CommunityOne Bancorp (NASDAQ:COB)
Q2 2014 Results Earnings Conference Call
July 29, 2014 11:00 AM ET
Beth DeSimone - Executive VP, General Counsel and Secretary, FNB United Corp.
Brian Simpson - Chief Executive Officer
Dave Nielsen - Chief Financial Officer
Neil Machovec - Chief Credit Officer
Hello. And welcome to the CommunityOne Bancorp’s Second Quarter 2014 Earnings Presentation. You will be in listen-only mode for the call. (Operator Instructions)
Please note this event is being recorded. I would now like to turn the conference over to Beth DeSimone. Ms. Beth DeSimone, please go ahead.
Good morning. I would like to welcome everyone to the CommunityOne Bancorp’s second quarter 2014 earnings presentation. If you are logged on to our website at www.community1.com, we have placed the slide presentation on the Investor Relations page of our website and you could follow along with presentation as we go through it.
The presentation today contains certain forward-looking statements, related to CommunityOne financial condition, results of operations, plans and objectives and business.
These statements are by their nature subject to risks and uncertainties, including those we have identified and discussed in our securities filing, including our annual report on Form 10-K, our quarterly report on Form 10-Q and our other securities filings.
Actual results may differ materially from those expressed in our forward-looking statements. We do not promise to update those forward-looking statements to reflect actual results or any changes in assumption or other factors that could affect them.
The presentation also contains certain non-GAAP financial measures. We believe that these non-GAAP measures are useful for investor in understanding our underlying operational performance and trends. A reconciliation of non-GAAP measures to the most directly comparable GAAP measure is included within tables in the presentation and in the appendix to it.
Now I am pleased to turn the call over to Brian Simpson, the Chief Executive Officer of CommunityOne Bancorp. Brian?
Thanks, Beth. Good morning and thank you for joining us. Today we will discuss CommunityOne’s result for the second quarter of 2014, which are summarized in this morning’s earnings release. As Beth mentioned, you can find an investor presentation which we will refer to during the call on the Investor Relations page of our website.
Joining me on today’s call are Dave Nielsen, the company’s Chief Financial Officer; and Neil Machovec, our Chief Credit Officer.
The second quarter of 2014 marks our fourth consecutive quarter of profitability with $3 million in net income before tax, 133% improvement over first quarter pretax income of $1.3 million and $6 million better than the second quarter of last year. After tax net income for the quarter was $2.8 million.
On a per share basis, we reported $0.13 net income per share as compared to net income of $0.06 and a net loss of $0.15 per share last quarter and in the second quarter of last year, respectively.
Stripping away non-core credit provision and non-recurring items, core earnings were $2.6 million in the quarter, up $0.9 million or 55% from the first quarter and up 40% on a linked-quarter basis.
Core earnings is a non-GAAP measure that excludes taxes, credit loan costs and non-recurring income and expense from our net income in order to measure and track performance of the company excluding these items.
We are very pleased that loan growth during the quarter was robust and broad based with solid growth across each of our lines of business. Growth accelerated over last quarter as loans were up $50.1 million that is 16% annualized growth. I will talk more about this important trend in a moment.
As Neil will discuss in more detail, we had another positive credit quarter with further reductions in NPA’s to 2.7% of assets and a continuation of our life charge-off experience. Year-to-date, we have averaged 12 basis points of net charge-offs. Productions in our problem loan book and low charge-offs drove to $1.7 million provision recovery.
Net interest income grew 2% on the quarter, despite a drop in accretion of the Granite purchased impaired portfolio. Net of that non-cash accretion, net income -- net interest income grew 9% year-over-year and added 11% annualized rate during the quarter. NIM dropped 3 basis points during the quarter to 3.4%, but is up 13 basis points on the linked-quarter basis.
We continue to see results from our expense reduction efforts with non-interest expenses down $5.4 million or 22% on a linked-quarter basis. Core expenses fell 2% from the first quarter, reducing core expenses to average asset to 3.4%, expenses up $0.4 million related to the U.S. treasury secondary offering in May drove the increase in total expenses on the quarter.
In addition to another quarter of improving profitability, we are very pleased with our progress on our four goals for 2014 outlined on page five. Our highest priority goal is to grow loans. We experienced very strong loan growth in the quarter, with loans held for investment up $50.1 million or 4% during the quarter or a 16% annualized growth rate.
Stripping out our portfolio of high quality purchased residential mortgage loans, organic growth in the portfolio was $34.8 million or 14% annualized growth rate. As we will discuss later, we are experiencing growth in all segments of our business, especially our commercial banking segment, where we expect additional growth from recent staff additions and new loan production offices.
Our loan growth and the increase in our loan to deposit ratio to 72% are both ahead of plan and as we indicated several quarters ago, asset resolution is no longer the headwind to loan growth that was in prior years.
