Square 1 Financial's (SQBK) CEO Doug Bowers on Q2 2014 Results - Earnings Call Transcript

Jul.25.14 | About: Square 1 (SQBK)

Square 1 Financial Inc (NASDAQ:SQBK)

Q2 2014 Earnings Conference Call

July 25, 2014 10:00 AM ET

Executives

Dee McDougal - Public Relations

Doug Bowers - President and CEO

Patrick Oakes - CFO

Diane Earle - Chief Credit Officer

Analysts

Aaron Deer - Sandler O'Neill & Partners

Julianna Balicka - KBW

Operator

Good day, ladies and gentlemen. And welcome to the Square 1 Financial, Inc. Earnings Conference Call. At time all participants are in a listen only mode. (Operator Instructions) As a reminder this conference is being recorded. I would like to now introduce your host for today’s conference Mr. Dee McDougal from Public Relations, you may begin.

Dee McDougal

Thank you, San. And thank you everyone for joining us for our second quarter 2014 earnings call. Doug Bowers, President and CEO; and Patrick Oakes, CFO, are here to discuss results. As a reminder the Square 1 Financial current earnings release is available on the Investor Relations section of square1financial.com.

I wish to caution you that we will be making forward-looking statements during this call and that actual results may differ materially. We encourage you to review the disclaimer in the earnings release dealing with forward looking information. Disclaimer applies equally to statements made in this call. In addition, some discussion may references to non-GAAP financial measures, information about those measures including reconciliation to GAAP measures may be found in SEC filings and in our earnings release. And with that I will turn the call over to President and CEO of Square 1 Financials, Doug Bowers.

Doug Bowers

Thank you, Dee. And thanks everyone for joining us today for our second quarter 2014 earnings call. I'm with our Chief Financial Officer, Patrick Oakes and our Chief Credit Officer, Diane Earle. Pat and I will have some comments and then we will open it up for questions.

To begin with, I'm pleased with our strong results for the second quarter and a continued good start for the first half of 2014 for Square 1 Bank. We delivered earnings of $8.1 million or $0.27 diluted earnings per share for the quarter. An increase of $3 million or 59% when compared to the same period last year. This growth and income was mainly the result of the overall increase in net interest income from our continued strong loan and strong deposit growth.

Our key performance ratios for the quarter were also quite strong with return on average assets at 1.22%, return on average common equity at 11.74% and a net interest margin of 4.03%. Average loans for the quarter increase $90.3 million or 4.8% to $1.1 billion, with the growth coming from virtually all of our key lines of business. Loans were up 27% versus June 30 of last year.

Moving to credit quality results, we are pleased there as well, as this quarter saw net charge offs decreased to $688,000 or 25 basis points of annualized average loans. We did experience a $2.7 million increase in non-accrual loans to $12.3 million as we placed two loans totaling $4 million on non-accrual status, both of which are fully reserved.

Our overall allowance for loan loss at June 30th was 1.87%, an increase from 1.80% in March 31. Certainly I'm happy with our credit performance for the first half. Know that there can be volatility in our credit performance quarter-to-quarter, but the first half of 2014 is very positive and we are well reserved to going into the second half.

We continue to see good growth in our deposits and our balance sheet client investment funds stemming from the growth in our client base coupled with deposit in flow from a strong venture capital funding environment. As you know venture capital fund raising continues to outpace 2013 levels with $7.4 billion raised in the second quarter alone.

Deposits for the quarter increased $247 million or 11% to $2.4 billion and up $505 million or 26% when compared to June 30 of last year. Our continued focus on providing appropriate off balance sheet alternatives such as Square 1 asset management to our clients has resulted in solid growth in our off balance sheet client investment funds for the quarter.

Overall, these off balance sheet funds grow $136 million or 21% to $780 million in the second quarter. We will continue to encourage our clients to use our off balance sheet alternatives as a way of helping to match the level of on balance sheet deposit growth and attract new clients. When putting it all together, we are pleased with the second quarter results and a momentum heading in the second half of the year.

Strong loan growth, up 27% year-over-year and the deposit activity that comes with it as a sign of the traction we are gaining in virtually all of our markets, the growth in our brand, the success of our hiring and the tailwinds we are experiencing from the venture industry which is accelerating. And now I’ll turn it over to Pat, who will talk more about our financial results. Pat.

Patrick Oakes

Thanks Doug, and good morning everyone. It was another solid quarter for us. Highlighted by the strong loan and deposit growth, Doug mentioned earlier. To highlight the quarter, I will walk through a few items regarding the margin, non-interest income and expenses. The net interest margin for the second quarter was 4.03%, a decrease of 9 basis points over the prior quarter driven by higher average cash balances of $98 million, which was result of the strong growth and deposits that occurred in the quarter.

Both loan and security yields were up from the prior quarter. We experience a 13 basis points increase in loan yields from both higher loan fee income and higher loan rates. Our overall cost to deposits remained unchanged at 2 basis points for the quarter. Non-interest income for the second quarter was $6.4 million, a decrease of 800,000 over the prior quarter.

