been modest during this period of economic weakness as we believe many consumers have been focused on reducing their personal debt. Consumer loans, including those secured by one-to-four family residential properties, were approximately 9% of our portfolio at June 30, 2014.

Deposits, customer retail repurchase agreements and loan repayments are the major sources of our funds for lending and other investment purposes. We compete with other financial institutions and financial intermediaries in attracting deposits and we generally attract deposits within our primary market areas. Much of the focus of our branch expansion over the years, including the Branch Acquisition, and our current marketing

efforts have been directed toward attracting additional deposit customer relationships and balances. This effort has been particularly focused on increasing transaction and savings accounts and for the past three years we have been very successful in increasing these core deposit balances. The long-term success of our deposit gathering activities is reflected not only in the growth of deposit balances, but also in increases in the level of deposit fees, service charges and other payment processing revenues compared to periods prior to that expansion.

Total deposits were $3.919 billion at June 30, 2014, compared to $3.683 billion three months earlier and $3.460 billion a year ago. Non-interest-bearing account balances increased 10% to $1.210 billion at June 30, 2014, compared to $1.096 billion at March 31, 2014, and increased 26% compared to $959 million a year ago largely as a result of our successful client acquisition strategies. Interest-bearing transaction and savings accounts increased 5% to $1.772 billion at June 30, 2014, compared to $1.682 billion at March 31, 2014 and $1.558 billion a year ago, while certificates of deposit increased 4% to $937 million at June 30, 2014, compared to $905 million at March 31, 2014 but decreased 1% compared to $944 million a year earlier. Non-certificate core deposits represented 76% of total deposits at June 30, 2014, compared to 73% of total deposits a year earlier. The Branch Acquisition increased total deposits by $212 million at June 30, 2014. These acquired deposits consisted of $80 million in non-interest-bearing demand accounts, $97 million in interest-bearing transaction and savings accounts, and $35 million in certificates of deposit.

Management’s Discussion and Analysis of Results of Operations is intended to assist in understanding our financial condition and results of operations. The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Selected Notes to the Consolidated Financial Statements contained in Item 1 of this Form 10-Q.

Summary of Critical Accounting Policies

Our significant accounting policies are described in Note 1 of the Notes to the Consolidated Financial Statements for the year ended December 31, 2013 included in the 2013 Form 10-K. Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified several accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. These policies relate to (i) the methodology for the recognition of interest income, (ii) determination of the provision and allowance for loan and lease losses, (iii) the valuation of financial assets and liabilities recorded at fair value, including OTTI losses, (iv) the valuation of intangibles, such as core deposit intangibles and mortgage servicing rights, (v) the valuation of real estate held for sale and (vi) the valuation of or recognition of deferred tax assets and liabilities. These policies and judgments, estimates and assumptions are described in greater detail below. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Further, subsequent changes in economic or market conditions could have a material impact on these estimates and our financial condition and operating results in future periods. There have been no significant changes in our application of accounting policies during the first six months of 2014.

Interest Income: (Note 1) Interest on loans and securities is accrued as earned unless management doubts the collectability of the asset or the unpaid interest. Interest accruals on loans are generally discontinued when loans become 90 days past due for payment of interest and the loans are then placed on nonaccrual status. All previously accrued but uncollected interest is deducted from interest income upon transfer to nonaccrual status. For any future payments collected, interest income is recognized only upon management’s assessment that there is a strong likelihood that the full amount of a loan will be repaid or recovered. A loan may be put on nonaccrual status sooner than this policy would dictate if, in management’s judgment, the amounts owed, principal or interest, may be uncollectable. While less common, similar interest reversal and nonaccrual treatment is applied to investment securities if their ultimate collectability becomes questionable.

Provision and Allowance for Loan Losses: (Note 7) The provision for loan losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves. We maintain an allowance for loan losses consistent in all material respects with the GAAP guidelines outlined in ASC 450, Contingencies. We have established systematic methodologies for the determination of the adequacy of our allowance for loan losses. The methodologies are set forth in a formal policy and take into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual problem loans. We increase our allowance for loan losses by charging provisions for probable loan losses against our income and value impaired loans consistent with the accounting guidelines outlined in ASC 310, Receivables.

The allowance for losses on loans is maintained at a level sufficient to provide for probable losses based on evaluating known and inherent risks in the loan portfolio and upon our continuing analysis of the factors underlying the quality of the loan portfolio. These factors include, among others, changes in the size and composition of the loan portfolio, delinquency rates, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectability may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. Realized losses related to specific assets are applied as a reduction of the carrying value of the assets and charged immediately against the allowance for loan loss reserve. Recoveries on previously charged off loans are credited to the allowance. The reserve is based upon factors and trends identified by us at the time financial statements are prepared. Although we use the best information available, future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions beyond our control. The adequacy of general and specific reserves is based on our continuing evaluation of the pertinent factors underlying the quality of the loan portfolio as well as individual review of certain large balance loans. Loans are considered impaired when, based on current information and events, we determine that it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, the financial condition of the borrower, the value of the underlying collateral and the current status of the economy. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value

of collateral if the loan is collateral dependent. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Loans that are collectively evaluated for impairment include residential real estate and consumer loans and, as appropriate, smaller balance non-homogeneous loans. Larger balance non-homogeneous residential construction and land, commercial real estate, commercial business loans and unsecured loans are individually evaluated for impairment.

Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, an allocated formula allowance and an unallocated allowance. Losses on specific loans are provided for when the losses are probable and estimable. General loan loss reserves are established to provide for inherent loan portfolio risks not specifically provided for on an individual loan basis. The level of general loan loss reserves is based on analysis of potential exposures existing in our loan portfolio including evaluation of historical trends, current market conditions and other relevant factors identified by us at the time the financial statements are prepared. The formula allowance is calculated by applying loss factors to outstanding loans, excluding those loans that are subject to individual analysis for specific allowances. Loss factors are based on our historical loss experience adjusted for significant environmental considerations, including the experience of other banking organizations, which in our judgment affect the collectability of the portfolio as of the evaluation date. The unallocated allowance is based upon our evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. This methodology may result in losses or recoveries differing significantly from those provided in the Consolidated Financial Statements.

While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of the Banks’ allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their judgment of information available to them at the time of their examination.

Fair Value Accounting and Measurement: (Note 11) We use fair value measurements to record fair value adjustments to certain financial assets and liabilities and to determine fair value disclosures. We include in the Notes to the Consolidated Financial Statements information about the extent to which fair value is used to measure financial assets and liabilities, the valuation methodologies used and the impact on our results of operations and financial condition. Additionally, for financial instruments not recorded at fair value we disclose, where appropriate, our estimate of their fair value. For more information regarding fair value accounting, please refer to Note 11 in the Selected Notes to the Consolidated Financial Statements in this report on Form 10-Q.

Other Intangible Assets: (Note 9) Other intangible assets consists primarily of core deposit intangibles (CDI), which are amounts recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the customer relationships associated with the deposits. Core deposit intangibles are being amortized on an accelerated basis over a weighted average estimated useful life of eight years. These assets are reviewed at least annually for events or circumstances that could impact their recoverability. These events could include loss of the underlying core deposits, increased competition or adverse changes in the economy. To the extent other identifiable intangible assets are deemed unrecoverable, impairment losses are recorded in other non-interest expense to reduce the carrying amount of the assets.

Mortgage Servicing Rights: (Note 9) Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of loans. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage loans, the value of the servicing right is estimated and capitalized. Fair value is based on market prices for comparable mortgage servicing contracts. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Real Estate Held for Sale: (Note 8) Property acquired by foreclosure or deed in lieu of foreclosure is recorded at the lower of the estimated fair value of the property, less expected selling costs, or the carrying value of the defaulted loan. Development and improvement costs relating to the property may be capitalized, while other holding costs are expensed. The carrying value of the property is periodically evaluated by management and, if necessary, allowances are established to reduce the carrying value to net realizable value. Gains or losses at the time the property is sold are charged or credited to operations in the period in which they are realized. The amounts the Banks will ultimately recover from real estate held for sale may differ substantially from the carrying value of the assets because of market factors beyond the Banks’ control or because of changes in the Banks’ strategies for recovering the investment.

Income Taxes and Deferred Taxes: (Note 12) The Company and its wholly-owned subsidiaries file consolidated U.S. federal income tax returns, as well as state income tax returns in Oregon and Idaho. Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset or liability is determined based on the enacted tax rates which are expected to be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Company’s income tax returns. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Under GAAP (ASC 740), a valuation allowance is required to be recognized if it is “more likely than not” that all or a portion of our deferred tax assets will not be realized.

Comparison of Financial Condition at June 30, 2014 and December 31, 2013

General. Total assets increased $356 million, or 8%, to $4.745 billion at June 30, 2014, from $4.389 billion at December 31, 2013. Net loans receivable (gross loans less deferred fees and discounts, and allowance for loan losses) increased $344 million, or 10%, to $3.688 billion at June 30, 2014, from $3.344 billion at December 31, 2013.

The increase in net loans included increases of $154 million in commercial real estate loans, $53 million in commercial business loans, $13 million in one- to four-family construction loans, $52 million in multifamily loans, $29 million in one- to four-family residential loans, $17 million in agricultural business loans, and $40 million in consumer loans, partially offset by decreases of $12 million in multifamily construction loans, and $2 million in land and land development loans. The increase in commercial real estate loans included $115 million for investment properties and $39 million for owner-occupied properties. The increase in commercial business loans is an encouraging sign of improving economic activity as well as additional successful sales results for our lending officers. The increase in agricultural business loans represents a normal seasonal increase for the second quarter. The Branch Acquisition resulted in an $88 million increase in loans, including $37 million in commercial real estate loans, $22 million in consumer loans, $13 million in commercial business loans, $11 million in one- to four-family real estate loans, $3 million in agricultural business loans and $2 million in multifamily real estate loans.

