City National's (CYN) CEO Russell Goldsmith on Q2 2014 Results - Earnings Call Transcript

Jul.25.14 | About: City National (CYN)

City National (NYSE:CYN)

Q2 2014 Earnings Call

July 24, 2014 5:00 pm ET

Executives

Cary Walker - Senior Vice President of Investor Relations

Russell D. Goldsmith - Chairman of the Board, Chief Executive Officer, President, Member of Special Matters Committee, Chairman of City National Bank and Chief Executive Officer of City National Bank

Christopher J. Carey - Chief Financial Officer, Executive Vice President, Chief Financial Officer of City National Bank and Executive Vice President of City National Bank

Analysts

Bob Ramsey - FBR Capital Markets & Co., Research Division

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Joe Morford - RBC Capital Markets, LLC, Research Division

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Timur Braziler - Deutsche Bank AG, Research Division

Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division

Operator

Good afternoon. I would like to welcome everyone to this discussion of City National Corporation's Second Quarter 2014 Financial Results. My name is Jaimie, and I will be your coordinator for today. [Operator Instructions] This call is being recorded and will be available shortly after it is completed on City National's website at cnb.com.

Now I will turn this call over to Cary Walker, Senior Vice President and Manager of Corporate Communications for City National. Please proceed.

Cary Walker

Thank you, good afternoon. Here to discuss City National's second quarter results are Chairman and Chief Executive Officer, Russell Goldsmith; and our Chief Financial Officer, Chris Carey.

This call will include comments and forward-looking statements based on current plans, expectations, events and financial industry trends that may affect the company's future operating results and financial position. These statements involve risks and uncertainties and future activities and results may differ materially from expectations.

Speakers on this call claim the protection of the Safe Harbor provisions in the Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from expected results, see the company's annual report on Form 10-K for the year ended December 31, 2013.

This afternoon City National released its financial results for the second quarter of this year. To get a copy of the news release, please visit our website at cnb.com. After comments by management today, we'll open up this call to your questions. And now I'd like to turn it over to our CEO, Russell Goldsmith.

Russell D. Goldsmith

Good afternoon. Thank you, all, for joining us today. About an hour ago, City National announced its financial results for the second quarter of 2014. As I'm sure you've seen from the news release, it was an excellent quarter. Assets topped $30 billion for the very first time in our 60-year history and net income grew 12% from a year ago, reaching a new quarterly record of $66.7 million. Loans and deposits also increased to record levels at quarter end. Our wealth management business continued to make strong gains and credit quality remains sound and even improved. Year-to-date, City National has earned $2.01 per share on revenue of $621 million. So we're pleased with the company's performance through the first half of the year and encouraged by the momentum we have going into the second half.

In a few minutes, Chris Carey and I will take your questions, but first we want to go over some of the second quarter highlights. One of them was clearly loan growth. In the second quarter, City National added $723 million to its loan portfolio. That's a 16% annualized rate of increase. About 1/3 -- little more than a 1/3 of this growth came from C&I lending, mostly in our specialty businesses, like corporate banking, our new mortgage warehouse lending unit, our equipment leasing team and our entertainment division. In addition, commercial real estate loans, as well as single-family mortgages, also made strong contributions to the loan growth in the second quarter. While City National's loans have grown at an annualized rate of 17% for the first half of 2014, we don't anticipate that this rate of growth will be fully sustained in the second half.