The non-interest income included 2.2 million in lower warrant income offset by $1.4 million increase in unrealized gains on our venture capital fund investments and $450,000 gain on the previously announced transfer of the contract for the management of Square 1 ventures. The total warrant income decreased to 21,000 from 2.2 million for the first quarter. As of June 30th, we held warrant positions from successful IPOs in five publically traded companies for a total unrealized gain of 800,000 compared to 2.5 million held in six public companies as of March 31st.

During the quarter we exercised warrants in four companies with the total value of 1.4 million and received equity securities. These securities are held and now available for sale, investment portfolio and are subject to their lockup. At June 30, the fair value of these equity securities was $1 million. Core banking income was 3.7 million for the second quarter, an increase of 503,000 or 16% from the second quarter of 2013 and decreased 325,000 from the previous quarter as a result of lower foreign exchange and letter of credit fees from their seasonally high first quarter results.

Non-interest expense increased by 1 million in the quarter to 16.6 million and was up 18% compared to the second quarter of 2013. The efficiency ratio remained relatively unchanged at 51% and down from 55% in the second quarter of 2013. The increase in expenses for the second quarter was mainly due to our overall growth as we continue to invest in our franchise and a higher reserve and unfunded commitments based on the change in our methodology.

The period end balance of the investment portfolio was 1.3 billion with an overall duration of 2.9 and available for sale duration of 2.2. The investment purchased in the second quarter consisted mostly of short duration agency mortgage backed securities, along with some non-agency mortgage backed and the other asset backed securities. Finally, let me provide a quick update on our capital.

On April 2nd, all of our Series A convertible preferred stock was converted by the holder into 500,000 common shares of our stock. During the second quarter the remaining 3.7 million of our convertible trust preferred securities were converted into 367,000 common shares. At June 30th, no convertible trust preferred securities remain outstanding. Now, I will turn it back over to Doug.

Doug Bowers

Thanks Pat. And operator, if we could open it up to see what questions we have. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Aaron Deer from Sandler O'Neill & Partners.

Doug Bowers

Good morning Aaron.

Aaron Deer - Sandler O'Neill & Partners

Very nice quarter. It sounds like you are pretty optimistic about the space you are operated in which isn't surprising given the trends there, but I would [indiscernible] if I didn’t ask how the pipeline is shaking up here for the back half of the year in terms of loan growth and just maybe give some color on what you are seeing in terms of that competitive environment and pricing?

Doug Bowers

Well, pretty good momentum going into the second half in terms of client activity and expectations around growth. So, a lot of good momentum in the venture space, broadly speaking, and we were enjoying our fair share of that given what we have done inside our company and given what’s going on in the industry. So the short answer is pretty good outlook there. With respect to competitiveness it’s very very competitive and we see that play out both in terms of pricing and structure. And so we're being very thoughtful and very selective as we pick through the opportunities that are out there for us. But saying that I’m pleased with how our loan overall loan name has hung in and we continue to see good opportunity.

Aaron Deer - Sandler O'Neill & Partners

Great, and then Pat, can you talk a little bit about the higher sequential yields which you saw in both of the loan book as well as the securities portfolios? I’m guessing that maybe there were some mix shifting going on within those individual books in terms of what product is being booked?

Patrick Oakes

Yes, so on the loan side it was really combination of overall loan yields and the fees associated with those, fees were high, it's probably the high end for us, it was 83 basis points. It's not normally that high, but we also saw a nice increase in just the overall loan yield. Part of that was yes, new fundings that we saw at higher rates and we also saw some payoffs in some lower yielding loans. Not just sustainable but it was nice bump up for the quarter. And on the security side, it was held by the mortgage backed portfolio, probably as much as anything, some slower prepays there to help that, beside that I think it was just some investments we made but it was not that much.

Aaron Deer - Sandler O'Neill & Partners

Okay. That’s helpful. And then I know here in the third quarter the trough dividend goes away and I guess probably a few basis points. And then of course we got the higher yields that we just discussed, but given the strong deposits which you had and the greater mix of securities and some additional cash in the balance sheet, what do you kind of expecting for the margin over the next couple of quarters?

Patrick Oakes

Yes, so obviously a lot of its driven by the amount of cash that we hold in the deposit growth that we see. As you can see we’ve try to invest a lot of those deposits, if there are core deposits that are coming in. So we’re going to continue to do that. It just seems like it's a short-term deposit we won in a sitting cash, but with that it depends on what cash does as much as anything else. I'm hoping we can keep that cash balance down a little bit which will help take some of the pressure up to margin, but we’re not afraid to hold more cash.

Doug Bowers

And the other thing I would add to that is. There is a pretty competitive environment out there on the loan side, so it would not surprise us to see a degree of compression on the loan margin side. And certainly we’re really pleased with the way the securities portfolio is holding up, but rates have compressed here with where the tenure is and so that too will probably have a little bit of pressure. But all in all it should hang in at a pretty good rate. But there will be some pressure on both ends of that. Is that helpful?

