Pacific Continental's (PCBK) CEO Hal Brown on Q2 2014 Results - Earnings Call Transcript

Jul.24.14 | About: Pacific Continental (PCBK)

Pacific Continental Corporation (NASDAQ:PCBK)

Q2 2014 Results Earnings Conference Call

July 24, 2014 02:00 PM ET

Executives

Mick Reynolds - EVP and Chief Financial Officer

Hal Brown - Chief Executive Officer

Roger Busse - President and COO

Casey Hogan - Chief Credit Officer

Analysts

Jacque Chimera - Keefe Bruyette & Woods

Jeff Rulis - D.A. Davidson

Don Worthington - Raymond James

Operator

Ladies and gentlemen, I would like to welcome you to today’s Conference Pacific Continental Corporation’s Second Quarter 2014 Earnings Call and Webcast. Before we get started, I would like to explain some of the ways that you can participate. This presentation is being recorded and you are currently in listen-only mode. At the conclusion of today’s presentation, management will entertain questions. (Operator Instructions). We will remind you of these instructions at the beginning of the question-and-answer session. (Operator Instructions).

Now without any further delay, I would like to introduce our first presenter Mick Reynolds, Executive Vice President and Chief Financial Officer. Mr. Reynolds, you now have the floor.

Mick Reynolds

Thank you Nicole and welcome to Pacific Continental Corporation’s conference call and webcast to discuss our second quarter 2014 results. Presenting today will be Hal Brown, Chief Executive Officer; Roger Busse, President and Chief Operating Officer; and me.

We will update you on our recent activities and discuss the financial results, reported in our press release distributed after market close July 23, 2014. Our press release is available in the Investor Relations section of our website at www.therightbank.com.

Before we commence the formal remarks, we advise you that this webcast contains forward-looking statements, which may include statement about future profitability, loan growth, problem asset resolution, changes in the net interest margin, and anticipated cost savings. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected. We undertake no obligation to publicly revise or update any forward-looking statements to reflect events or circumstances that arise in the future.

You should carefully review any risk factors described in the company’s periodic reports on Forms 10-K, 10-Q, 8-K and any other documents filed with or furnished to the Securities and Exchange Commission. This statement is included for the express purpose of invoking the Safe Harbor Provisions, the forward-looking statement under applicable law.

Now let me introduce and turn the call to Hal Brown, Chief Executive Officer of Pacific Continental Corporation.

Hal Brown

Welcome and thank you for joining us today as we discuss our second quarter 2014 results. The second quarter results pretty much mirrored what we suggested during last quarter's conference call. So again, our prepared remarks will be quite short. I will characterize the quarter as one of continued improvement as we again achieved record net income, driven primarily through long growth and efficiencies.

Credit quality statistics continued the trend of improvement and hence we again made no provision for loan losses. The margin appears to have stabilized as loans replaced securities on the balance sheet offsetting declines in our loan yields. We appear however to have been a bit optimistic in our net loan growth as early pay-offs, construction completion and normal amortization offset what was a very strong quarter of production. In fact Q2 was the strongest production quarter since the start of the recession with over $178 million in new or renewed loans. Core deposits expanded during the quarter which is a historical pre-recession pattern of limited growth in the first quarter followed by growth during the remainder of the year.

We continue to report strong efficiency figure which for the quarter was 58.38%. You will have noted from the press release that during the quarter we invested in the company by purchasing 134,722 shares for 1.8 million. We also announced the declaration of a $0.10 regular dividend and a $0.03 special dividend to August 4th shareholders of record.

These second quarter repurchases plus the future dividend proceeds of approximately 2.3 million roughly equal our Q2 earnings of $4.1 million. This maintains our recent practice of leveraging our shareholders’ investment by holding capital constant while growing the balance sheet. It is expected that until a more attractive use of capital develops, we will continue to return a 100% of previous quarter’s earnings through dividends and share repurchases.

Following Mick’s and Roger’s remarks, I will conclude today’s prepared presentation by addressing the third of our recent press releases describing our succession plans.

So, with that as an introduction, I’ll turn the call over to Mick Reynolds, Executive Vice President and Chief Financial Officer. Mick?

Mick Reynolds

Thank you, Hal. In my portion of the presentation, I’ll be addressing our net interest margin; securities portfolio and provide more information on non-interest income and expense. Also when appropriate and as best possible, I will provide listeners and the analysts with third quarter 2014 expectations.

Our second quarter net interest margin was 4.34% and up 2 basis points over the prior quarter. The second quarter margin was enhanced by 3 basis points due to the accretion of fair value marks and 4 basis points due to non-recurring items. Examining our core margin which eliminates the non-recurring items and the accretion of the acquired loans, we continue to see stabilization due to continued improvement in our earning asset mix and higher yields on our securities portfolio.