Things haven't changed that much since we talked with you about loan growth at the end of the first quarter. Loan demand is still moderate in the communities we serve, line utilization remains flat, pricing is still very competitive and competition is quite strong. All in all though, we're very pleased with not merely the growth, but the diversification and the quality of City National's loan portfolio. Rather than build a portfolio that's dominated by 1 or 2 sectors, or 1 or 2 industries, or 1 or 2 product types, City National has long held the view that it's much more prudent and sustainable to grow its loan portfolio with a robust mix across a range of solid product types, strong sectors and growing industries, as well as strong geographies, combined with the quality bankers who have the experience and expertise in their particular lending areas and/or geographies. That strategy is also reflected in what you can see in our credit quality, which continued to improve in the second quarter. It improved so much so that the company actually had to record a $1 million allowance reversal for the first time in many years. Nonaccruals fell to 35 basis points of total loan balances. Classified loans went down dramatically by more than 1/3. Net charge-offs were $3.6 million. In fact, this is the first quarter in 2 years that we have not had net recoveries. Clearly, credit quality has improved, actually more than we anticipated at this point, and strong recoveries on certain loans that we patiently held as REO, have been realized more rapidly than might have been expected. Yet at this time, we still expect to resume loan loss provisioning later in the year as our loan portfolio continues to grow and the pool of likely recoveries should continue to shrink.

Another performance highlight through the first half of the year and in the second quarter was deposit growth. Between the first and second quarters, City National has added $920 million more in deposits, bringing total balances to $26.7 billion. And remarkably, 98% of those deposits are core deposits. Growth in the second quarter was due largely to an increase in business demand deposits, both from new clients and a few large client events. City National's Wealth Management business also continues to gain traction. Trust and investment fee income grew at an annualized rate of 10% in the second quarter, reflecting not only market appreciation, but also the success of our merged City National Rochdale and some of our investment affiliates.

As City National grows its income, we have continued at the same time to make a steady stream of investments over the past few years in the talent and technology capabilities and systems that set City National apart and enhance our ability to grow our businesses while building our infrastructure to fully support our growth and comply with all regulatory requirements. In the first half of this year, for example, we added some very talented people across the company. And in this quarter, in particular, we've added more bankers in several of our key growth areas namely, San Francisco, San Jose and New York City. In addition, we recently recruited 5 outstanding bankers to deliver our private client services capabilities in Ventura County, where we've been for a number of years and also expand that into Santa Barbara. Similarly, our national entertainment office recently added a small team in Florida to expand our entertainment division's sports clientele in that state. And of course, we continue to invest significantly in mobile banking, our online capabilities and a range of other technologies that reflect City National's strong and long-standing commitment to build its tech offerings in order both to meet the changing habits and expectations of our clients, and to improve our internal productivity and effectiveness.

City National in our view has performed well through the first 6 months of the year and we're reasonably optimistic that, that will continue through the second half of the year. However, with short-term rates still at very low levels, loan demand improving only modesty and the economy, while clearly getting better, still not fully recovered or business confidence fully restored, as a result, our businesses remain challenging.

We've been seeing clear evidence that the U.S. economy is picking up some steam as I'm sure you have all seen. We're seeing it, in particular, in most of the communities that City National serves. If you look closely at the economies of Southern California and the San Francisco Bay area in particular, they are outperforming the country's economic recovery as a whole.

City National's year-to-date performance speaks not only to improving economic conditions in the communities we're in, but also the fundamental strength, the considerable capabilities and the broad diversification of our business strategies and the ability of our talented team of colleagues to execute well across the board and grow our business and gain new business.

Now to give you some more detail on our earnings report, let me turn over the call to our dynamic CFO, Mr. Carey.

Christopher J. Carey

Thanks, Russell. Good afternoon, all. Now obviously we're very pleased with the company's performance, both in the second quarter and year-to-date. Russell has talked about the strong growth of loans and deposits and our wealth business. In a moment, I'll add a few words about the margin, noninterest income and expense. So let's start with the margin.

You can see that it moved higher for the second quarter in a row and I would point out that 13 basis points of the improvement really came out of the covered loan portfolio that is a little volatile, that prepays weren't much higher this quarter. And so without that, we were up 6 basis points, although we did have some higher loan recoveries. And as we look into the detail more, it still is a good story in that our C&I yield, if you cut through all that, was only slightly down, the largest -- the smallest decline that we've seen in quite some time. While there's still pressure on pricing, we're happy to see that the yields are somewhat stabilizing. We also had a higher yield in our investment portfolio, which was helpful.

