Chemical Financial's (CHFC) CEO David Ramaker on Q2 2014 Results - Earnings Call Transcript

Jul.23.14 | About: Chemical Financial (CHFC)

Chemical Financial Corporation (NASDAQ:CHFC)

Q2 2014 Earnings Conference Call

July 23, 2014 11:00 a.m. ET

Executives

Michelle Pilaske – Executive Assistant to the President and CEO

David Ramaker – President and CEO

Lori Gwizdala – EVP, CFO and Treasurer

Analysts

Mike Perito – KBW

Andrew Liesch – Sandler O’Neill

John Rodis – FIG Partners

Daniel Cardenas-Raymond James

Operator

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Chemical Financial Corporation’s Second Quarter Earnings Conference Call. At this all participants are in a listen-only mode, later we will conduct a question and answer session and instructions will be given at that time. As a reminder today’s conference is being recorded. It is now my pleasure to introduce Michelle Pilaske from Chemical Financial Corporation. Please go ahead ma’am.

Michelle Pilaske

Thank you very much. As a reminder a copy of today’s earnings release can be accessed by logging onto cemincalbankmi.com and selecting the investor info tab at the top of the website. We’ve also included a brief slide presentation on our investor info page for supplemental information that may be referenced throughout today’s call. With me today are David Ramaker, Chairman, Chief Executive Officer and President of Chemical Financial Corporation; and Lori Gwizdala, Executive Vice President, Chief Financial Officer and Treasurer. After brief comments from management, we’ll open the call to your questions.

Before we begin, I would like to caution listeners that this conference may contain forward looking statements about Chemical, its businesses, strategies and prospects. Please refer to our forward looking statements disclaimer on page three of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in forward looking statements.

And now I would like to turn the call over to David Ramaker.

David Ramaker

Thank you Michelle and good morning everyone. Thank you for joining us on today’s call. With a strong second quarter we’re continuing our positive earnings momentum in 2014. Earlier today we announced second quarter 2014 net income of $16.2 million or $0.54 per diluted share, up from second quarter of 2013 net income of $14.2 million or $0.51 per diluted share and also up from the first quarter of 2014 net income of $13.8 million or $0.46 per diluted share. I would note that the per share earnings rose from each of the comparable periods despite a higher number of outstanding shares due primarily to our September 2013 and June 2014 follow on common equity offerings.

Looking at the highlights of the quarter on slide 4, it was really a story of strong performance in our core banking business, especially lending. I’ll let Lori provide the details in a minute, but our organic loan growth over the past six quarters which we believe is the combination of an improving Michigan economy and market share gains is driving our earnings momentum.

By funding much of that growth with our low-cost retail deposit base while keeping expenses in line, we are able to see the benefits of the portfolio growth really drive our bottom line financials. And despite having a higher number of shares outstanding even before fully deploying the capital we raised in the aforementioned follow on offerings, we have seen an increase in earnings on a per share basis. So we are feeling pretty good about where we’re sitting.

It goes without saying that lower credit related costs are providing some financial benefit, although going forward we will see the incremental earnings benefit from these costs decreasing, as marginal credit quality improvements decline. In order words the bottom line benefit from cutting the loan loss provision almost in half from $18.5 million annually to $11 million annually is far greater than cutting at almost in half again.

During the quarter shareholders of Northwestern Bank Corp., the holding company of Northwestern Bank formally approved the agreement and plan of merger pursuant to which Chemical will acquire all of the outstanding shares of Northwestern’s common stock. We look forward to consummating our strategic partnership with Northwestern which we view as a premier Northwestern Michigan community banking franchise upon receipt of regulatory approval yet here in the third quarter.

Post closing we will integrate Northwestern Bank with its 25 locations across the 11 Northwestern Michigan counties under the Chemical bank banner to provide a compelling community-driven Michigan-focused institution with the state’s residents and businesses.

Also during the quarter we took advantage of favorable market conditions to complete the equity raise that I mentioned earlier, the proceeds of which we plan to rapidly deploy into organic and acquisitive growth opportunities.