Our core net interest margin for the second quarter 2014 was 4.26% compared to 4.25% and 4.28% for the first quarter 2014 and fourth quarter 2013, respectively. Our core margin which again eliminates the accretion and non-recurring items is expected to remain relatively stable with second quarter as we expected continued loan growth to further enhance the earning asset mix thus offsetting erosion in loan yields. We continue to see limited opportunities to lower the cost of funds in core deposits and we’ll continue to look for opportunities to extend wholesale funding maturity structure which may increase the cost of our longer-term interest bearing liabilities but does decrease our exposure to rising rates.

Now turning to the securities portfolio. At June 30, 2014, the portfolio had a pre-tax unrealized gain of 5.9 million, an increase of 3.6 million over the prior quarter as long-term market rates decline in spreads tightened significantly. During the second quarter 2014, we did sell one of our private label mortgage backed securities at a loss of 100,000. This particular security would have acquired an impairment charge in the second quarter and potentially additional impairment in future quarters. Thus we believe that was prudent to sell the security at the loss.

The average life and duration of the portfolio at June 30, 2014 was 4.2 and 3.8 years and unchanged from year-end 2013. We anticipate the portfolio of balance will decline modestly in the third quarter as projected cash flows will be used to partially fund anticipated loan growth.

Turning now to non-interest income and expense. For the second quarter when excluding the sales securities, our non-interest income was within the range we had suggested in our last conference call. We anticipate our third quarter 2014 non-interest income, absent the loss on securities will be relatively flat with the second quarter and range from 1.2 million to 1.3 million.

Looking to the third quarter 2014, we expect expenses to be up over second quarter in the range of 9.4 million to 9.6 million due to increased personnel and marketing costs. Our average certain expense category such as other real-estate expense and legal fees can be volatile so that's our actual results may vary from our projections.

And that completes my prepared remarks and I'll now turn it over to Roger Busse, President and Chief Operating Officer.

Roger Busse

Thank you, Mick. Today I will briefly discuss our key credit statistics and trends then describe various factors related to the bank's second quarter loan and deposit activity. I will specifically address again a loan portfolio and provide an update on healthcare segment. In addition I will discuss our expectation for loan and deposit growth.

Let’s begin with credit, credit quality continued its positive migration. As of June 30th non-performing assets as a percentage of total assets reduced to 1.08%, the 30 to 89 day pass due ratio fell to 0.08% and the allowance as a percentage of net non-performing loans was a robust 340%. Net recoveries during the quarter were $281,000 and the net charge-off ratio fell to 0.05% when annualized to average loans, classified assets also declined and ended the quarter at 24.7% of total capital down from the 29% recorded at last year. OREO remain virtually unchanged, dental portfolio credit statistics also continued to perform near or above the quality measurements associated with the overall portfolio. Consequently when combined these factors and the positive credit trends suggest that loan loss reserves will like remain adequate in the coming quarter. Subject to of course to loan growth or unforeseen changes.

Let’s now discuss growth trends beginning with loans. Loan growth continued for the 12th consecutive quarter annualized year-to-date loan growth was 7.37%, gross loans, loans net of commitments increased $10 million during the second quarter, down from the 26.4 million achieved in the first quarter, payoffs and pay downs were up over the previous quarter impacting second quarter’s net results. However it is important to note that many of these payoffs in the second quarter appear to reflect an improving economy. For example, $5.5 million of the payoffs were firm refinances or completed residential construction loans, 1.1 million was the sale of the bear land parcel. Another $6.9 million of payoffs were related to the completion of multifamily construction loans. Seasonal working capital lines were also paid down $4.9 million and some companies apparently chose to dealer rich and reduce obligations due to improved cash positions or completion of projects.

Looking forward, new loans booked last quarter included commitments for owner and non-owner occupied construction loans that will advance funds up to their total commitment limits in coming months. These pending advances combined with a solid level of our loan opportunities in all of our market pipelines which also stand virtually all loan categories from C&I to CRE suggest that they will be positive if not strong net loan growth during the next quarter.

Dental loans contracted $3 million during the quarter, bringing the dental outstandings to $302.8 million or 29.4% of the total loan portfolio as of June 30th. While intense pricing competition continues for dental loans, request for payoffs have drop noticeably during the second quarter and new opportunities continue at a steady pace.

As of June 30, 2014 national dental loans represented 44.2% of that portfolio or $133.7 million. The bank now has dental relationships in 31 states. While the competition for dental acquisition loans is expected to continue. Net growth is possible in coming quarters due to the steady flow of new opportunities and the careful but deliberate expansion of our market footprint.