The aggregate balance of interest-earning deposits and securities increased $10 million from December 31, 2013 to $713 million at June 30, 2014. Interest-earning deposits decreased $5 million during the quarter to $63 million, while our total investment in securities increased $15 million to $650 million at June 30, 2014. Securities purchases during the six-month period have been modest and were primarily mortgage-backed securities and intermediate-term taxable and tax-exempt municipal securities purchased to support our Community Reinvestment Act goals. Securities sales have also been modest and were primarily sales of mortgage-backed securities. The average effective duration of Banner's securities portfolio was approximately 3.3 years at June 30, 2014. Net fair value adjustments to the portfolio of securities held for trading, which are included in net income, were $3.4 million in the six months ended June 30, 2014. In addition, for the six months ended June 30, 2014, fair value adjustments for securities designated as available-for-sale reflected an increase of $4.8 million, for the six months ended June 30, 2014, which was included net of the associated tax expense of $1.7 million. as a component of other comprehensive income and largely occurred as a result of modestly decreased interest rates. (See Note 11 of the Selected Notes to the Consolidated Financial Statements in this Form 10-Q.)

REO increased $344,000, to $4.4 million at June 30, 2014, compared to $4.0 million at December 31, 2013. The June 30, 2014 total included $2 million in residential construction, land or land development projects and $2 million in single-family homes. During the three months ended June 30, 2014, we transferred $2 million of loans into REO, disposed of $1 million of REO properties recognizing $157,000 in gains related to those sales, and did not have any valuation adjustments. During the six months ended June 30, 2014, we transferred $2.7 million of loans into REO, disposed of $2.7 million of REO properties recognizing $316,000 in gains related to those sales, and charged-off $37,000 in valuation adjustments (see “Asset Quality” discussion below).

Deposits increased $301 million, or 8%, to $3.919 billion at June 30, 2014 from $3.618 billion at December 31, 2013, largely as a result of the Branch Acquisition, as well as an $84 million increase in brokered deposits utilized to meet short-term funding needs caused by the strong loan growth and expected seasonal deposit outflows. Non-interest-bearing deposits increased by $95 million, or 8%, to $1.210 billion at June 30, 2014, compared to $1.115 billion at December 31, 2013, and have increased by 26% compared to a year earlier. Interest-bearing transaction and savings accounts increased by $142 million, or 9%, to $1.772 billion at June 30, 2014 from $1.630 billion at December 31, 2013 and have increased by 14% compared to a year earlier. Certificates of deposit increased $64 million, or 7%, to $937 million at June 30, 2014 from $873 million at December 31, 2013, but have decreased by 1% compared to a year earlier. Non-certificate core deposits increased to 76% of total deposits at the end of the second quarter, compared to 73% of total deposits a year earlier. The Branch Acquisition resulted in a $212 million increase in deposits, including $80 million in non-interest bearing deposits, $97 million in interest-bearing transaction and savings accounts, and $35 million in certificates of deposit.

FHLB advances increased $18 million, or 66%, to $45 million at June 30, 2014 from $27 million at December 31, 2013 to fund loan demand. The new advances all have very short-term maturities with correspondingly low interest rates. Other borrowings, consisting of retail repurchase agreements primarily related to customer cash management accounts, increased $6 million, or 7%, to $89 million at June 30, 2014, compared to $83 million at December 31, 2013. No additional junior subordinated debentures were issued or matured during the quarter and the estimated fair value of these instruments increased $3 million to $77 million at June 30, 2014 from $74 million at December 31, 2013. For more information, see Notes 10, 11 and 12 of the Selected Notes to the Consolidated Financial Statements.

Total stockholders' equity increased $24 million, or 4%, to $563 million at June 30, 2014 compared to $539 million at December 31, 2013. The increase in equity primarily reflects the year-to-date net income reduced by payment of dividends to common stockholders. In addition, there was an improvement of $3.1 million in accumulated other comprehensive income representing a decline in the unrealized loss, net of tax, on securities available-for-sale. Tangible common stockholders' equity, which excludes intangible assets, also increased $23 million to $559 million, or 11.79% of tangible assets at June 30, 2014, compared to $537 million, or 12.23% at December 31, 2013. In the six months ended June 30, 2014, we did not have any repurchases of our common stock as part of the publicly announced repurchase plan, but 537 shares were surrendered by employees to satisfy tax withholding obligations upon the vesting of restricted stock grants. Additionally, there were 47,890 shares redeemed and canceled that related to the termination of the ESOP.

Comparison of Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013

For the quarter ended June 30, 2014, net income was $17.0 million, or $0.88 per diluted share. This compares to net income of $11.8 million, or $0.60 per diluted share, for the quarter ended June 30, 2013. For the six months ended June 30, 2014, net income was $27.6 million, or $1.42

per diluted share. This compares to net income of $23.3 million, or $1.20 per diluted share, for the six months ended June 30, 2013. As expected, our current quarter and six month operating results continued to be influenced by very low interest rates and modest economic growth, which pressured asset yields and reduced mortgage banking revenues compared to the same periods a year ago. Nonetheless, significant growth in earning assets, as well as changes in the asset mix and further reductions in funding costs combined to offset this yield pressure. In addition, credit costs remained low and deposit fees and other payment processing revenues increased compared to a year earlier reflecting further growth in client relationships. In the quarter ended June 30, 2014, net income was also significantly augmented by the $9.1 million bargain purchase gain ($5.8 million net of income tax) realized from the Branch Acquisition. As a result, net income for the current quarter and six months remains solid, represents further progress in 2014 and produced an annualized return on average assets of 1.51% for the quarter and 1.24% for the six months ended June 30, 2014, a significant improvement from 0.97% and 1.11% for the same periods a year ago.

Net Interest Income. Net interest income before provision for loan losses increased by $1.6 million, or 4%, to $43.8 million for the quarter ended June 30, 2014, compared to $42.2 million for the same quarter one year earlier, as a decrease in the net interest margin was more than offset by an increase in the average balance of interest-earning assets. The net interest margin of 4.06% for the quarter ended June 30, 2014 was 14 basis points lower than for the same quarter in the prior year. The decrease in the net interest margin compared to a year earlier reflects the impact of persistently low market interest rates on earning asset yields, which was only partially offset by changes in the earning asset mix and reductions in deposit and other funding costs. Nonaccrual loans reduced the margin by three basis points in the second quarter of 2014, while net collections on nonaccrual loans added two basis points to the margin in the second quarter of 2013. In addition, the decrease in the average balance of real estate owned as of June 30, 2014 compared to June 30, 2013 reduced the adverse effect of this non-interest-earning asset on the net interest margin.

The net interest spread decreased to 4.03% for the quarter ended June 30, 2014 compared to 4.17% for the same quarter a year earlier. Reflecting generally lower market interest rates as well as changes in asset mix, the yield on earning assets for the quarter ended June 30, 2014 was 4.31%, a decrease of 22 basis points compared to the same quarter a year earlier. While declining less than asset yields, funding costs were also significantly lower, especially deposit costs which decreased eight basis points to 0.21% from 0.29% a year earlier, leading to a decrease of eight basis points for all funding liabilities to 0.28% for the quarter ended June 30, 2014.

Net interest income before provision for loan losses increased by $2.9 million, or 4%, to $86.1 million for the six months ended June 30, 2014 compared to $83.2 million for the same period one year earlier, as a result of an increase in average interest-earning assets and despite a 12 basis point decrease in the net interest margin. The net interest margin decreased to 4.06% for the six months ended June 30, 2014 compared to 4.18% for the same period in the prior year and, similar to the results for the current quarter, this decrease was a result of the effect of lower asset yields and occurred despite lower funding costs and fewer non-performing assets. Nonaccruing loans reduced the margin by three basis points during the six months ended June 30, 2014, compared to a two basis point reduction for the same period one year earlier.

Interest Income. Interest income for the quarter ended June 30, 2014 was $46.5 million, compared to $45.6 million for the same quarter in the prior year, an increase of $969,000, or 2%. The increase in interest income occurred as a result of an increase in the average balances of interest-earning assets, which was largely offset by a decline in the yield. The average balance of interest-earning assets was $4.333 billion for the quarter ended June 30, 2014, an increase of $295 million, or 7%, compared to $4.038 billion one year earlier. The yield on average interest-earning assets decreased to 4.31% for the quarter ended June 30, 2014, compared to 4.53% for the same quarter one year earlier. The decrease in the yield on earning assets reflects the continuing erosion of yields as loans mature or prepay and are replaced by lower yielding assets in the current low interest rate environment. Average loans receivable for the quarter ended June 30, 2014 increased $338 million, or 10%, to $3.589 billion, compared to $3.251 billion for the same quarter in the prior year. Interest income on loans increased by $907,000, or 2%, to $43.2 million for the current quarter from $42.3 million for the quarter ended June 30, 2013, reflecting the impact of the $338 million increase in average loan balances, partially offset by a 39 basis point decrease in the average yield on loans. The average yield on loans was 4.83% for the quarter ended June 30, 2014, compared to 5.22% for the same quarter one year earlier.