Let me now turn the call over to Lori Gwizdala, our Chief Financial Officer to provide some color on the key metrics for the quarter before making a few closing comments. Lori?

Lori Gwizdala

Thank you, David. As David mentioned and as you read in the release that we distributed this morning we had another good quarter. I will review a few of the key drivers and I will begin on slide 5.

Our net income of $16.2 million in the second quarter of 2014 was $2 million or 14% higher than the second quarter of 2013 as we benefited from significantly higher net interest income and a lower provision for loan losses. We also earned $2.4 million or 17% more in the second quarter of this year over the first quarter of 2014, again benefitting from significantly higher net interest income, but also significantly higher non-interest income.

Slide 6, shows our quarterly trend in net income. You’ll note that net income in the second quarter of this year was significantly higher than the net income we reported in each of the nine previous quarters. It really was a good quarter.

Moving to slide 7, total loans are $4.9 billion at June 30, 2014, up $145 million in the second quarter and a quarter of a billion dollars or 5.4% higher than total loans at year end 2013, and $563 million or 13% higher than total loans [ph] a year ago.

We remain extremely encouraged by our recent track record of loan growth. The second quarter increase in loans occurred across all loan types, but was strongest in the consumer and home equity loan categories. The second quarter loan growth was spread rather evenly across our four regions while year-to-date loan growth has been slightly weighted to the west side of the state. We attribute the loan growth this year as David mentioned to a combination of improving economic conditions and increased market share.

Turning to slide 8, average deposits in the second quarter of 2014 were $5.15 billion, up almost $275 million or 5.6% over the second quarter of 2013. Our focus remains on attracting core deposits, we’re letting maturing broker deposits run off. This strategy has resulted in our deposit base, that is over 99% comprised of core deposits, with an average cost of deposits that reached a low 28 basis points during the second quarter of this year.

On slide 9, you’ll see we continued to benefit from positive credit quality trends. Our provision for loan losses declined $1.5 million in the second quarter of this year, compared to the second quarter of 2013. While net loan charge-offs were $2.2 million or 0.18% of average loans this quarter. This compared favorably to net loan charge-offs of $3.65 million or 0.34% of average loans in the second quarter of 2013, and is consistent with first quarter 2014’s $2.2 million of net loan charge-offs, or 0.19% of average loans.

At June 30, 2014, the allowance for loan losses of our originated loan portfolio was $77.3 million, and was 105% of our non-performing loan balance of $73.7 million. We remain optimistic with the overall trend line of our credit quality.

Moving to slide 10, our net interest income continues to trend favorably and we’ve been able to keep our net interest margin relatively stable due to the significant growth in our loan portfolio, in spite of declining loan yields over the past few years.

Our net interest income was $51.5 million in the second quarter of 2014, which was $3.1 million or 6.4% higher than net interest income of $48.4 million in the second quarter of 2013. The increase was largely attributable to the $575 million or 13.5% increase in average loans between these two quarters.

Our net interest margin in the second quarter of 2014 was 3.59%, 1 basis point lower than the second quarter of the prior year as the increase attributable to our loan growth was offset by the impact of loans per pricing. The decline in the yield of our loan portfolio in the second quarter of 2014 was just 2 basis points. This is a positive development that we believe will help us to maintain the net interest margin and continue to grow our net interest income.

Turing to slide 11, in terms of non-interest income attributing to our financial performance, it was essentially flat in the second quarter of 2014 at $15.8 million versus the $15.9 million we achieved in the second quarter of last year. We experienced increases in a number of non-interest income categories in the second quarter of this year that largely offset the reduction in mortgage banking revenue and the investment securities gains realized in the second quarter of 2013. We also saw a rebound from the first quarter’s $13.7 million in non-interest income, with increases across all major categories of non-interest income.

Moving to slide 12, operating expenses were up modestly totaling $42.4 million in the second quarter of this year versus $41 million in the second quarter of 2013. During this year’s second quarter we incurred $0.7 million of non-recurring transaction costs associated with the Northwestern transaction. On an apples to apples basis, operating expenses were up just $0.7 million or 1.8% from the prior year quarter.

I will now turn the call back to David for some closing remarks before we take your questions.