The healthcare portfolio other than dental enjoyed quality growth. As of June 30, 2014 this segment grew 13.7% over year end 2013 to $70.4 million. The majority of this expansion was in veterinary lending, both acquisition and owner occupied financing. The bank continues to carefully evaluates strategies for additional growth in veterinarian and other medical related segments particularly optometry and expects to further expand this healthcare segment during the remainder of 2014.

Finally I am pleased to report that core depots increased $35.6 million during the second quarter. Growth was experienced in both large and small depositors that is those under and over $1 million. More, the deposit pipelines for all markets are solid. This suggests that deposit growth will continue, thereby reflecting the typical seasonal pattern of deposit growth in the second half of the year.

That completes my prepared remarks. I'll now turn the presentation back to Hal.

Hal Brown

Thank you gentlemen. As you can infer from our comments we remain optimistic for the remainder of 2014. We expect a stable net interest margin, continued good efficiency and improving credit metrics, limited negative loan migration and strengthening net loan growth. These suggested trends are the basis for our optimistic outlook and provides me with the confidence to move forward with my retirement decision.

Having now worked four decades in the industry and nearly 30 years at the right bank, it's time to begin a new chapter in my life and I have announced my retirement effective at the end of this year. I have several bucket list items that need to be checked off beginning with a long bike right next summer.

My years at Pacific Continental have been absolutely wonderful and fully rewarding. But I am looking forward to many new experiences. One of the banks recognized strength is its stepped up management and I will leave Pacific Continental in very good hands.

The Board of Directors have selected Roger Busse as a Successor CEO and I could not be more pleased with his future appointment. Most of you have met and are familiar with Roger and I believe you will agree that Roger’s leadership experience, PCB tenure and business acumen makes him the perfect choice as PCB’s next CEO. Roger joined the bank in 2003 as our Chief Credit Officer and I can attribute much of our last decade’s success to the strategic collaboration between Roger and our executive team to transform our small community bank practices to our practices today that can support the size and complexity of our growing multi-state regional institution.

In 2006 Roger was promoted to President Chief Operating Officer and since that time he and I have shared many corporate and strategic responsibilities. During the remainder of the year we will work even more closely together to ensure a seamless and transparent transition.

My leaving does result in a bit of musical chairs as we promote until there is executive positions, Casey Hogan, currently Chief Credit Officer, will take Roger’s position previous role as Chief Operating Officer, and in turn Damon Rose, Senior Credit Officer, will become Chief Credit Officer. These changes will be effective on my resignation at the end of the year.

Although beginning next year I will no longer be involved daily, I won’t be disappearing immediately. Roger has asked that I make myself available for regular consultation and I will remain available to assist at his request through mid 2017. I will also continue to serve on the Board through the expiration of my current term providing additional months of continuity. It is too early to say good bye just yet as we have couple of quarters remaining in 2014 and we still got a lot of good work to do.

But with that I think we will end our prepared remarks and take your questions, addition to Roger and Mick, Casey Hogan is also available to answer any credit related questions. So, Nicole, would you please open the lines.

Question-and-Answer Session

Operator

Thank you. We have now opened the phone lines for questions. (Operator Instructions). We have Jacque Chimera with Keefe Bruyette & Woods and she will be live and able to speak and be heard momentarily.

Jacque Chimera - Keefe Bruyette & Woods

Hi, good morning everyone.

Hal Brown

Good morning, Jacque.

Jacque Chimera - Keefe Bruyette & Woods

Hi. I wanted if you could touch on some of the M&A discussions that you been having and if that case that that discussion is increased over the last quarter?

Hal Brown

We continue to be in compensations. As you know, it's impossible for us to talk about the specifics of them. But we continue to look for acquisitions of banks that have good liability structure, that's the first filter that we look to. And we're really looking at institutions in the $300 million and less category.

Jacque Chimera - Keefe Bruyette & Woods

Okay. So, still pretty much unchanged from last quarter?

Hal Brown

Yes.

Jacque Chimera - Keefe Bruyette & Woods

And has the pace picked up over the last three months?

Hal Brown

No, I don't think the pace is changed.

Jacque Chimera - Keefe Bruyette & Woods

Okay. And then secondly, last quarter and I'm not sure who it was that had discussed it, but you talked about the competition that was coming from other lenders in the dental space. Is part of the pay downs that happened in the quarter, is that still from that same competition or has that shifted?