Interest income for the six months ended June 30, 2014 was $91.6 million, compared to $90.1 million for the same period in the prior year, an increase of $1.5 million, or 2%. As with quarterly results, the year-to-date results reflect a $260.2 million, or 6%, increase in the average balance of interest-earning assets, offset by a 20 basis point reduction in the yield on interest-earning assets.

The combined average balance of mortgage-backed securities, other investment securities, and daily interest-bearing deposits decreased to $744 million for the quarter ended June 30, 2014 (excluding the effect of fair value adjustments), compared to $787 million for the quarter ended June 30, 2013; however, the interest and dividend income from those investments increased by $62,000 compared to the same quarter in the prior year. The average yield on the combined portfolio increased to 1.80% for the quarter ended June 30, 2014, from 1.67% for the same quarter one year earlier. The adverse impact of relatively low market rates on the combined yield on these investments was offset by changes in the mix to include lower balances of daily interest-bearing deposits and more higher-yielding securities. For the quarter ended June 30, 2014, the yield on mortgage-backed securities decreased one basis point to 1.66% compared to the quarter ended June 30, 2013; however, for the six-months ended June 30, 2014, the yield on mortgage-backed securities increased five basis points to 1.68% compared to the same period in the previous year. For the quarter ended June 30, 2014, the yield on other securities increased 29 basis points to 2.41% compared to the quarter ended June 30, 2013 and for the six-months ended June 30, 2014, the yield on other securities increased 32 basis points to 2.45% compared to the same period in the previous year.

Interest Expense. Interest expense for the quarter ended June 30, 2014 was $2.7 million, compared to $3.3 million for the same quarter in the prior year, a decrease of $591,000, or 18%. The decrease in interest expense occurred as a result of an eight basis point decrease in the average cost of all funding liabilities to 0.28% for the quarter ended June 30, 2014, from 0.36% for the same quarter one year earlier, partially offset by a $241 million increase in average funding liabilities. This increase in average funding liabilities reflects increases in transaction and savings

accounts including non-interest-bearing accounts, and advances from the FHLB, offset by a continued decline in the average balance of certificates of deposit compared to one year ago. Interest expense for the six months ended June 30, 2014 and 2013 was $5.5 million and $6.9 million, respectively, and similar to quarterly results, the reduction is reflective of a decrease in the average rate paid for most interest-bearing liabilities, partially offset by an increase in their average balances over that time period.

Deposit interest expense decreased $580,000, or 23%, to $1.9 million for the quarter ended June 30, 2014, compared to $2.5 million for the same quarter in the prior year, as a result of an eight basis point decrease in the cost of deposits. Average deposit balances increased to $3.701 billion for the quarter ended June 30, 2014, from $3.490 billion for the quarter ended June 30, 2013, and the average rate paid on deposit balances decreased to 0.21% in the second quarter of 2014 from 0.29% for the quarter ended June 30, 2013. The cost of interest-bearing deposits decreased by nine basis points to 0.30% for the quarter ended June 30, 2014 compared to 0.39% in the same quarter a year earlier despite a $61 million increase in the average balance of interest-bearing accounts. Also contributing to the decrease in total deposit costs was a $150 million increase in the average balances of non-interest-bearing accounts. While we do not anticipate further reductions in market interest rates, we do expect additional modest declines in deposit costs over the near term as maturities of certificates of deposit will present further repricing opportunities and competitive pricing should remain restrained in the current economic environment. Further, continuing changes in our deposit mix, especially growth in lower cost transaction and savings accounts, in particular non-interest-bearing deposits, have meaningfully contributed to the decrease in our funding costs compared to earlier periods, and should also result in lower deposit costs going forward. However, it is clear that the pace of decline in deposit costs compared to prior periods has slowed and that the opportunity for future reductions is limited.

For the six months ended June 30, 2014, deposit interest expense decreased $1.3 million to $3.9 million compared to $5.2 million for the same period one year ago. Similar to the quarter, average deposit costs decreased by nine basis points and the average balance of deposits increased $164 million for the six months ended June 30, 2014 compared to the same period one year ago.

Average FHLB advances (excluding the effect of fair value adjustments) were $68 million for the quarter ended June 30, 2014, compared to $35 million for the same quarter one year earlier, and the average rate paid on FHLB advances for the quarter ended June 30, 2014 decreased to 0.30% from 0.46% for the same quarter one year earlier. Average FHLB advances increased as a result of certain cash management activities at Banner Bank, while the cost of the advances declined as a larger portion of the advances were reflective of the current low interest rate environment. Interest expense on FHLB advances increased to $51,000 for the quarter ended June 30, 2014 from $40,000 for the quarter ended June 30, 2013. For the six months ended June 30, 2014, interest expense on FHLB advances increased by $26,000 to $90,000 compared to $64,000 for the same period in the prior year. Average FHLB advances excluding the effect of fair value adjustments decreased $2.4 million to $34.1 million over that same time period compared to $36.5 million for the six months ended June 30, 2013. The average rate paid on FHLB advances decreased 36 basis points to 0.31% for the six months ended June 30, 2014, compared to 0.67% for the same period a year ago.

Other borrowings consist primarily of retail repurchase agreements with customers secured by certain investment securities. The average balance for other borrowings increased $3 million to $88 million during the current quarter from $91 million during the same quarter a year earlier, while the rate on other borrowings decreased to 0.21% from 0.22% a year earlier. As a result, interest expense for other borrowings decreased to $45,000 for the quarter ended June 30, 2014, compared to $51,000 for the quarter ended June 30, 2013. For the six months ended June 30, 2014, the average balance for other borrowings increased $1 million to $88 million compared to $87 million during the same period a year earlier, while the rate on other borrowings decreased to 0.20% from 0.25% a year earlier.

Junior subordinated debentures which were issued in connection with our issuance of trust preferred securities had an average balance of $124 million (excluding the effect of fair value adjustments) and an average cost of 2.35% and 2.36%, respectively, for the quarter and six months ended June 30, 2014. Junior subordinated debentures outstanding in the same periods in the prior year had the same average balance of $124 million (excluding the effect of fair value adjustments) with higher average costs of 2.41% and 2.42%, respectively, for the quarter and six months ended June 30, 2013. The junior subordinated debentures are adjustable-rate instruments with repricing frequencies of three months based upon the three-month LIBOR index.

Analysis of Net Interest Spread. The following table presents for the periods indicated our condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities with additional comparative data on our operating performance (dollars in thousands):



	Three Months Ended June 30, 2014							Three Months Ended June 30, 2013
	Average Balance			Interest and Dividends		Yield/ Cost ⁽³⁾		Average Balance			Interest and Dividends		Yield/ Cost ⁽³⁾
Interest-earning assets:
Mortgage loans	$	2,607,763		$	32,351	4.98	%	$	2,364,677		$	31,518	5.35	%
Commercial/agricultural loans	868,070			9,092		4.20		783,618			9,212		4.72
Consumer and other loans	112,821			1,756		6.24		102,513			1,562		6.11
Total loans ⁽¹⁾	3,588,654			43,199		4.83		3,250,808			42,292		5.22
Mortgage-backed securities	349,743			1,446		1.66		334,840			1,394		1.67
Other securities	306,489			1,843		2.41		347,750			1,839		2.12
Interest-bearing deposits with banks	54,887			43		0.31		68,130			46		0.27
FHLB stock	33,055			9		0.11		36,358			—		—
Total investment securities	744,174			3,341		1.80		787,078			3,279		1.67
Total interest-earning assets	4,332,828			46,540		4.31		4,037,886			45,571		4.53
Non-interest-earning assets	197,799							212,661
Total assets	$	4,530,627						$	4,250,547
Deposits:
Interest-bearing checking accounts	$	428,059		87		0.08		$	401,864		96		0.10
Savings accounts	826,043			314		0.15		753,585			388		0.21
Money market accounts	420,343			175		0.17		409,203			232		0.23
Certificates of deposit	915,312			1,334		0.58		964,035			1,774		0.74
Total interest-bearing deposits	2,589,757			1,910		0.30		2,528,687			2,490		0.39
Non-interest-bearing deposits	1,110,979			—		—		960,938			—		—
Total deposits	3,700,736			1,910		0.21		3,489,625			2,490		0.29
Other interest-bearing liabilities:
FHLB advances	67,510			51		0.30		34,961			40		0.46
Other borrowings	88,040			45		0.21		91,015			51		0.22
Junior subordinated debentures	123,716			726		2.35		123,716			742		2.41
Total borrowings	279,266			822		1.18		249,692			833		1.34
Total funding liabilities	3,980,002			2,732		0.28		3,739,317			3,323		0.36
Other non-interest-bearing liabilities ⁽²⁾	(4,237		)					(12,390		)
Total liabilities	3,975,765							3,726,927
Stockholders’ equity	554,862							523,620
Total liabilities and stockholders’ equity	$	4,530,627						$	4,250,547
Net interest income/rate spread				$	43,808	4.03	%				$	42,248	4.17	%
Net interest margin						4.06	%						4.20	%
Additional Key Financial Ratios:
Return on average assets						1.51	%						1.11	%
Return on average equity						12.29							9.00
Average equity / average assets						12.25							12.32
Average interest-earning assets / average interest-bearing liabilities						151.02							145.33
Average interest-earning assets / average funding liabilities						108.86							107.98
Non-interest (other operating) income / average assets						1.78							1.00
Non-interest (other operating) expense / average assets						3.40							3.35
Efficiency ratio ⁽⁴⁾						60.11							67.06


⁽¹⁾	Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past due. Amortization of net deferred loan fees/costs is included with interest on loans.