Now turning to non-interest income. Fee income tied to trust, investment, brokerage and mutual fund services is up 9% from the first quarter of this year and 17% year-to-date, thanks in part to increased sales activity and market appreciation. There was one big change, an increase on the brokerage and mutual fund line, which includes $3.8 million in performance fees related to the merger of 2 City National Rochdale funds. It's worth noting that part of this was offset by a $1.9 million in professional fees we needed to pay out for sub-advisory expense. We also, for the year-to-date, recorded $7.2 million in security gains, $5 million in the second quarter, but they were nearly offset by net -- varying $6.4 million in net variable expenses related to covered loans, $2.8 million in the second quarter versus $3.6 million in the first quarter, which as I said last quarter, are running higher than we expected. I would also note that second quarter gain of $6.8 million for disposal of assets included $2.6 million related to FDIC covered assets. The rest came from our legacy portfolio.

Now we turn to expenses. The increase in the second quarter was due to several things. Higher legal and professional fees, some of which were associated with loan recoveries and the fund merger, I just mentioned a few moments ago. Increased headcount and salary increases that took effect in March. We still expect overall expense growth this year to be in line with the 3% reported for 2013. However, we don't expect any noticeable ramp-up in expenses. We have consistently invested in our infrastructure over the many, many years in the past, and are still doing that. One example I would give you is that in the fourth quarter of 2013, we completed the implementation of the new state-of-the-art BSA/AML system that is fully integrated and while providing some efficiencies, keeps us having the best practice profile in an important compliance area. One more thing I'd mention, most of you are aware that City National now has a $105 million of sub-debt that is called in the third quarter, that has a yield of 9%. We redeemed $50 million on July 15 and have notified investors that we plan to call the remaining $55 million in August. Going forward, that will reduce interest expense by about $2 million per quarter.

So I'll sum it up by saying that we're very pleased with what City National has achieved in the first half of 2014. The company is performing well, its balance sheet is strong and the investments we made over the past several years are producing results. What's more, the economy appears to be gaining momentum, especially in the markets we serve.

Now, Russell and I will be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Bob Ramsey from FBR Capital Markets.

Bob Ramsey - FBR Capital Markets & Co., Research Division

I think you mentioned that there were higher commercial recoveries, which gave you a little bit of lift in your NIM and commercial loan yields. How much was that of an impact this quarter?

Christopher J. Carey

Several million.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Okay, great. And then you talk about the sub-debt redemption. Presumably that's going to give you a little bit of lift in your margin. Is your margin guidance factoring that in when you say you expect the margin to be down a little bit? Or is that not a piece of it?

Christopher J. Carey

Well, so let me just talk a little bit about margins since it's a popular subject. We don't expect to be at the 3 21 level because of the high prepay interest. But if you normalize that prepay interest down, it was $18 million in the quarter. We tend to think that a normal level at the moment is around 10, which brings our margin down to the 3.08%, 3.09% level. And while we think that we're starting to see that at least probably for the next quarter or so, that's more of a level that's probably achievable. So that would still be up from the first quarter, but it would add a couple of basis points probably either way. If anything, that is a little more downside risk, but, yes, that is going to help us, but we still have other pressures on the margin. We still have the covered loans running off, in general, which is one small headwind we now have.

Operator

The next question comes from Steven Alexopoulos from JPMorgan.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Chris, just a follow-up on Bob's question. When you said several million, do you mind giving us the number? What was the dollar of actual loan recoveries x the covered? Just trying to figure out how much of the NII growth was not backed?

Christopher J. Carey

Yes, it's about -- it's just right around $2 million.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

$2 million. Okay. And then on the securities portfolio, the yields pick up pretty nicely. I guess that's partially a function of moving to the longer duration portfolio. Can you talk about how much move this quarter?