Aaron Deer - Sandler O'Neill & Partners

Yes, absolutely. And Doug, I know year-over-year you guys have had a lot of bankers and support staff, but the compensation cost actually is held fairly, in the second quarter and I suppose some of that is just lower payroll taxes and such. But can you talk about the success that you’re having in attracting new bankers in what markets and what verticals you're bringing on new people?

Doug Bowers

So, but we do have important hiring, recruiting efforts that have been underway, actually for the last several quarters. And we’ve hired in the Valley in Boston as probably our two biggest arenas of hiring. But, and all in all the second quarter there were six new hires on the banking side. So we think of it as being very true to our core markets which are away from the Valley in Boston that’s how this bank grew up and where we had considerable success. And then we’re feeling a momentum that we started in the Valley and in Boston and continuing to add there. So, Boston matters a lot, the Valley matters a lot in terms of most recent growth. We’ve also added to our VCS team, our SBA team as well.

Operator

(Operator Instructions) We do have a question from Julianna Balicka from KBW. Your line is now open.

Julianna Balicka – KBW

Good morning. To follow-up on some of the questions, on the loan yields question, you mentioned in your answer that loan fees are 83 basis points over yield in the quarter? Can you remind us what was that last quarter?

Patrick Oakes

It was roughly about 70, high 70, 77, 76 somewhere around there.

Julianna Balicka – KBW

Okay. And then you mentioned that some lower yielding loans had rolled off when you put on higher yielding loans and that’s relative to other things it's an unusual combination, so maybe you can talk a little bit about the lower yielding loans, what kind of loans that was rolled off. And did they rolled off because they just matured, did they just get competed away? Can you give us a little bit more color on what’s going on there?

Patrick Oakes

So I think it was -- I don’t think it was anything in particular, I think it was couple of loans and I think some of them just pay off more than anything else, not in competition. Will be unique for us, we had, to have that mix I wouldn’t expect that to continue.

Doug Bowers

And the other thing I'd add Julianna is the compliment as you know, we’re mostly early in expansion stage in terms of the client mix for us. There is not as much later stage private equity kind of activity and while it’s competitive everywhere, the actual, the mix of growth, the first six months [indiscernible] was four in the early expansion stage side of things.

Julianna Balicka – KBW

Okay. That makes sense. And in terms during the IPO one of the topics that you would discuss with investing in the business and Aaron asked about that hiring, but could you update us as to your progress on some of the other investments you were making into your platforms for credit management et cetera, online banking?

Doug Bowers

Yes. So I think of it as three core areas. So in no particular order, a one was that we were having new office space, we have a new office now in San Francisco that we opened in April. We have expanded office space that we are opening in New York, which will be in September and then we have a new office that will be in Chicago. So that’s number one.

Number two is, if we have two platforms that we are upgrading significantly, one on the credit side which just went live this week and then the other is the online treasury platform which we are upgrading significantly and that will take place in the fourth quarter. And then finally is the increase to our -- primarily to our front office if you will or complemented bankers. And that too is moved to the pace we have set.

Julianna Balicka – KBW

Very good, that makes sense. And then translating back into our numbers, how much of the expense increased? Should we be thinking about in terms of dollars or percentages, how do you -- for the new few quarters then?

Patrick Oakes

So, we are seeing some of that flowing already as you can see the increases in some of the other expense categories. You will see the New York lease obviously in the fourth quarter. The Chicago office has been delayed, it will happen this year but much later in the year than we had thought. So, some of those are members are in and some will continue to go throughout the rest of the year, but most of the expense growth you will see is really obviously related to the personnel side and that’s the biggest line item.

Doug Bowers

And most of that will show through in the second half, or more of it will show through in the second half. So you'll have a degree of higher expenses in the second half versus the first half.

Julianna Balicka - KBW

Okay, very good and then you also talked about your positive outlook for the rest of the year in terms of the industry that you bank in and we saw similar outlook of extraordinary deposit growth in Silicon Valley asked from your guys on the linked quarter annualized basis. So when you think about ongoing deposit growth and deposit growth in this quarter, as you say that this is just more of a trigger just as for one off really really good quarter and you expect this depend on slow down a little bit in the near future or kind of how are you managing around the idea of that 40% linked quarter annualized average deposit growth?

Doug Bowers

Yeah, well first of all Julianna, I applause your ability to get us to overwhelming forecast the future which is not something we are going to do a lot of. I think what I'd say is that the industry is in ever better place. Our brand is in an ever better place and we have put more bankers to the task of growing and they have been very successful. So, I don’t have any reason to be anything but pretty optimistic given the current state of things, both in the industry and where we are at.

Operator

At this time I'm showing no further questions. I would like to turn the call back over to management for further remarks.

Doug Bowers

Well, thank you. Obviously, we are pleased with our second quarter and the first half results. And we will look forward to good things for the rest of the year. Thank you all for participating, we appreciate it. Thank you, operator.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program, you may now disconnect.

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