Roger Busse

Yes, Jacque this is Roger. Competition continues and we did receive some pay downs, but it has begun to slow somewhat from those competitors, particularly the national competitor. And one of the indications as I noted in my webcast comments is that request for pay-offs has slowed significantly during the last quarter as well. So yes, there were payoffs but it appears to be somewhat slowing.

Jacque Chimera - Keefe Bruyette & Woods

Okay, great. Well, I will set back now but Hal congratulations on your retirement and congratulations everyone also on your promotions.

Hal Brown

Thanks Jacque.

Operator

We have a question from Jeff Rulis with D.A. Davidson. And he’ll be live and able to speak and be heard momentarily.

Jeff Rulis - D.A. Davidson

Thanks, good morning.

Hal Brown

Good morning.

Roger Busse

Hi Jeff.

Jeff Rulis - D.A. Davidson

Hi. And Hal also congratulations and our time is limited but the bank is in good hands. So anyway I guess on to the questions in terms of the -- on the capital management side, the decision to kind of pick-up the buyback a bit, is that maybe just flush out the thoughts behind that kind of that to protect the stock is having added flexibility along with the special dividend, any additional thoughts there?

Hal Brown

Well Jeff, our outlook for the remainder of the year is very good. And frankly we ask investors to buy our stock. And so it seemed appropriate for us to also participate in that. And so we’ve done our internal rate of return analysis. And this does appear to be a good use of our capital.

Jeff Rulis - D.A. Davidson

Okay. And then maybe just a sort of a follow-on on the dental competition. While it sounds like a source of payoffs in some activity, last couple of quarters has limited growth. I guess do you guys view anything structurally changing versus a couple of years ago; there was perhaps a better opportunity and now having that niche and having it be so profitable? Do you get the sense that maybe matching historical growth levels would be difficult going forward, even if it does pick-up a little bit from the last couple of quarters?

Roger Busse

Jeff, this is Roger. So, I would suggest that the evidence that we’ve seen in our discussions today would indicate that growth will be slower than in the past, as you just mentioned, yes. But there is still potential for portfolio expansion, particularly given that we continue to receive a good number of loan opportunities, similar to what we received before.

There is a slowing number of payoff requests. And but that portfolio and its current position at about 29.4% of the total loan portfolio is -- it's possible to see some slight growth. But it's going to continue to be a challenge going forward.

Mick Reynolds

Yes, Jeff, this is Mick Reynolds. And I would just add that these are mostly anywhere from 5 year to 10 year fully amortizing loans. And once you get to a certain size, the amortization, just the pure amortization without the pay-offs creates a, I guess somewhat of a barrier to the kind of rapid growth we saw initially and that takes a lot more production just to offset the amortization in the portfolio.

Jeff Rulis - D.A. Davidson

Makes sense, okay. And then maybe last one and maybe it's for Mick or whoever. On the expense side, you obviously had some success with some efficiency improvements. And I noted you mentioned the expense expected to pick-up a bit in the next quarter or two. But I guess structurally anything a little longer term, do you still feel like there is some expense reductions to be had in the platform as in a mid 50% efficiency ratio are you comfortable where you are at?

Roger Busse

Jeff, we pay a lot of attention to expenses. Thanks to our Board requires us to pay a lot of attention to expenses, they do a nice job there. Frankly, our goal is to kind of hold the expenses as best we can and grow the asset base with that existing expense. But we do have to pay attention to personnel expenses additions when it's appropriate.

So if I had to speculate on the efficiency ratio I think it's right roughly where it is today in the mid to high 50s.

Jeff Rulis - D.A. Davidson

Okay. Thank you.

Roger Busse

Thank you.

Operator

Don Worthington with Raymond James has a question. He will be able to speak and be heard momentarily.

Don Worthington - Raymond James

Well, good morning everyone.

Roger Busse

Hi, Don.

Don Worthington - Raymond James

Also my congratulations as well to all. I guess following up a little bit more on the dental you currently in 31 states are you looking at expanding that out to other markets?

Roger Busse

Don, this is Roger. We expect that we will continue to grow our footprint but we're very deliberate in that growth. We want to make sure we understand the appropriate risk and our perfection rights et cetera in those various states in which we expand. But yes, it's possible that our footprint will expand again that gives us that affords us more opportunities for deals as we enter these new markets and high quality deals as well.

Don Worthington - Raymond James

Okay, great. Roger you mentioned that you are seeing healthy pipelines in most loan types is that also true in terms of your three markets are you seeing a growth potential in all three?

Roger Busse

Yes, all three markets are showing stable or solid pipelines if you will that continue to be strong I would say strong. How those materialize as always a challenge to guess, but given the pipelines we have today we would continue to see as I mentioned growth similar or better to what we just experienced.