Christopher J. Carey

If you look at our financial reports, it's $2 million on a point-to-point. It might be slight -- it's $200 million on a point-to-point. It might be slightly higher on the average number. I don't have that with me, but the bigger part of the improvement clearly was the HTM [ph] piece.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Right. Should we think about that as a good quarterly run rate in terms of migration from the one portfolio to the other?

Christopher J. Carey

I think it could come off a little bit from there, but it should be in that range.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Okay. And then maybe, Russell, a follow-up on your comments about line utilization staying flat. We're hearing from a couple of banks out there, it seems like we're hearing increased confidence from borrowers, some banks EMI utilization pick up. It seemed more steady-state from you, you guys this quarter -- I guess, the last few quarters are a little more optimistic. Is that right? It was more similar this quarter to prior quarters?

Russell D. Goldsmith

I think in terms of the actual line utilization, it is flat. I do think we're seeing some pickup in confidence. Certainly, line utilization is not the whole story since the bulk of our loan growth was from existing clients, and you can see it in a place say like Commercial Real Estate where construction has picked up. That's clearly a level of confidence that you wouldn't have seen 12, 18 months ago. So there's more to the confidence question than just line utilization. But I think, it gives you a balance to -- we're moving in the right direction, we're making progress, but there's still -- we're still not fully back.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Okay, got you. And as we think, I guess, the commentary on loan growth strong was, it will be strong but slow in the back half of the year. Just wondering how much of this is coming from the competitive environment.

Russell D. Goldsmith

How would you characterize it, strong but slow? Is that how the competitors are saying it is?

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

No, no, I'm saying is -- I guess, if you've had great loan growth in the back half -- in the first half and you're guiding to slower growth in the second half. I'm just wondering what's driving the outlook for slower growth in the back half. Is it the competitive environment that you're slightly getting a little more of a challenge?

Russell D. Goldsmith

Well, I think that as we've looked at where the growth is in the first half, what we're trying to say is that growing at a 17% annualized rate still seems to us to be a very robust rate of growth and that sitting here right now with summer and some of the things that go on in the second half of the year, we're just trying to suggest, we don't think that loan growth is necessarily going to continue at that same level. Fortunately, our team has been doing a very good job and we've gotten that level of growth in the first half. It's possible we'll get it again in the second half. But sitting here right now, our best guesstimate is it will be a little bit below that.

Christopher J. Carey

And I would just add, Steve, we don't -- we aren't assuming that there's going to be any meaningful change in the utilization of -- of the lines. So if the economy really did get stronger noticeably, I mean, we're still waiting for that to really change. It hasn't over the last number of years. So we're not factoring that in. So if you had really solid -- really higher growth than I think people are expecting, or you just have a change there that we can't really forecast, it might be better.

Operator

The next question comes from Joe Morford from RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC, Research Division

I guess, a couple of questions. Hopefully, you talked about the deposit growth this quarter probably helped by client events, is that like IPOs or real estate paydowns? And also you mentioned about expansion into Santa Barbara in the Private Banking side, is that kind of a new venture for you or have you been serving that market already for a while?

Christopher J. Carey

In terms of the client events, yes, one of our clients had a very robust IPO in particular, that put a lot of money into the bank. Another client had a different type of event that put considerable amount of money into the bank and that's not going to all sit in demand deposits indefinitely. So that skews the numbers a little bit, although there may be more client events like that, given the robust and successful nature of our client base. In terms of Santa Barbara, as you know, Joe, we've been in Ventura County for, gosh, almost 20 years now. And as I've offered private banking, we saw an opportunity to bring in a terrific team of bankers who've been based in Santa Barbara, who can really improve our private banking and wealth management outreach in Ventura County, as well as extend that set of capabilities into Santa Barbara County. We've got a lot of brand recognition there, a lot of clients with second homes there and some first homes. And so combined with the skill of this team, we thought a very small office located in Santa Barbara was a good logical extension. It's not a big expansion. We're not planning to open a bunch of branches in Santa Barbara or something like that. But we think, given our position in Southern California, and given the opportunity to bring in some terrific people, that this was a good modest step forward, both in introducing us physically into Santa Barbara, as well as expanding what we can do in Ventura.