On the deposit front, we are seeing modest growth, with deposits up $15.1 million since year end or 2% annualized growth rate. During the quarter, deposits were down $4.2 million as core deposits fell 2.1% on seasonal declines in interest bearing DDA accounts and declines in money market balances, partially offset by a $6.3 million increase in non-interest bearing deposits.
Our treasury management product improvements and investments in mobile banking infrastructure are on track and should support growth in future quarters.
As I mentioned earlier, we are seeing good results from our expense reduction efforts, even as we make investments in key areas. Year-over-year, core expenses are down 6% and I highlight a number of items that should drive further improvements.
Headcount is down 11%, primarily on continuing branch rationalization efforts and the implementation of branch staffing models. We have recently renegotiated one of our most significant vendor contracts and anticipate related savings starting in the second half of 2014 and accelerating in 2015 and 2016.
Starting in the third quarter, improvements in our capital, earnings and assets quality to drive a decline in the annual costs of our FDIC insurance and other regulatory expenses of greater than a $1 million. Overall, core NIE to average assets declined to 3.47% during the quarter and is better than our goal for the year.
Our fourth key goal is to resolve our remaining credit issues and we’re currently ahead of schedule with very little credit costs incurred to date. We reduce NPA’s 9% in the quarter, reducing the NPA to averages asset ratios of 2.7% versus a year end goal of 2.3%.
We have reduced classified assets by $22 million year-to-date versus a full year reduction goal of $40 million and we brought the Bank’s classified asset ratio down to 56% from 67% at year end, well on track to reach our goal of 45% by year end.
Before I turn the program over Dave and Neil, I want highlight on page six a few of the actions we have taken that are contributing to our solid lending performance. In late June and earlier this month, we expanded our commercial and real state teams in coverage area and we anticipate that these steps will further accelerate the growth we are seeing from our commercial banking business.
In June, we opened a loan production office in Raleigh with two experience commercial and real estate bankers, and we expect to add one or two additional bankers to this team in the next several months. Raleigh is a very important market to us, as it is the second largest economic hub in North Carolina behind Charlotte and the fastest growing.
In July, we hired a team of four experienced commercial and real estate bankers to lead and expand our existing team in Greensboro. Among the team is our new regional banking President and our Greensboro Market President.
In addition, we hired a team of two more experienced real estate and commercial bankers to open an LPO in Winston-Salem. We expect this hires will drive accelerated growth in our business in Greensboro, Winston-Salem and the Piedmont Triad, the third largest market in the state behind Charlotte and Raleigh/Durham
Bankers we added to our team were attracted to us by the distinctive model that is driving our success. First, we matched experienced and focused C&I bankers with owners and managers of operating businesses. Likewise, we matched CRE bankers with real state investors and developers.
By doing so, our clients benefit from receiving more insightful advise and better solutions than they do from institutions that follow a more generalist model. In addition, our deal team approach to assessment and acting on a client need is far more responsive than the traditional credit committee process that is common among our competitors.
We are also taking a numbers of steps to accelerate our consumer and mortgage leading business. We recently hired mortgage executive to lead our new non-branch origination channel, supplementing the production of our existing branch referral business.
This new channel will focus exclusively on realtors and builders, and other non-branch origination channels, primarily in the larger markets in our footprint, Charlotte, Raleigh and Greensboro, Winston-Salem. In addition, recent infrastructure investment has been driving accelerated growth in our exciting indirect auto finance business.
Now, let me turn the program over to Dave for a more detailed discussion of our second quarter financial results
Thank, Brian. Turning to page seven you can see the detail of our net interest income and net interest margin for the quarter. Net income was $15.7 million in the quarter, that’s an increase of 2% from the first quarter on a 1.3% increase in average earning assets.
Average earning assets were in fact $24.3 million higher during the second quarter as a result of the strong loan growth that Brian mentioned with average loans growing $29.1 million.
Excluding the impact of a $2.2 million decline in the non-cash accretion on purchased impaired loans in the second quarter, net interest income actually grew 9% year-over-year and grew at an 11% annualized growth rate in the second quarter.
Interest accretion from the Granite purchased impaired loans in excess of the contractual interest received fell during the quarter from $0.9 million to $0.7 million as I just mentioned, as a result of the reduction in balances of purchased impaired loans from asset resolution activities and repayments. The balance of purchased impaired loans fell from $149 million at the end of the first quarter of this year to $141.2 million at the end of the second quarter, that’s about a 5% decrease.
Net interest margin was 3.40% in the second quarter, that’s an increase of 13 basis points from the second quarter of last year, but 3 basis points lower than the first quarter. The NIM drop was the result of a 2 basis points increase in the cost of wholesale funding, as well as the decline in earning asset yield, which fell this quarter by 3 basis points to 3.95%. The decrease in earning asset yield was the result of the decline in purchased impaired loan accretion that I just mentioned.