David Ramaker

Thank you, Lori. Let me close by emphasizing three things. First we continue to execute on our strategy of being Michigan’s community bank of choice. We believe that we are benefiting from market share gains and the recovering Michigan marketplace as a result of the strategy and we continue to seek opportunities to pair with likeminded, community-orientated institutions as a key element of the strategy.

Second, we are extremely pleased with our progress on our growth by acquisition strategy. We look forward to soon consummating our partnership with Northwestern Bank Corp. and bringing Northwestern Bank into the Chemical Bank fold. We believe that with our recently completed follow on equity raise we are well positioned from a capital perspective to pursue additional opportunities for acquisitive growth that may be presented in Michigan’s consolidating banking industry.

Finally, we believe that an important part of our current and future success is our focus on the things we can control. We can’t control the economy, the fed, interest rates or the regulatory environment. We can control things like customer satisfaction, our expenses, loan underwriting discipline, approach to risk management, compliance, employee retention and so forth. Although we spend a lot of time talking externally about growth, such growth both organic and acquisitive is facilitated by the fact that we are building off a strong core internal banking operation. Internally, we talk a great deal about ensuring that we meet the needs of our customers which will in turn drive our overall performance.

As always, we appreciate your time and interest in Chemical Financial Corporation. On that note Eric, let’s open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we will take our first question from Chris McGratty with KBW.

Mike Perito – KBW

Hi good morning everyone. This is actually Mike Perito stepping in for Chris.

David Ramaker

Hi Mike, how are you?

Mike Perito – KBW

Good. Thanks. Quick question on the provision. You guys mentioned in your preparatory remarks how it’s been tracking pretty low for the last few quarters, but looking at your loan growth for the last five or six quarters or so it’s been pretty strong, near term do you guys expect to be able to maintain this level of provision?

David Ramaker

Well we don’t typically give forward looking guidance, but we feel pretty comfortable with the provisioning expense that we have been doing because of the credit quality of the portfolio that it continues to improve. I think over the near term you can continue to see something along that line.

Mike Perito – KBW

And then maybe just switching over to the securities portfolio it shrunk a little bit sequentially as it looks like you guys remix little bit of your earning assets which you guys mentioned in your margin remarks. I guess have do you guys think about the size of securities portfolio of Chemical [ph]?

David Ramaker

Couple of things [ph], one to balance off interest rate risk but also from a standpoint of providing liquidity. As we continue to see loan growth which we expect to continue, we’ll continue to monitor what we need to do from a liquidity perspective and [indiscernible].

Mike Perito – KBW

And just last one from me. Just in terms of the M&A conversations that you guys are seeing, there has been quite a bit of activity in Michigan. Is there still as much conversations today as there was maybe the first time you guys raised capital?

David Ramaker

I would say there’s more.

Mike Perito – KBW

More. Okay. Great. Thanks for taking my questions.

David Ramaker

You’re welcome.

Operator

And we’ll take our next question from Andrew Liesch of Sandler O’Neill.

Andrew Liesch – Sandler O’Neill

Would you mind talking a little bit about just the commercial lending environment in your footprint, what you have been seeing lately from your customers like what are they telling you as far as their businesses are concerned and how is demand and your outlook for commercial growth going forward?

David Ramaker

Our pipelines are robust. So we believe commercial loan growth both from a C&I and commercial real estate perspective will continue to grow and continue to move forward. Our customers are feeling very good about prospects there. Their particular pipelines are and orders are growing as well especially on the manufacturing side. So to that extent we’re seeing on a lot of opportunity to help those customers grow their business.

Andrew Liesch – Sandler O’Neill

And then Lori maybe you have this in front of you, the other one item in the expenses. Does that include any OREO gains, and was curious if they are like what the size of them more this quarter?

Lori Gwizdala

Yes. The other category is where that those gains are and they did include gains and they were $500,000 in this quarter compared to $400,000 in the first quarter and $800,000 in the second quarter of last year. So they reduce our expenses less this year than last year. So that’s not really the reason why we’ve been able to maintain expenses so well.

Operator

Thank you. And we’ll take our next question from John Rodis of FIG Partners.