⁽²⁾	Average other non-interest-bearing liabilities include fair value adjustments related to FHLB advances and junior subordinated debentures.


⁽³⁾	Yields and costs have not been adjusted for the effect of tax-exempt interest.


⁽⁴⁾	Other operating expense divided by the total of net interest income (before provision for loan losses) and other operating income (non-interest income).




	Six Months Ended June 30, 2014							Six Months Ended June 30, 2013
	Average Balance			Interest and Dividends		Yield/ Cost ⁽³⁾		Average Balance			Interest and Dividends		Yield/ Cost ⁽³⁾
Interest-earning assets:
Mortgage loans	$	2,559,911		$	63,503	5.00	%	$	2,362,016		$	62,747	5.36	%
Commercial/agricultural loans	860,404			17,945		4.21		768,081			17,691		4.64
Consumer and other loans	112,009			3,494		6.29		103,019			3,343		6.54
Total loans ⁽¹⁾	3,532,324			84,942		4.85		3,233,116			83,781		5.23
Mortgage-backed securities	351,042			2,917		1.68		317,168			2,566		1.63
Other securities	303,390			3,681		2.45		342,575			3,620		2.13
Interest-bearing deposits with banks	56,610			88		0.31		87,930			113		0.26
FHLB stock	34,098			18		0.11		36,506			—		—
Total investment securities	745,140			6,704		1.81		784,179			6,299		1.62
Total interest-earning assets	4,277,464			91,646		4.32		4,017,295			90,080		4.52
Non-interest-earning assets	199,006							215,006
Total assets	$	4,476,470						$	4,232,301
Deposits:
Interest-bearing checking accounts	$	423,548		172		0.08		$	396,684		192		0.10
Savings accounts	822,702			634		0.16		748,942			769		0.21
Money market accounts	417,666			372		0.18		410,598			496		0.24
Certificates of deposit	902,679			2,696		0.60		984,898			3,753		0.77
Total interest-bearing deposits	2,566,595			3,874		0.30		2,541,122			5,210		0.41
Non-interest-bearing deposits	1,093,646			—		—		954,642			—		—
Total deposits	3,660,241			3,874		0.21		3,495,764			5,210		0.30
Other interest-bearing liabilities:
FHLB advances	59,048			90		0.31		19,394			64		0.67
Other borrowings	88,105			89		0.20		87,075			107		0.25
Junior subordinated debentures	123,716			1,446		2.36		123,716			1,482		2.42
Total borrowings	270,869			1,625		1.21		230,185			1,653		1.45
Total funding liabilities	3,931,110			5,499		0.28		3,725,949			6,863		0.37
Other non-interest-bearing liabilities ⁽²⁾	(5,154		)					(12,888		)
Total liabilities	3,925,956							3,713,061
Stockholders’ equity	550,514							519,240
Total liabilities and stockholders’ equity	$	4,476,470						$	4,232,301
Net interest income/rate spread				$	86,147	4.04	%				$	83,217	4.15	%
Net interest margin						4.06	%						4.18	%
Additional Key Financial Ratios:
Return on average assets						1.24	%						1.11	%
Return on average equity						10.10							9.06
Average equity / average assets						12.30							12.27
Average interest-earning assets / average interest-bearing liabilities						150.75							144.96
Average interest-earning assets / average funding liabilities						108.81							107.82
Non-interest (other operating) income / average assets						1.31							0.98
Non-interest (other operating) expense / average assets						3.33							3.31
Efficiency ratio ⁽⁴⁾						64.28							66.99


⁽¹⁾	Average balances include loans accounted for on a nonaccrual basis and loans 90 days or more past due. Amortization of net deferred loan fees/costs is included with interest on loans.


⁽²⁾	Average other non-interest-bearing liabilities include fair value adjustments related to FHLB advances and junior subordinated debentures.


⁽³⁾	Yields and costs have not been adjusted for the effect of tax-exempt interest.


⁽⁴⁾	Other operating expense divided by the total of net interest income (before provision for loan losses) and other operating income (non-interest income).

Provision and Allowance for Loan Losses. As a result of substantial reserves already in place representing 1.97% of total loans outstanding, as well as declining delinquencies and net charge-offs, we did not record a provision for loan losses in either the quarter or the six months ended June 30, 2014. Similarly, we did not record a provision in either the quarter or the six months ended June 30, 2013, as we also had substantial reserves at the end of each of those periods and were experiencing improving credit quality trends during those periods. As discussed in the Summary of Critical Accounting Policies section above and in Note 1 of the Selected Notes to the Consolidated Financial Statements in this Form 10-Q, the provision and allowance for loan losses is one of the most critical accounting estimates included in our Consolidated Financial Statements.

The provision for loan losses reflects the amount required to maintain the allowance for losses at an appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves, trends in delinquencies and net charge-offs and current economic conditions. Reflecting lingering weakness in the economy, we continue to maintain a substantial allowance for loan losses at June 30, 2014 even though non-performing loans declined during the quarter. Nonetheless, our credit quality indicators have continued to improve, eliminating the need for a provision for loan losses for the first six months of 2014.

We recorded net charge-offs of $61,000 for the quarter ended June 30, 2014, compared to $275,000 for the same quarter in the prior year. Non-performing loans decreased by $3 million during the quarter ended June 30, 2014 to $20 million, and decreased by $6 million compared to the quarter ended June 30, 2013. A comparison of the allowance for loan losses at June 30, 2014 and 2013 reflects a decrease of $3 million to $74 million at June 30, 2014, from $77 million at June 30, 2013. Included in our allowance at June 30, 2014 was an unallocated portion of $7 million, which is based upon our evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. The allowance for loan losses as a percentage of total loans (loans receivable excluding allowance for losses) decreased to 1.97% at June 30, 2014, from 2.34% at June 30, 2013. However, with the decrease in problem loans, the allowance as a percentage of non-performing loans increased to 376% at June 30, 2014, compared to 300% of non-performing loans at December 31, 2013 and 294% a year earlier.

As of June 30, 2014, we had identified $57 million of impaired loans. Impaired loans are comprised of loans on nonaccrual, TDRs that are performing under their restructured terms and loans that are 90 days or more past due, but are still on accrual. Impaired loans may be evaluated for reserve purposes using either a specific impairment analysis or collectively evaluated as part of homogeneous pools. For more information on these impaired loans, refer to Note 11 of the Selected Notes to the Consolidated Financial Statements, Fair Value Accounting and Measurement, in this Form 10-Q.

We believe that the allowance for loan losses as of June 30, 2014 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that these estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of the allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.

Other Operating Income. Other operating income, which includes changes in the valuation of financial instruments carried at fair value, OTTI charges and recoveries, gain on sale of securities, and the Branch Acquisition bargain purchase gain in the current quarter, as well as non-interest revenues from core operations, was $20.1 million for the quarter ended June 30, 2014, compared to $10.6 million for the same quarter in the prior year. Our other operating income for the three months ended June 30, 2014 included the Branch Acquisition bargain purchase gain of $9.1 million and a $464,000 net gain for fair value adjustments as a result of changes in the valuation of our securities portfolios. During the quarter ended June 30, 2013, fair value adjustments resulted in a net loss of $255,000. For a more detailed discussion of our fair value adjustments, please refer to Note 11 in the Selected Notes to the Consolidated Financial Statements in this Form 10-Q.

Other operating income, including changes in the valuation of financial instruments carried at fair value, OTTI charges and recoveries, gain on sale of securities, and the Branch Acquisition bargain purchase gain, was $29.0 million for the six months ended June 30, 2014, compared to $20.6 million for the same period in the prior year. Our other operating income for the six months ended June 30, 2014 included the $9.1 million Branch Acquisition bargain purchase gain, a gain on the sale of securities of $35,000, and fair value adjustments resulting in a gain of $209,000, compared to a gain on sale of securities of $1.0 million, an OTTI recovery of $409,000, and fair value adjustments resulting in a loss of $1.6 million during the same period one year ago.

Excluding the fair value and OTTI adjustments, gain on sale of securities and Branch Acquisition bargain purchase gain, other operating income from core operations decreased by $276,000, or 3%, to $10.6 million for the quarter ended June 30, 2014, compared to $10.9 million for the quarter ended June 30, 2013, largely as a result of decreased revenues from mortgage banking operations. Mortgage banking revenues decreased by $1.0 million as increased mortgage rates slowed originations for refinancing. By contrast, deposit fees and service charges increased by $718,000 compared to the second quarter a year ago reflecting growth in the number of deposit accounts, increased transaction activity and our decision to change our debit card relationship to MasterCard^®. The change to MasterCard resulted in some one-time income recognition which added approximately $120,000 of revenue to the current quarter and will also boost third quarter revenues modestly. There will also be an ongoing positive impact on our revenues, as well as continuing benefits for our clients from this changed relationship. Other operating income from core operations decreased by $1.1 million, or 5%, to $19.7 million for the six months ended June 30, 2014. Similar to the quarterly discussion above, mortgage banking operations decreased by $2.0 million compared to the first six months of the prior year while deposit fees and service charges increased by $1.0 million.

Other Operating Expenses. Other operating expenses increased by $3.0 million, to $38.4 million for the quarter ended June 30, 2014, compared to $35.5 million for the quarter ended June 30, 2013, largely as a result of Branch Acquisition-related costs, increased salary and employee benefits, payment and card processing and professional services expenses, which were partially offset by decreased advertising and marketing expense and state/municipal business and use taxes as well as an increase in the credit for capitalized loan origination costs. Branch Acquisition-related costs were $2.0 million for the quarter ended June 30, 2014 and there were no acquisition-related costs in the same quarter one year ago.