Don Worthington - Raymond James

Okay, great. Thank you.

Roger Busse

Thank you.

Operator

And Eric Grulke has a question. He’ll be allowed and able to speak and be heard momentarily. Eric you’re now live and can be heard. Is your phone muted?

Unidentified Analyst

Hi there.

Operator

We can hear you now.

Roger Busse

Yes.

Unidentified Analyst

Okay. Sorry about that. My congratulations to everybody as well. Just a couple of questions, the prior question about the buyback and the dividend, yes I was maybe a little bit surprised that you bought shares back up at this level compared to where you’ve done it in the past, of course you can only buy the market that you’re in and not the market you want to be in. But was any of your decision on that based on any type of share awards that were issued this quarter? It looks like there might there has been a little bit more of activity there because the share count didn’t really declined that much compared to what you bought back?

Roger Busse

It is true that during the second quarter we do issue our annual equity rewards. But I think that’s just coincidental, not really related to the decision to purchase shares. But it did get the shares roughly the same as a result of that.

Unidentified Analyst

Okay. And then the other question I had I forgot who was talking about this maybe Roger, you mentioned the veterinary lending which you’ve mentioned before and I think you also mentioned potential expansion into the optometry field. And I would just kind of curious as you look at expanding healthcare. How do you look at the different practices that are out there compared to the core of what you've been doing? What I mean by that is, you've been very articulate about the unique qualities of dental lending, its not there aren't any reimbursement risks with Medicare people tend to pay it out of their own pocket or of insurance.

There are a lot of benefits for this, but when you start to go and to be more mainstream type of medical fields. Is that deviate away from that core strategy that's worked really well in dental and perhaps in veterinary for the same reason people want to take care of their dog, right. Could you maybe talk a little bit about that your thought on that strategy?

Roger Busse

Yeah, Eric this is Roger. I'll start and then Casey can fill and if he'd like. Well, frankly, we're very careful about which kind of healthcare segments we get into. We first and foremost when I make sure that there is true enterprise value in the practices. And because we're cash flow lenders we also want to understand the appropriate multiples for cash flow coverage within those various practice.

So given that if you look at veterinary lending, you have a very similar characteristics in many ways to franchise or to the value if you will of the entity on a enterprise value basis as well as strong cash flows. You do have to be particularly careful about which segments you're in and you also need to understand the specific types of lending that you're alluding to do in those segments. All of those characteristics are considered before we enter any healthcare segment, that is same with optometry. We've done a lot of research and we look at various types of practices to finance and what kind of enterprise valuations they have.

So again, we will be selective which segment within optometry that we enter. But given that and the bottom-line to answer to your question, they do have similar characteristics. I don’t know Casey, if you would add anything.

Casey Hogan

Thank you, Roger. I think you covered it pretty well. But Eric, just to kind of add on, we are very thoughtful and very thorough in our analysis of most of the industry, second to practice that maybe associated with the opportunity as well as the individual doc that maybe are specific borrower. So we have a very thorough and committed process to work through. So we think we are pretty good at it.

Unidentified Analyst

Okay. And then just one last one if I could, maybe for Mick. Maybe you could talk just a little bit about how the balance sheet is positioned right now for a potential rise in rates? I mean clearly who knows when rates are going to go up, what part of the curve is going to increase or not increase. But if you are looking at what you have now, if there is risk that the short end lifts and the intermediate and the long end don’t, how comfortable are you with the ability to keep the margin where it is if that happens?

Mick Reynolds

Well, we are fairly comfortable over the long-term. The balance sheet, we do pay a lot of attention to it, using both our securities portfolio and the wholesale, long-term wholesale funding options that we have available to help mitigate some of the risk we see on the loan side at least the longer term ones. On a short-term basis, we have some liability, sensitive issues and that we use rate blowers. And so a rate rise would not necessarily immediately have those loans re-priced. So short-term, we could see some margin compression. Our indications and modeling would indicate that moderates and come downs and as return asset sensitive after approximately 12 months. And so, we're pretty comfortable with where we're at.

And currently there is a lot of assumptions in these models. And then some of them are very critical. And one of the biggest piece is trying to evaluate how core deposits are going to price in a rising rate environment. We've been in this low rate environment for so long, it's many of us have forgotten how deposits maybe priced when rates do rise.

Unidentified Analyst

Okay. Thanks very much for answering all the questions.

Roger Busse

Thanks Eric.

Operator

There are no more questions in the queue at this time.

Roger Busse

Well, I guess as there are no further questions. Again thank you for your attendance and we do look forward to speaking with you again following our third quarter results. So have a great summer and we'll see you soon.

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