John Rodis – FIG Partners

David, maybe just a follow-up on your comments on C&I growth, I guess balances linked quarter were relatively flat. More pay-downs elevated this quarter in that area?

David Ramaker

That’s a good observation, John. We did have a couple of larger transaction that did pay off, not necessarily anything that we did. So that’s I guess my reason for optimism as we look forward and look at our pipelines from a standpoint of future growth.

John Rodis – FIG Partners

Okay. Fair enough. Obviously you had nice growth in the consumer portfolio and typically you saw that in the second quarter. How much of the growth this quarter was driven by the new branches or relatively new branches that you purchased from Independent a year or two ago?

David Ramaker

No. I don’t know that we necessarily -- I’m not necessarily tracking it from that perspective.

John Rodis – FIG Partners

How would you characterize, I guess, your ability to grow the loans in that region? I guess if that’s a better way to look at it.

David Ramaker

Okay. Well the north region, that is one of the primary products. So consumer lending is one of the primary products from a lending perspective that we actually have in that marketplace. So I think to that extent the addition of those offices it took us a while to get those offices moving forward from a lending perspective on the consumer and mortgage side, but we’re starting to see benefits from that in a much higher way. It was a little bit easier to see the benefits from those branches from a commercial perspective virtually immediately. But no, the acquisition of those branches from Independent not only is starting to fuel some loan growth in north region but obviously was the fuel that we needed to fund the loan growth that we have seen over the last year. So it’s worked very well.

John Rodis – FIG Partners

Okay. And...

Lori Gwizdala

Maybe to add just some color relative to for our success, that our north region which would include those new branches they did make up about 40% of our consumer loan growth and -- consumer and residential mortgage which was really mostly consumer in the second quarter and their portfolio only makes up about 25%, 26%. So we did get a fair amount of our loan growth from that new region.

John Rodis – FIG Partners

Okay. That’s helpful. Thanks Lori. David, maybe just one another question for you on the M&A environment. Has anything changed, I guess, little bit better or worse on the regulatory side in the last few months that would --it sounds like you’re still very optimistic about doing deals going forward, but has anything changed significantly on the regulatory front?

David Ramaker

No, I wouldn’t say, you mean for us or for the industry?

John Rodis – FIG Partners

I mean for the industry, but obviously as it relates to you guys.

David Ramaker

Well no, I mean obviously today the risk on any transaction is probably more related to compliance and regulation than it is to safety and soundness, and that’s when we are going in and doing due diligence. That’s almost become as much if it’s not more the focus to try to determine what kind of risk we’re taking on from a compliance perspective these days. Just because of the robust nature of our regulators in relationship to compliance and consumer protection. [They seem] soundness and looking at the quality of the portfolio, we’ve done this, we will close 21 transactions and we’ve been very good at how we’ve analyzed those portfolios over in the past. So the real focus is truly on the consumer compliance and following regulations and looking at the history of the particular entities that we’re looking at.

John Rodis – FIG Partners

Yeah, okay, that makes sense. Lori, maybe just one quick question for you, on the mortgage side you saw a nice rebound from the -- on a linked quarter basis. Is the right way to sort of look at that, to back out roughly what $400,000 that you, I guess, reversed for the reserve I guess?

Lori Gwizdala

Yeah, that would be correct.

Operator

And we’ll take our next question from Daniel Cardenas from Raymond James.

Daniel Cardenas-Raymond James

Had you guys had a chance to look at Northwestern’s second quarter results and I know you probably can’t comment too much, but if you had, are they pretty much in line with your expectations?

David Ramaker

Lori you want to.

Lori Gwizdala

Well, no we haven’t seen their second quarter, but even if we had I think that we really can’t comment on that. As David said I think the transaction is going along well and we’re proceeding to close. No surprises that we would need to report.

Daniel Cardenas-Raymond James

Okay, and then in terms of the loan growth we saw this quarter. Do you have the average loan size?

Lori Gwizdala

I do not have the average loan size. However 70% of our loan growth in the second quarter came from the consumer portfolio. So those are typically smaller loans. They’re new and used cars, RVs, some boats marine vehicles, but primarily new and used cars.