Salary and employee benefits expense increased $1.1 million, or 5%, to $22.3 million for the quarter ended June 30, 2014, compared to $21.2 million for the quarter ended June 30, 2013, primarily reflecting salary and wage adjustments, incentive bonus accruals, and increased health insurance and other benefit costs somewhat offset by reduced mortgage banking commissions.

Partially offsetting the increase in compensation, the credit for capitalized loan origination costs increased by $212,000 compared to the same quarter a year earlier. Payment and card processing expenses increased $297,000 (12%) compared to the same period one year earlier reflecting increased transactions as a result of the significant growth in core deposits. Professional services expense was $289,000 (35%) higher than in the prior year. Occupancy expense increased $125,000, or 2%, to $5.5 million for the quarter ended June 30, 2014, compared to $5.4 million for the quarter ended June 30, 2013 due largely to increased depreciation expense related to computer hardware and software upgrades and building repair and maintenance expenses. Advertising and marketing expenses decreased $428,000, or 24%, to $1.4 million for the quarter ended June 30, 2014, compared to $1.8 million for the quarter ended June 30, 2013. State/municipal business and use tax expense of $388,000 was $150,000 lower than in the same period one year earlier due to the reduction in the state tax rate from 1.80% to 1.50%. Net gains from REO operations were $109,000 for the quarter ended June 30, 2014 compared to net gains of $195,000 for the quarter ended June 30, 2013.

Other operating expenses for the six months ended June 30, 2014 increased $4.4 million, or 6%, to $74.0 million compared to $69.6 million for the six months ended June 30, 2013. Branch Acquisition-related costs added $2.0 million to operating expenses in the first six months this year compared to no acquisition-related costs in the same period last year. Salary and employee benefits expense increased $1.5 million, or 4%, to $43.5 million for the six months ended June 30, 2014 compared to $42.0 million for the six months ended June 30, 2013, again reflecting salary and wage adjustments and other benefit costs, partially offset by reduced mortgage banking commissions. In addition, the credit for capitalized loan origination costs decreased by $464,000 compared to the same six-month period a year earlier. Reflecting the significant growth in core deposits, expenses for payment and card processing increased by $508,000, or 11%, to $5.3 million for the six months ended June 30, 2014, compared to $4.8 million for the same period in the prior year. Occupancy expenses increased $492,000, or 5%, to $11.2 million for the six months ended June 30, 2014, compared to $10.7 million for the same period in the prior year. REO operations for the six months ended June 30, 2014 resulted in a $70,000 net gain, compared to a net gain of $446,000 for the prior-year period, and included $37,000 of valuation adjustments and $316,000 of net gains on the sale of properties. Professional services expense for the six months ended June 30, 2014 increased $389,000, or 23%, compared to one year ago. Partially offsetting those increases were decreases in advertising and marketing expenses and state/municipal business and use taxes of $872,000 (26%) and $456,000 (45%), respectively. Most other operating expenses were little changed from a year earlier.

Income Taxes. In the quarter ended June 30, 2014, we recognized $8.5 million in income tax expense for an effective tax rate of 33.3%, which reflects our normal statutory tax rate reduced by the impact of tax-exempt income and certain tax credits. Our normal, expected statutory income tax rate is 36.5%, representing a blend of the statutory federal income tax rate of 35.0% and apportioned effects of the 7.6% Oregon and Idaho income tax rates. For the quarter ended June 30, 2013, we recognized $5.7 million in income tax expense for an effective tax rate of 32.5%. For the six months ended June 30, 2014, we recognized $13.5 million in income tax expense for an effective tax rate of 32.9%. For the six months ended June 30, 2013, we recognized $10.9 million in income tax expense for an effective tax rate of 31.9%. For more discussion on our deferred tax asset, please refer to Note 12 in the Selected Notes to the Consolidated Financial Statements in this report on Form 10-Q.

Asset Quality

Achieving and maintaining a moderate risk profile by employing appropriate underwriting standards, avoiding excessive asset concentrations and aggressively managing troubled assets has been and will continue to be a primary focus for us. As a result, our non-performing assets declined substantially in 2013 and have decreased further in the first six months of 2014. Our key credit quality metrics have improved compared to a year ago, including improvement during the second quarter of this year, and as a result our collection costs have been further reduced. In addition, our reserve levels are substantial and, as a result of our impairment analysis and charge-off actions, reflect current appraisals and valuation estimates as well as recent regulatory examination results. While our non-performing assets and credit costs have been materially reduced, we continue to be actively engaged with our borrowers in resolving remaining problem assets and with the effective management of real estate owned as a result of foreclosures.

Non-Performing Assets: Non-performing assets decreased to $24 million, or 0.51% of total assets, at June 30, 2014, from $29 million, or 0.66% of total assets, at December 31, 2013, and $33 million, or 0.78% of total assets, at June 30, 2013. Construction and land development loans, including related REO, represented approximately 15% of our non-performing assets at June 30, 2014. Reflecting lingering weakness in the economy and property values which now have generally stabilized but are lower than when many of the related loans were originated, we continued to maintain a substantial allowance for loan losses even though non-performing loans declined. At June 30, 2014, our allowance for loan losses was $74 million, or 1.97% of total loans and 376% of non-performing loans, compared to $74 million, or 2.17% of total loans and 300% of non-performing loans at December 31, 2013. Included in our allowance at June 30, 2014 was an unallocated portion of $7 million, which is based upon our evaluation of various factors that are not directly measured in the determination of the formula and specific allowances. We believe our level of non-performing loans and assets, which declined significantly during the past two years, is manageable and further believe that we have sufficient capital and human resources to manage the collection of our non-performing assets in an orderly fashion.

The primary components of the $24 million in non-performing assets are $16 million in nonaccrual loans and $4.5 million in REO and other repossessed assets. The geographic distribution of REO included approximately $687,000, or 15%, in the Puget Sound region, $2.4 million, or 53%, in the greater Portland market area, $207,000, or 5%, in the greater Boise market area, and $1.2 million, or 27%, in other areas of Washington, Oregon and Idaho.

Loans are reported as restructured when we grant concessions to a borrower experiencing financial difficulties that we would not otherwise consider. As a result of these concessions, restructured loans or TDRs are impaired as the Banks will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement. If any restructured loan becomes delinquent or other matters call into question the borrower's ability to repay full interest and principal in accordance with the restructured terms, the restructured loan(s) would be reclassified as nonaccrual. At June 30, 2014, we had $37 million of restructured loans currently performing under their restructured terms.

The following table sets forth information with respect to our non-performing assets and restructured loans at the dates indicated (dollars in thousands):



	June 30, 2014			December 31, 2013			June 30, 2013
Nonaccrual Loans: ⁽¹⁾
Secured by real estate:
Commercial	$	2,692		$	6,287		$	4,810
Multifamily	422			—			335
Construction and land	1,296			1,193			2,775
One- to four-family	9,354			12,532			11,465
Commercial business	925			723			2,819
Agricultural business, including secured by farmland	104			—			—
Consumer	1,205			1,173			1,938
	15,998			21,908			24,142
Loans more than 90 days delinquent, still on accrual:
Secured by real estate:
Commercial	993			—			—
One- to four-family	2,181			2,611			1,897
Commercial business	280			—			4
Agricultural business, including secured by farmland	—			105			—
Consumer	293			144			58
	3,747			2,860			1,959
Total non-performing loans	19,745			24,768			26,101
REO, net ⁽²⁾	4,388			4,044			6,714
Other repossessed assets held for sale ⁽²⁾	69			115			118
Total non-performing assets	$	24,202		$	28,927		$	32,933

Total non-performing loans to loans before allowance for loan losses	0.52		%	0.72		%	0.79		%
Total non-performing loans to total assets	0.42		%	0.56		%	0.62		%
Total non-performing assets to total assets	0.51		%	0.66		%	0.78		%

Restructured loans ⁽³⁾	$	37,461		$	47,428		$	51,732

Loans 30-89 days past due and on accrual	$	7,670		$	8,784		$	5,902


⁽¹⁾	Includes $3.9 million of non-accrual restructured loans. For the six months ended June 30, 2014, $599,000 in interest income would have been recorded had nonaccrual loans been current.

(2)

Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate held for sale until it is sold. When property is acquired, it is recorded at the lower of the estimated fair value of the property, less expected selling costs, or the carrying value of the defaulted loan. Subsequent to foreclosure, the property is carried at the lower of the foreclosed amount or net realizable value. Upon receipt of a new appraisal and market analysis, the carrying value is written down through the establishment of a specific reserve to the anticipated sales price, less selling and holding costs.


(3)	These loans are performing under their restructured terms.

The following table sets forth the Company’s non-performing assets by geographic concentration at June 30, 2014 (dollars in thousands):



	Washington			Oregon			Idaho			Total
Secured by real estate:
Commercial	$	3,685		$	—		$	—		$	3,685
Multifamily	422			—			—			422
Construction and land
Residential land acquisition & development	—			750			—			750
Residential land improved lots	—			546			—			546
Total construction and land	—			1,296			—			1,296
One- to four-family	8,279			2,672			584			11,535
Commercial business	1,163			42			—			1,205
Agricultural business, including secured by farmland	104			—			—			104
Consumer	1,356			6			136			1,498
Total non-performing loans	15,009			4,016			720			19,745
REO	1,801			2,380			207			4,388
Other repossessed assets	69			—			—			69
Total non-performing assets	$	16,879		$	6,396		$	927		$	24,202
Percent of non-performing assets	70		%	26		%	4		%	100		%

In addition to the non-performing loans as of June 30, 2014, we had other classified loans with an aggregate outstanding balance of $62 million that are not on nonaccrual status, with respect to which known information concerning possible credit problems with the borrowers or the cash flows of the properties securing the respective loans has caused management to be concerned about the ability of the borrowers to comply with present loan repayment terms. This may result in the future inclusion of such loans in the nonaccrual loan category.