Joe Morford - RBC Capital Markets, LLC, Research Division

Yes, that makes sense. And then, Chris, I guess I had a couple of little things. You cited maybe a couple of million dollars of outsized legal, but even so, it's still higher. What's maybe a good run rate there? Are we settling in at a new higher level? And also, what about the tax rate going forward, any guidance there?

Christopher J. Carey

Well, I mean I think we're closer to a more normal run rate this quarter probably and the tax rate is probably closer to a more normal run rate this quarter. It was a little higher in the first quarter, which should hopefully be around where it is now for the remainder of the year.

Operator

The next question comes from Aaron Deer from Sandler O'Neill.

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Following up on the expense line and actually something that you said earlier in the call, Chris, about -- I guess it was, call it "guidance," but I think you referenced to 2013 expenses and then said 3% above that is kind of what you're looking for. Can you define that a little bit for me?

Christopher J. Carey

Well, we're looking to grow our total expense for the year, roughly up 3% over the total expenses for last year, assuming we don't find some really large team or an acquisition or something like that, that comes along.

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Okay. I just want to -- so there were -- it sounds like -- in addition to the outsize, kind of expenses that you identified, that there's probably some other lines where things ran a little high in the second quarter then?

Christopher J. Carey

Yes. Legal ran a little high. That's probably be the other notable one, that I would say. Those would be the 2.

Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division

Okay. And then, Russell, you highlighted some of the success that you're having in some of your specialty lending areas. I was wondering if you can also talk about what you're doing in some of the tech and innovation blending. I know you've done some hires there and I'm just curious, what -- how big would you like to see that particular book grow to? And can you talk a little bit about the nature of the lending that you're doing there, if it's truly kind of venture back stuff or if it's more just along the lines of -- just young growing companies that kind of fit that more tech profile?

Russell D. Goldsmith

We're very, very pleased with what we're seeing in the growth of our specialty focus on technology industries and we're seeing loans that are north of $100 million in outstandings. And as we expected in that -- the way that industry works, we're seeing deposit levels that are triple that. And so that's a good trend. We've got -- we've been building the team nicely under Rod Werner and John Kreutter's leadership. We've talked about the fact that City National has a number of, what I would call, geographically focused businesses. And we have a number of national businesses. And technology, like entertainment, is a nice mix of both in that we're headquartered in the Silicon Valley with a growing team in Palo Alto, new offices this year in Palo Alto. And at the same time, because we've added teams now in Boston, New York and Santa Monica, as well as given our capabilities in Atlanta in Orange County and San Diego County, we cover an enormous percentage of the technology infrastructure, if you will. And we're doing that with a relatively small team of just under 20 people. We're going to continue to grow that team and grow that book as we do in a number of areas. You've seen us do that in franchise finance. You've seen us do that in the ABL sector, in any number of areas. And I think given the enormous diversity and growth in technology that's happening in this country, it's very exciting. It's the most dynamic economic story, not just in America, but in the world. And it's headquartered right here in our backyard in Northern California. So we're enthused about it. We've got great people and we're going to grow it at, I think at a very robust cliff for the foreseeable future. But at the same time, relative to the total portfolio, it's still quite small.

Operator

The next question comes from Dave Rochester from Deutsche Bank.

Timur Braziler - Deutsche Bank AG, Research Division

This is actually Timur Braziler filling in for Dave. My first question is a follow-up to Steve's earlier question regarding securities yields. Was the bump up this quarter at all a function of lower premium amortization expense? Or was it fully driven by higher purchase yields?