Daniel Cardenas-Raymond James

Okay.

David Ramaker

And Dan, let me back up to the Northwestern comment for just a second. I think the way that we can answer the question more than anything else is that we are being well received in the market. The Northwestern employees are doing a nice job of explaining who Chemical Bank is and we’re seeing good retention rates of a – from a standpoint of customers and so from that perspective, that’s what we’re really focused on at this point.

Daniel Cardenas-Raymond James

Okay, that makes sense. And then maybe pro forma, where does your legal lending limit go and then maybe some comments as to what your appetite for pursuing larger credits might be once the transaction is completed?

David Ramaker

Well we’ll need to revisit our in-house limit when the transaction closes or as we get closer to closing the transaction. We have historically had an in-house limit that’s well south of what our legal is and I don’t anticipate that’s lot to be changing. It speaks to how we underwrite credit and how we’re trying to create granularity in the portfolio. So there are obviously opportunities out there to do much larger transactions and we’re trying to stick to what we think we know how we do business and how we have grown the portfolio and we’ve been pretty successful obviously over the last six quarters. So we’re looking forward to continuing that.

Operator

(Operator Instructions) We’ll take our next question from Eric Grubelich who is a private investor.

Unidentified Analyst

Lori Good morning. Actually a number of my questions just got answered, but I have a couple of things related to that. The first is on the consumer side since that was most of the growth and it sounds like it’s more instalment than home equity. What are the yields you’re getting on this newer paper compared to the existing portfolio yield right now?

Lori Gwizdala

Well the newer yields are a little bit below 3%. You know and that’s reflective of current market rates and current market conditions. But the portfolio has a very short average life and so it’s the average, the average of those loans are three years or less. So while the yield is lower, that portfolio is constantly churning.

Unidentified Analyst

What I was trying to understand was the -- and I assume that 3% is a blend of used card and new car probably more used, I would imagine the – - is it coming in much less than where the existing portfolio yield is or not?

Lori Gwizdala

It is, it is coming in slightly less, the overall portfolio I have that here is just below 4%. I think it’s 3.5%, 3.58%. So it is coming in less, but the loan growth is offsetting that decline in margins over growing net interest income.

Unidentified Analyst

Okay, and David, I think the question Mike Perito asked you earlier about the provision. Was your answer about the provision staying low? Was that more a function of the quality of the new credit you’re paying [ph] on or trends you see in problem loans continuing to improve or both?

David Ramaker

I would – Eric I’d probably answer it by saying both. The characteristic of the portfolio continues to improve. The specific reserves that we need to put on credit continue to improve from that perspective and obviously the percentage of non-classified assets continues to increase. So the historical needs from a credit quality perspective, from a provisioning standpoint, the characteristics drive that down. As Lori indicated the reserve is over 105% of our problem assets and so from that perspective we’re feeling very good about that.

Unidentified Analyst

Okay and then one last thing. You had a question about the, any appetite to change your in-house limit or the size of the credits that you put on. I guess the answer was we’re going to look at it once we close the deal. But there’s not going to be a substantive change. Could you just remind us what’s your rough in-house limit now on a loan or relationship basis?

David Ramaker

On a relationship basis it’s $25 million.

Operator

(Operator instructions) It appears that there are no further questions at this time. Mr. Ramaker, I’d like to turn the call back over to you for any additional or closing remarks.

David Ramaker

Thank you, Eric. Again we appreciate your time and interest in Chemical Financial Corporation. We remain confident in our prospects going forward. By making Chemical Bank the community oriented, Michigan center of financial institution of choice in the markets we serve and seeking to partner with likeminded institutions in the state as Michigan’s banking industry consolidates. We believe we are well positioned to achieve additional competitive and acquisitive market share gains as we move forward. Thank you all again. Look forward to talking to you in the future.

Operator

This concludes today’s call. Thank you for your participation.

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Chemical Financial (NASDAQ:CHFC): Q2 EPS of $0.54 beats by $0.05. Revenue of $67.26M (+13.3% Y/Y) beats by $1.34M.