We have no nonaccrual lending relationships with aggregate loan exposures in excess of $1 million. There were seven non-accrual lending relationships that collectively comprise $4.9 million, or 30.7% of our total non-performing loans as of June 30, 2014. At that date the single largest non-performing lending relationship consisted of two loans that totaled $940,000 secured by single family residences located in the greater Portland, Oregon area. The second largest non-performing lending relationship consisted of three loans that totaled $850,000 secured by commercial real estate and a single family residence. The third largest non-performing lending relationship consisted one loan that totaled $750,000 and is secured by real estate being developed for residential purposes in the greater Portland, Oregon area. The remaining balance of our non-performing loans consists of 79 lending relationships with borrowers located throughout our market areas.

We record REO (acquired through a lending relationship) at fair value on a non-recurring basis. All REO properties are recorded at the lower of the estimated fair value of the property, less estimate selling costs, or the carrying value of the loan. From time to time, non-recurring fair value adjustments to REO are recorded to reflect partial write-downs based on an observable market price or current appraised value of property. The individual carrying values of these assets are reviewed for impairment at least annually and any additional impairment charges are expensed to operations. For the quarter ended June 30, 2014, we had no impairment charges, compared to the quarter ended June 30, 2013 in which we recognized $226,000 of impairment charges related to these types of assets. For the six months ended June 30, 2014 and 2013, we recognized $37,000 and $299,000, respectively, of these impairment charges.

At June 30, 2014, we had $4.4 million of REO, the most significant components of which are a commercial office building in the greater Spokane, Washington area with a book value of $935,000; a subdivision in the greater Portland, Oregon area consisting of eight residential buildable lots and 33.2 acres of undeveloped land with a book value of $798,000; and three residential lots in the greater Portland, Oregon area with a book value of $504,000. All other REO holdings have individual book values of less than $500,000. The geographic distribution of REO included approximately $2.4 million, or 53%, in the greater Portland market area, $687,000, or 15%, in the Puget Sound region, $207,000, or 5%, in the greater Boise market area, and $1.2 million, or 27%, in other areas of Washington, Oregon and Idaho.

Liquidity and Capital Resources

Our primary sources of funds are deposits, borrowings, proceeds from loan principal and interest payments and sales of loans, and the maturity of and interest income on mortgage-backed and investment securities. While maturities and scheduled amortization of loans and mortgage-backed securities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions, competition and our pricing strategies.

Our primary investing activity is the origination and purchase of loans and, in certain periods, the purchase of securities. During the six months ended June 30, 2014 and 2013, our loan originations exceeded our loan repayments by $316 million and $329 million, respectively. During those periods we purchased loans of $102 million and $91,000, respectively. During the six months ended June 30, 2014 and 2013, we sold

$161 million and $276 million, respectively, of loans. Securities purchased during the six months ended June 30, 2014 and 2013 totaled $66 million and $212 million, respectively, and securities repayments, maturities and sales were $58 million and $202 million, respectively.

Our primary financing activity is gathering deposits. Deposits increased by $301 million during the first six months of 2014, including a $64 million increase in certificates of deposits. The Branch Acquisition resulted in a $212 million increase in deposits, including $80 million in non-interest bearing deposits, $97 million in interest-bearing transaction and savings accounts, and $35 million in certificates of deposit. The increase in certificate balances in the six months ended June 30, 2014 reflects an $84 million increase in brokered deposits issued to provide additional funding to support the strong loan growth. Certificates of deposits are generally more price sensitive than other retail deposits and our pricing of those deposits varies significantly based upon our liquidity management strategies at any point in time. At June 30, 2014, certificates of deposit amounted to $937 million, or 24% of our total deposits, including $709 million which were scheduled to mature within one year. While no assurance can be given as to future periods, historically, we have been able to retain a significant amount of our deposits as they mature.

FHLB advances (excluding fair value adjustments) increased $18 million, from December 31, 2013 to $45 million at June 30, 2014, and decreased $9 million from June 30, 2013 to meet loan funding needs. As of June 30, 2014, FHLB advances were for short-term borrowings. Other borrowings increased $6 million to $89 million for the six months ended June 30, 2014 and decreased $2 million from one year ago. The increase in other borrowings in the six months ended June 30, 2014 was due to an increase of retail repurchase agreements.

We must maintain an adequate level of liquidity to ensure the availability of sufficient funds to accommodate deposit withdrawals, to support loan growth, to satisfy financial commitments and to take advantage of investment opportunities. During the six months ended June 30, 2014 and 2013, we used our sources of funds primarily to fund loan commitments, purchase securities, and pay maturing savings certificates and deposit withdrawals. At June 30, 2014, we had outstanding loan commitments totaling $1.225 billion, including undisbursed loans in process and unused credit lines totaling $1.182 billion. While representing potential growth in the loan portfolio and lending activities, this level of commitments is proportionally consistent with our historical experience and does not represent a departure from normal operations.

We generally maintain sufficient cash and readily marketable securities to meet short-term liquidity needs; however, our primary liquidity management practice to supplement deposits is to increase or decrease short-term borrowings, including FHLB advances and Federal Reserve Bank of San Francisco (FRBSF) borrowings. We maintain credit facilities with the FHLB-Seattle, which at June 30, 2014 provide for advances that in the aggregate may equal the lesser of 35% of Banner Bank’s assets or adjusted qualifying collateral (subject to a sufficient level of ownership of FHLB stock), up to a total possible credit line of $849 million, and 25% of Islanders Bank’s assets or adjusted qualifying collateral, up to a total possible credit line of $23 million. Advances under these credit facilities (excluding fair value adjustments) totaled $45 million, or 1.0% of our assets at June 30, 2014. In addition, Banner Bank has been approved for participation in the FRBSF’s Borrower-In-Custody (BIC) program. Under this program Banner Bank had available lines of credit of approximately $680 million as of June 30, 2014, subject to certain collateral requirements, namely the collateral type and risk rating of eligible pledged loans. We had no funds borrowed from the FRBSF at June 30, 2014 or December 31, 2013. Management believes it has adequate resources and funding potential to meet our foreseeable liquidity requirements.

Banner Corporation is a separate legal entity from the Banks and, on a stand-alone level, must provide for its own liquidity and pay its own operating expenses and cash dividends. Banner's primary sources of funds consist of capital raised through dividends or capital distributions from the Banks, although there are regulatory restrictions on the ability of the Banks to pay dividends. At June 30, 2014, the Company (on an unconsolidated basis) had liquid assets of $41.6 million.

As noted below, Banner Corporation and its subsidiary banks continued to maintain capital levels significantly in excess of the requirements to be categorized as “Well-Capitalized” under applicable regulatory standards. During the six months ended June 30, 2014, total equity increased $24 million, or 4%, to $563 million. Total equity at June 30, 2014 is entirely attributable to common stock. At June 30, 2014, tangible common stockholders’ equity, which excludes other intangible assets, was $559 million, or 11.79% of tangible assets. See the discussion and reconciliation of non-GAAP financial information in the Executive Overview section of Management’s Discussion and Analysis of Financial Condition and Results of Operation in this Form 10-Q for more detailed information with respect to tangible common stockholders’ equity. Also, see the capital requirements discussion and table below with respect to our regulatory capital positions.

Capital Requirements

Banner Corporation is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended and the regulations of the Federal Reserve. Banner Bank and Islanders Bank, as state-chartered, federally insured commercial banks, are subject to the capital requirements established by the FDIC.

The capital adequacy requirements are quantitative measures established by regulation that require Banner Corporation and the Banks to maintain minimum amounts and ratios of capital. The Federal Reserve requires Banner Corporation to maintain capital adequacy that generally parallels the FDIC requirements. The FDIC requires the Banks to maintain minimum ratios of Tier 1 total capital to risk-weighted assets as well as Tier 1 leverage capital to average assets. At June 30, 2014, Banner Corporation and the Banks each exceeded all regulatory capital requirements. (See Item 1, “Business–Regulation,” and Note 18 of the Notes to the Consolidated Financial Statements included in the 2013 Form 10-K for additional information regarding regulatory capital requirements for Banner and the Banks.)

The actual regulatory capital ratios calculated for Banner Corporation, Banner Bank and Islanders Bank as of June 30, 2014, along with the minimum capital amounts and ratios, were as follows (dollars in thousands):



	Actual				Minimum for Capital Adequacy Purposes				Minimum to be Categorized as “Well-Capitalized” Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Banner Corporation—consolidated
Total capital to risk-weighted assets	$	667,027	16.45	%	$	324,294	8.00	%	n/a		n/a
Tier 1 capital to risk-weighted assets	616,055		15.20		162,147		4.00		n/a		n/a
Tier 1 leverage capital to average assets	616,055		13.65		180,496		4.00		n/a		n/a
Banner Bank
Total capital to risk-weighted assets	582,843		15.08		309,260		8.00		$	386,574	10.00	%
Tier 1 capital to risk-weighted assets	534,223		13.82		154,630		4.00		231,945		6.00
Tier 1 leverage capital to average assets	534,223		12.50		170,948		4.00		213,685		5.00
Islanders Bank
Total capital to risk-weighted assets	35,697		19.26		14,831		8.00		18,538		10.00
Tier 1 capital to risk-weighted assets	33,376		18.00		7,415		4.00		11,123		6.00
Tier 1 leverage capital to average assets	33,376		13.96		9,563		4.00		11,954		5.00

ITEM 3 – Quantitative and Qualitative Disclosures About Market Risk

Market Risk and Asset/Liability Management

Our financial condition and operations are influenced significantly by general economic conditions, including the absolute level of interest rates as well as changes in interest rates and the slope of the yield curve. Our profitability is dependent to a large extent on our net interest income, which is the difference between the interest received from our interest-earning assets and the interest expense incurred on our interest-bearing liabilities.

