REGULATORY 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 (BHCA), 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 Federal Reserve requires Banner to maintain capital adequacy that generally parallels the FDIC requirements.

The following table shows the regulatory capital ratios of the Company and the Banks and the minimum regulatory requirements (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
December 31, 2016:
The Company—consolidated:
Total capital to risk-weighted assets	$	1,214,913	13.40	%	$	725,566	8.00	%	$	906,957	10.00	%
Tier 1 capital to risk-weighted assets	1,125,267		12.41		544,174		6.00		544,174		6.00
Tier 1 common equity to risk-weighted assets	1,014,994		11.19		408,131		4.50		n/a		n/a
Tier 1 capital to average leverage assets	1,125,267		11.83		380,519		4.00		n/a		n/a
Banner Bank:
Total capital to risk- weighted assets	1,043,837		11.76		709,882		8.00		887,352		10.00
Tier 1 capital to risk- weighted assets	956,298		10.78		532,411		6.00		709,882		8.00
Tier 1 common equity to risk-weighted assets	956,298		10.78		399,308		4.50		576,779		6.50
Tier 1 capital to average leverage assets	956,298		10.34		369,936		4.00		462,420		5.00
Islanders Bank:
Total capital to risk- weighted assets	35,207		18.43		15,281		8.00		19,101		10.00
Tier 1 capital to risk- weighted assets	33,099		17.33		11,461		6.00		15,281		8.00
Tier 1 common equity to risk-weighted assets	33,099		17.33		8,598		4.50		12,416		6.50
Tier 1 capital to average leverage assets	33,099		12.72		10,405		4.00		13,006		5.00
December 31, 2015:
The Company—consolidated:
Total capital to risk-weighted assets	$	1,139,554	13.63	%	$	668,941	8.00	%	$	836,530	10.00	%
Tier 1 capital to risk-weighted assets	1,057,597		12.65		501,706		6.00		501,918		6.00
Tier 1 common equity to risk-weighted assets	1,013,971		12.13		376,279		4.50		n/a		n/a
Tier 1 capital to average leverage assets	1,057,597		11.06		382,617		4.00		n/a		n/a
Banner Bank:
Total capital to risk- weighted assets	1,030,601		12.61		653,606		8.00		817,008		10.00	%
Tier 1 capital to risk- weighted assets	950,865		11.64		490,205		6.00		653,606		8.00
Tier 1 common equity to risk-weighted assets	950,865		11.64		367,653		4.50		531,055		6.50
Tier 1 capital to average leverage assets	950,865		10.23		371,807		4.00		464,759		5.00
Islanders Bank:
Total capital to risk- weighted assets	38,448		20.31		15,146		8.00		18,932		10.00
Tier 1 capital to risk- weighted assets	36,227		19.14		11,359		6.00		15,146		8.00
Tier 1 common equity to risk-weighted assets	36,227		19.14		8,520		4.50		12,306		6.50
Tier 1 capital to average leverage assets	36,227		13.38		10,826		4.00		13,533		5.00

At December 31, 2016, Banner Corporation and the Banks each exceeded all regulatory capital adequacy requirements. There have been no conditions or events since December 31, 2016 that have materially adversely changed the Tier 1 or Tier 2 capital of the Company or the Banks. However, events beyond the control of the Banks, such as weak or depressed economic conditions in areas where the Banks have most of their loans, could adversely affect future earnings and, consequently, the ability of the Banks to meet their respective capital requirements. The Company may not declare or pay cash dividends on, or repurchase, any of its shares of common stock if the effect thereof would cause equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration and payment would otherwise violate regulatory requirements.

On July 2, 2013, the Federal Reserve approved a final rule (Final Rule) to establish a new comprehensive regulatory capital framework for all U.S. financial institutions and their holding companies. On July 9, 2013, the Final Rule was approved as an interim final rule by the FDIC. The Final Rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The Final Rule includes new risk-based capital and leverage ratios, which were effective January 1, 2015 and revised the definition of what constitutes “capital” for purposes of calculating those ratios.

Effective January 1, 2015 (with some changes transitioned into full effectiveness over two to four years), Banner and the Banks became subject to the new capital requirements adopted by the Federal Reserve and the FDIC. These new requirements created a new required ratio for common equity Tier 1 (CET1) capital, increased the leverage and Tier 1 capital ratios, changed the risk-weights of certain assets for purposes of the risk-based capital ratios, created an additional capital conservation buffer over the required capital ratios and changed what qualifies as capital for purposes of meeting these various capital requirements. Beginning in 2016, failure to maintain the required capital conservation buffer will limit Banner's ability and the ability of the Banks to pay dividends, repurchase shares or pay discretionary bonuses. Under the new capital regulations, the minimum capital ratios applicable to Banner and the Banks are: (i) a CETI capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from prior rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. CET1 generally consists of common stock; retained earnings; accumulated other comprehensive income (AOCI), unless an election is made to exclude AOCI from regulatory capital, as discussed below; and certain minority interests; all subject to applicable regulatory adjustments and deductions. There are a number of changes in what constitutes regulatory capital, some of which are subject to transition periods. These changes include the phasing-out of certain instruments as qualifying capital. Banner and the Banks do not have any of these instruments. Under the new requirements for total capital, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of CET1 will be deducted from capital. In the first quarter of 2015, we elected to permanently opt-out of the inclusion of AOCI in our capital calculations, to reduce the impact of market volatility on our regulatory capital levels.

The new requirements also included changes in the risk-weights of certain assets to better reflect credit risk and other risk exposures. These included a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in non-accrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (up from 0%); a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital; and increased risk-weights (0% to 600%) for equity exposures.

In addition to the minimum CET1, Tier 1, total capital and leverage ratios, Banner and each of the Banks now have to maintain a capital conservation buffer consisting of additional CET1 capital above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. This new capital conservation buffer requirement began to be phased in starting in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented to an amount equal to 2.5% of risk-weighted assets in January 2019.