Christopher J. Carey

Part of it was lower premium amortization. I don't know the exact amount, but part of it was that.

Timur Braziler - Deutsche Bank AG, Research Division

Okay, great. And then just, if you don't mind sharing, what was the average yield on new securities purchased during the quarter?

Christopher J. Carey

Well, we really have kind of 3 portfolios. So we have [indiscernible] what we call a stiff portfolio, which is very short-term. Now it's about 85 basis points. And then you go to our core portfolio, which I think was around 2. And then our health maturity, which is in the low 3s. On the average, it might be a little 3 3 4. So it's a range across those 3 portfolios that make up the whole $8.7 billion portfolio.

Timur Braziler - Deutsche Bank AG, Research Division

Okay, great. And then during your prepared remarks, you had mentioned that the competition remains pretty tough, particularly on the commercial side. Is this competition mainly on pricing or in structure or both? And then just maybe how did it impact spreads during the quarter?

Russell D. Goldsmith

Well, I think depending on who the competition is on any given transaction, sometimes it's price, sometimes its structure, sometimes it's both. And I think as you would expect competition as a way of tightening spreads and pushing down pricing, but I think our team has done a good job of competing aggressively where it makes sense, and you can see our margins actually up or fairly stable in this quarter.

Timur Braziler - Deutsche Bank AG, Research Division

All right. Is there any particular industry that you saw the greatest amount of added competition?

Russell D. Goldsmith

No. The nice thing about City National being so diversified and in so many geographies and industries, is that we see a variety of competitors. In technology, obviously, there's a couple of dominant players that we compete with there. In other areas, it's just -- they're not present at all. So you're going to see, given our business, a broad range of competitors. And I think given what we all know about what's going on in banking, in the economy and rates, generally speaking, they're all quite competitive. If I knew of one that was not competitive at all, we would jump in with both feet and I wouldn't mention it on the call.

Timur Braziler - Deutsche Bank AG, Research Division

Okay, understood. And then just lastly a bit of a modeling question, but Other Income line increased a little bit this quarter. Was that a factor of just the first quarter number being unusually low? Or is there anything onetime in nature in that number?

Christopher J. Carey

I don't think there's anything onetime, but we always have some variability there, particularly with our lease residual income, which was up over $1 million this quarter. The other thing as we are putting a big push on our credit card business and we had a $0.5 million increase in our interchange and we are really gaining a lot of momentum there and just really penetrating our client base. So that one would be a little bit more steady and the other one can be a little bit more variable.

Operator

[Operator Instructions] The next question comes from Jennifer Demba from SunTrust.

Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division

Question on the newer New York City branches. Just wondering what the early returns on those are at this point.

Christopher J. Carey

We're very enthused about this, the 2 offices in Manhattan, they've been open for less than a year, in one case, and about a year in the other. And I think that we're -- we've generated an enormous increase in brand recognition and credibility in New York by virtue of having these. As you may know, in addition, we expanded our facilities for our entertainment division and our private bank and wealth management in the process of taking space, both on -- in 6th Avenue and Park Avenue. And for the first time we've introduced some of our capabilities in our kind of higher-end, core banking branch, banking capability with what we call Preferred Banking and some small business banking. We have a small team, relatively speaking, tackling what is an incredible economy in Manhattan and we're very pleased with how it's going so far.

Operator

At this time, there are no more questions in the audio queue. So I would like to turn the call back over to Mr. Goldsmith.

Russell D. Goldsmith

Thank you, operator. I want to thank everyone who participated in the call today for joining us. We always appreciate your interest in City National, and look forward to speaking with you again at the end of the third quarter. Meanwhile, of course, Chris and I, are available if you have any other questions. Thanks very much and have a good afternoon.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.

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City National (NYSE:CYN): Q2 EPS of $1.11 beats by $0.14. Revenue of $320M (+12.2% Y/Y) beats by $10.85M.