Our activities, like all financial institutions, inherently involve the assumption of interest rate risk. Interest rate risk is the risk that changes in market interest rates will have an adverse impact on the institution’s earnings and underlying economic value. Interest rate risk is determined by the maturity and repricing characteristics of an institution’s assets, liabilities and off-balance-sheet contracts. Interest rate risk is measured by the variability of financial performance and economic value resulting from changes in interest rates. Interest rate risk is the primary market risk affecting our financial performance.

The greatest source of interest rate risk to us results from the mismatch of maturities or repricing intervals for rate sensitive assets, liabilities and off-balance-sheet contracts. This mismatch or gap is generally characterized by a substantially shorter maturity structure for interest-bearing liabilities than interest-earning assets, although our floating-rate assets tend to be more immediately responsive to changes in market rates than most funding deposit liabilities. Additional interest rate risk results from mismatched repricing indices and formula (basis risk and yield curve risk), and product caps and floors and early repayment or withdrawal provisions (option risk), which may be contractual or market driven, that are generally more favorable to customers than to us. An exception to this generalization is the beneficial effect of interest rate floors on a substantial portion of our performing floating-rate loans, which help us maintain higher loan yields in periods when market interest rates decline significantly. However, in a declining interest rate environment, as loans with floors are repaid they generally are replaced with new loans which have lower interest rate floors. As of June 30, 2014, our loans with interest rate floors totaled approximately $1.7 billion and had a weighted average floor rate of 4.81%. An additional source of interest rate risk, which is currently of concern, is a prolonged period of exceptionally low market interest rates. Because interest-bearing deposit costs have been reduced to nominal levels, there is very little possibility that they will be significantly further reduced and our non-interest-bearing deposits are an increasingly significant percentage of total deposits. By contrast, if market rates remain very low, loan and securities yields will likely continue to decline as longer-term instruments mature or are repaid. As a result, a prolonged period of very low interest rates will likely result in compression of our net interest margin. While this pressure on the margin may be mitigated by further changes in the mix of assets and deposits, particularly increases in non-interest-bearing deposits, a prolonged period of low interest rates will present a very difficult operating environment for most banks, including us.

The principal objectives of asset/liability management are: to evaluate the interest rate risk exposure; to determine the level of risk appropriate given our operating environment, business plan strategies, performance objectives, capital and liquidity constraints, and asset and liability allocation alternatives; and to manage our interest rate risk consistent with regulatory guidelines and policies approved by the Board of Directors. Through such management, we seek to reduce the vulnerability of our earnings and capital position to changes in the level of interest rates. Our actions in this regard are taken under the guidance of the Asset/Liability Management Committee, which is comprised of members of our senior management. The Committee closely monitors our interest sensitivity exposure, asset and liability allocation decisions, liquidity and capital positions, and local and national economic conditions and attempts to structure the loan and investment portfolios and funding sources to maximize earnings within acceptable risk tolerances.

Sensitivity Analysis

Our primary monitoring tool for assessing interest rate risk is asset/liability simulation modeling, which is designed to capture the dynamics of balance sheet, interest rate and spread movements and to quantify variations in net interest income resulting from those movements under different rate environments. The sensitivity of net interest income to changes in the modeled interest rate environments provides a measurement of interest rate risk. We also utilize economic value analysis, which addresses changes in estimated net economic value of equity arising from changes in the level of interest rates. The net economic value of equity is estimated by separately valuing our assets and liabilities under varying interest rate environments. The extent to which assets gain or lose value in relation to the gains or losses of liability values under the various interest rate assumptions determines the sensitivity of net economic value to changes in interest rates and provides an additional measure of interest rate risk.

The interest rate sensitivity analysis performed by us incorporates beginning-of-the-period rate, balance and maturity data, using various levels of aggregation of that data, as well as certain assumptions concerning the maturity, repricing, amortization and prepayment characteristics of loans and other interest-earning assets and the repricing and withdrawal of deposits and other interest-bearing liabilities into an asset/liability computer simulation model. We update and prepare simulation modeling at least quarterly for review by senior management and the directors. We believe the data and assumptions are realistic representations of our portfolio and possible outcomes under the various interest rate scenarios. Nonetheless, the interest rate sensitivity of our net interest income and net economic value of equity could vary substantially if different assumptions were used or if actual experience differs from the assumptions used.

The following table sets forth, as of June 30, 2014, the estimated changes in our net interest income over one-year and two-year time horizons and the estimated changes in economic value of equity based on the indicated interest rate environments (dollars in thousands):



	Estimated Increase (Decrease) in
Change (in Basis Points) in Interest Rates ⁽¹⁾	Net Interest Income Next 12 Months					Net Interest Income Next 24 Months					Economic Value of Equity
+400	$	(1,192	)	(0.7	)%	$	10,813		3.00	%	$	(70,642	)	(9.2	)%
+300	(879		)	(0.5	)	8,711			2.40		(48,594		)	(6.3	)
+200	(488		)	(0.3	)	6,753			1.90		(28,962		)	(3.8	)
+100	(901		)	(0.5	)	2,765			0.80		(10,726		)	(1.4	)
0	—			—		—			—		—			—
-25	(133		)	(0.1	)	(1,904		)	(0.50	)	(10,082		)	(1.3	)
-50	(1,552		)	(0.9	)	(6,645		)	(1.80	)	(35,195		)	(4.6	)


⁽¹⁾	Assumes an instantaneous and sustained uniform change in market interest rates at all maturities; however, no rates are allowed to go below zero. The current federal funds rate is 0.25%.

Another (although less reliable) monitoring tool for assessing interest rate risk is gap analysis. The matching of the repricing characteristics of assets and liabilities may be analyzed by examining the extent to which assets and liabilities are interest sensitive and by monitoring an institution’s interest sensitivity gap. An asset or liability is said to be interest sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest-bearing liabilities anticipated to mature or reprice, based upon certain assumptions, within that same time period. A gap is considered positive when the amount of interest-sensitive assets exceeds the amount of interest-sensitive liabilities. A gap is considered negative when the amount of interest-sensitive liabilities exceeds the amount of interest-sensitive assets. Generally, during a period of rising rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.

Certain shortcomings are inherent in gap analysis. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of some borrowers to service their debt may decrease in the event of a severe change in market rates.

The following table presents our interest sensitivity gap between interest-earning assets and interest-bearing liabilities at June 30, 2014 (dollars in thousands). The table sets forth the amounts of interest-earning assets and interest-bearing liabilities which are anticipated by us, based upon certain assumptions, to reprice or mature in each of the future periods shown. At June 30, 2014, total interest-earning assets maturing or repricing within one year exceeded total interest-bearing liabilities maturing or repricing in the same time period by $599 million, representing a one-year cumulative gap to total assets ratio of 12.63%. Management is aware of the sources of interest rate risk and in its opinion actively monitors and manages it to the extent possible. The interest rate risk indicators and interest sensitivity gaps as of June 30, 2014 are within our internal policy guidelines and management considers that our current level of interest rate risk is reasonable.



	Within 6 Months			After 6 Months Within 1 Year			After 1 Year Within 3 Years			After 3 Years Within 5 Years			After 5 Years Within 10 Years			Over 10 Years			Total
Interest-earning assets: ⁽¹⁾
Construction loans	$	212,603		$	7,361		$	10,607		$	2,187		$	407		$	73		$	233,238
Fixed-rate mortgage loans	128,496			99,962			254,611			150,492			164,541			88,123			886,225
Adjustable-rate mortgage loans	541,800			146,189			442,570			275,054			23,492			—			1,429,105
Fixed-rate mortgage-backed securities	63,143			42,687			154,648			47,151			14,175			15,689			337,493
Adjustable-rate mortgage-backed securities	2,511			—			—			—			—			—			2,511
Fixed-rate commercial/agricultural loans	45,293			46,771			99,878			35,780			13,985			908			242,615
Adjustable-rate commercial/agricultural loans	606,550			9,436			30,099			20,356			1,182			—			667,623
Consumer and other loans	189,658			15,820			64,909			23,817			15,453			1,452			311,109
Investment securities and interest-earning deposits	177,352			12,052			42,798			56,164			64,355			45,457			398,178
Total rate sensitive assets	1,967,406			380,278			1,100,120			611,001			297,590			151,702			4,508,097
Interest-bearing liabilities: ⁽²⁾
Regular savings and interest checking accounts	204,422			190,118			443,610			443,610			—			—			1,281,760
Money market deposit accounts	245,053			147,032			98,021			—			—			—			490,106
Certificates of deposit	492,911			210,949			186,330			41,405			5,356			36			936,987
FHLB advances	45,200			—			—			—			—			—			45,200
Other borrowings	—			—			—			—			—			—			—
Junior subordinated debentures	123,716			—			—			—			—			—			123,716
Retail repurchase agreements	88,946			—			—			—			—			—			88,946
Total rate sensitive liabilities	1,200,248			548,099			727,961			485,015			5,356			36			2,966,715
Excess (deficiency) of interest-sensitive assets over interest-sensitive liabilities	$	767,158		$	(167,821	)	$	372,159		$	125,986		$	292,234		$	151,666		$	1,541,382
Cumulative excess (deficiency) of interest-sensitive assets	$	767,158		$	599,337		$	971,496		$	1,097,482		$	1,389,716		$	1,541,382		$	1,541,382
Cumulative ratio of interest-earning assets to interest-bearing liabilities	163.92		%	134.28		%	139.23		%	137.06		%	146.84		%	151.96		%	151.96		%
Interest sensitivity gap to total assets	16.17		%	(3.54		)%	7.84		%	2.65		%	6.16		%	3.20		%	32.48		%
Ratio of cumulative gap to total assets	16.17		%	12.63		%	20.47		%	23.13		%	29.29		%	32.48		%	32.48		%

(Footnotes on following page)

Footnotes for Table of Interest Sensitivity Gap

⁽¹⁾

Adjustable-rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due to mature, and fixed-rate assets are included in the period in which they are scheduled to be repaid based upon scheduled amortization, in each case adjusted to take into account estimated prepayments. Mortgage loans and other loans are not reduced for allowances for loan losses and non-performing loans. Mortgage loans, mortgage-backed securities, other loans and investment securities are not adjusted for deferred fees, unamortized acquisition premiums and discounts.

⁽²⁾

Adjustable-rate liabilities are included in the period in which interest rates are next scheduled to adjust rather than in the period they are due to mature. Although regular savings, demand, interest checking, and money market deposit accounts are subject to immediate withdrawal, based on historical experience management considers a substantial amount of such accounts to be core deposits having significantly longer maturities. For the purpose of the gap analysis, these accounts have been assigned decay rates to reflect their longer effective maturities. If all of these accounts had been assumed to be short-term, the one-year cumulative gap of interest-sensitive assets would have been (385,903), or (8.13)% of total assets at June 30, 2014. Interest-bearing liabilities for this table exclude certain non-interest-bearing deposits which are included in the average balance calculations in the table contained in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Comparison of Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013” of this report on Form 10-Q.

ITEM 4 – Controls and Procedures

The management of Banner Corporation is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (Exchange Act). A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Also, because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. As a result of these inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

(a)

Evaluation of Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management as of the end of the period covered by this report. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2014, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.


(b)	Changes in Internal Controls Over Financial Reporting: In the quarter ended June 30, 2014, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1 – Legal Proceedings

In the normal course of business, we have various legal proceedings and other contingent matters outstanding. These proceedings and the associated legal claims are often contested and the outcome of individual matters is not always predictable. These claims and counter claims typically arise during the course of collection efforts on problem loans or with respect to actions to enforce liens on properties in which we hold a security interest. We are not a party to any pending legal proceedings that management believes would have a material adverse effect on our financial condition or operations.

ITEM 1A – Risk Factors

There have been no material changes in the risk factors previously disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013 (File No. 0-26584) or otherwise previously disclosed in our Form 10-Q reports filed subsequently.

ITEM 2 – Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable

(b) Not applicable

(c) The following table provides information about repurchases of common stock by the Company during the quarter ended June 30, 2014:



Period	Total Number of Common Shares Purchased	Average Price Paid per Common Share		Total Number of Shares Purchased as Part of Publicly Announced Plan	Maximum Number of Remaining Shares that May be Purchased at Period End under the Plan
April 1, 2014 – April 30, 2014	1,470	$	40.31	n/a	978,826
May 1, 2014 – May 31, 2014	75	39.52		n/a	978,826
June 1, 2014 – June 30, 2014	4,697	38.79		n/a	978,826
Total for quarter	6,242	39.15		n/a	978,826

The 6,242 shares were surrendered by employees to satisfy tax withholding obligations upon the vesting of restricted stock grants.

On March 26, 2014, the Company announced that its Board of Directors had authorized the repurchase of up to 978,826 shares of the Company's common stock, or 5% of the Company's outstanding shares. Under the plan, shares may be repurchased by the Company in open market purchases. The extent to which the Company repurchases its shares and the timing of such repurchases will depend upon market conditions and other corporate considerations.

ITEM 3 – Defaults upon Senior Securities

Not Applicable.

ITEM 4 – Mine Safety Disclosures

Not Applicable

ITEM 5 – Other Information

Not Applicable.

ITEM 6 – Exhibits



Exhibit	Index of Exhibits

3{a}	Amended and Restated Articles of Incorporation of Registrant [incorporated by reference to the Registrant’s Current Report on Form 8-K filed on April 28, 2010 (File No. 000-26584)], as amended on May 26, 2011 [incorporated by reference to the Current Report on Form 8-K filed on June 1, 2011 (File No. 000-26584)].

3{b}	Bylaws of Registrant [incorporated by reference to Exhibit 3.2 to the Current Report on Form 8-K filed on April 1, 2011 (File No. 000-26584)].

4{a}	Warrant to purchase shares of Company’s common stock dated November 21, 2008 [incorporated by reference to the Registrant’s Current Report on Form 8-K filed on November 24, 2008 (File No. 000-26584)].

10{a}	Executive Salary Continuation Agreement with Gary L. Sirmon [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended March 31, 1996 (File No. 000-26584)].

10{b}	Amended and Restated Employment Agreement with Mark J. Grescovich [incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed on June 4, 2013 (File No. 000-26584)].

10{c}	1996 Stock Option Plan [incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 dated August 26, 1996 (File No. 333-10819)].

10{d}	Supplemental Retirement Plan as Amended with Jesse G. Foster [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended March 31, 1997 (File No. 000-26584)].

10{e}	Supplemental Executive Retirement Program Agreement with D. Michael Jones [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended December 31, 2003 (File No. 000-26584)].

10{f}	Form of Supplemental Executive Retirement Program Agreement with Gary Sirmon, Lloyd W. Baker, Cynthia D. Purcell, and Richard B. Barton [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended December 31, 2001 and the exhibits filed with the Form 8-K on May 6, 2008 (File No. 000-26584)].

10{g}	1998 Stock Option Plan [incorporated by reference to exhibits filed with the Registration Statement on Form S-8 dated February 2, 1999 (File No. 333-71625)].

10{h}	2001 Stock Option Plan [incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 dated August 8, 2001 (File No. 333-67168)].

10{i}	Form of Employment Agreement entered into with Lloyd W. Baker, Cynthia D. Purcell, Richard B. Barton, and Douglas M. Bennett [incorporated by reference to exhibits filed with the Form 8-K on June 25, 2014 (File No. 000-26584)].

10{j}	2004 Executive Officer and Director Stock Account Deferred Compensation Plan [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended December 31, 2005 (File No. 000-26584)].

10{k}	2004 Executive Officer and Director Investment Account Deferred Compensation Plan [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended December 31, 2005 (File No. 000-26584)].

10{l}	Long-Term Incentive Plan and Form of Repricing Agreement [incorporated by reference to the exhibits filed with the Form 8-K on May 6, 2008 (File No. 000-26584)].

10{m}	2005 Executive Officer and Director Stock Account Deferred Compensation Plan [incorporated by reference to exhibits filed with the Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 000-26584)]

10{n}	Entry into an Indemnification Agreement with each of the Registrant's Directors [incorporated by reference to exhibits filed with the Form 8-K on January 29, 2010 (File No. 000-26584)].

10{o}	2012 Restricted Stock and Incentive Bonus Plan [incorporated by reference as Appendix B to the Registrant’s Definitive Proxy Statement on Schedule 14A filed on March 19, 2013 (File No. 000-26584)].

10{p}	Form of Performance-Based Restricted Stock Award Agreement [incorporated by reference to Exhibit 10.1 included in the Registrant's Current Report on Form 8-K filed on June 4, 2013 (File No. 000-26584)].

10{q}	Form of Time-Based Restricted Stock Award Agreement [incorporated by reference to Exhibit 10.1 included in the Registrant's Current Report on Form 8-K filed on June 4, 2013 (File No. 000-26584)].

10{r}	2014 Omnibus Incentive Plan [incorporated by reference as Appendix C to the Registrant's Definitive Proxy Statement on Schedule 14A filed on March 24, 2014 (File No. 000-26584)].



10{s}	Forms of Equity-Based Award Agreements: Incentive Stock Option Award Agreement, Non-Qualified Stock Option Award Agreement, Restricted Stock Award Agreement, Restricted Stock Unit Award Agreement, Stock Appreciation Right Award Agreement, and Performance Unit Award Agreement [incorporated by reference to Exhibits 10.2 - 10.7 included in the Registration Statement on Form S-8 dated May 9, 2014 (File No. 333-195835)].

31.1	Certification of Chief Executive Officer pursuant to the Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	Certification of Chief Financial Officer pursuant to the Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32	Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101	The following materials from Banner Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Statements of Financial Condition; (b) Consolidated Statements of Operations; (c) Consolidated Statements of Comprehensive Income (Loss); (d) Consolidated Statements of Stockholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Selected Notes to Consolidated Financial Statements.*

	* Pursuant to Rule 406T of Regulations S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



	Banner Corporation

August 8, 2014	/s/ Mark J. Grescovich
	Mark J. Grescovich
	President and Chief Executive Officer (Principal Executive Officer)

August 8, 2014	/s/ Lloyd W. Baker
	Lloyd W. Baker
	Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)