Investment portfolio yields rose this quarter by 5 basis points to 2.72%, as a result of the impact that reduced prepayment expectations on our mortgage-backed securities portfolio. The cost of interest bearing deposits was pretty stable this quarter at 48 basis points. As compared to this time last year, the cost of interest bearing deposits though is about 6 basis points lower. Including our non-interest bearing deposits, the actual overall cost of our total deposit funding base was 40 basis points in the quarter, that’s also the same as last year.
As I mentioned, the average cost of liabilities did increase 2 basis points during the quarter, as a result of the full quarter impact of interest rate swaps that we executed in the first quarter, as cash flow hedges of our floating rate FHLB debt in order to fix the interest rates of those liabilities and also to extend their duration.
Moving on to page 8, noninterest income, you can see that noninterest income was $4.9 million for the quarter, that’s an increase of 24% over last quarter. During the quarter, we realized the gain of $720,000 on the sale of SBIC investment that had converted into a publicly traded equity and we sold that at the expiration of a lockup period. Net of this noncore item, core noninterest income was $4.2 million, that’s about 6% increase from last quarter.
Mortgage loan income was also improved in the second quarter, up about $87,000 on seasonal increase in origination volume, which was up 70% from the previous quarter to $42.4 million. Fannie Mae volume was $15.4 million or about 32% of origination volume.
Year-over-year loan production declined by about 30%, that’s better than the industry that we’ve seen from the MBA. We are continuing to selectively add mortgage loan officers in our more active markets like Charlotte and Greensboro in addition to the non-branch channel that Brian mentioned earlier.
Service charge income was also improved this quarter, up 4% quarter-on-quarter on better NSF and overdraft protection activity. Cardholder merchant services income also grew on stronger debit card and merchant activity and we are quite pleased with both of those. The Wealth division has another solid quarter with revenues up just under $400,000, that’s up 11% this quarter.
Moving on to page 9, noninterest expense continued to be well controlled and fell $5.4 million or 22% from the comparable quarter in 2013, as a result of reduced OREO levels and associated expenses, as well as expense synergies from the Bank of Granite merger. Core noninterest expense was $0.4 million or 2% lower than the first quarter as a result of reduced personnel expenses and decline in professional fees in the quarter. Year-over-year core noninterest expense declined 6%.
Average FTEs continued to decline and they were 558, that’s down from 576 last quarter and 630 in the second quarter of last year, reductions of 3% and 11% respectively. The 11% reduction has been driven by branch closures and improvements in branch staffing models, which have been and continued to be ongoing. In total, noninterest expense rose $0.5 million in the second quarter from the first quarter, most of this net change can be attributed to $0.4 million of expenses incurred in the sale of the U.S. treasuries position, the company that was completed in April.
Loan origination during the quarter resulted in $0.2 million in additional reserve for unfunded commitments that closed through other expenses.
And finally, OREO expenses increased $0.7 million during the second quarter based on the concentration and the timing of OREO appraisals related to the appraisal of our OREO portfolio in the second quarter of 2013. And Neil will talk a little bit more about this later. Offsetting these increases were declines in personnel costs for the reasons I just mentioned, as well as professional fees during the quarter of $0.6 million in total.
You can also see that our FDIC and other regulatory costs started to drop at the end of the second quarter based on capital earnings and asset quality improvements, and I do expect these costs to continue to decline through the remainder of the year. And Brian mentioned earlier that there will be additional savings expected to start in the second half of the year related to vendor contracts that are being renegotiated.
On page 10, you can see total assets were essentially flat during the quarter, as we continue to rotate out of our securities book and cash and into loans. During the quarter loans grew to 62% of assets, that’s up from 51% a year ago. I will talk a little bit more about loans in detail in a minute. The investment portfolio fell by approximately $30 million during the quarter as a result of normal maturities, prepayments and sales. This decline was offset by $7.6 million unrealized gain in the AFS portfolio during the quarter due to falling interest rates.
For a net decline in the portfolio GAAP balance of $5.3 million. The portfolio has been constructed as we have noted previously to generate cash flow to fund expected loan growth and remains weighted towards government sponsored entity mortgage-backed securities.
Page 11 shows loan portfolio, we had a very strong quarter from a loan growth perspective as Brian mentioned. And you can see that in the chart at the top of page 11, total loans including loans held for sale grew just under $50 million and annualized growth rate of 16%. All of our lines of business grew loans and all categories of loans grew this quarter.
Excluding the impact of problem loan resolution out of the portfolio, total pass rated loans grew by $63.1 million during the quarter to $1.15 billion, that’s a 23% annualized growth rate.
Excluding the purchased residential mortgage loan portfolio, which grew by $15.1 million during the quarter as a result of a $19.6 million residential mortgage loan pool purchased, organic loans grew 3% during the quarter and an annualized growth of 14%. We also continue to resolve problem assets during the quarter with non-pass rated loans declining $13.2 million or 10%.
The chart at the bottom of the page shows loan mixed by category over time. And you can see in terms of loan composition, we remain consistent with our goal to have a balanced portfolio between commercial and consumer loan exposures. Overlaid also on this chart is the annualized quarterly growth rate for the total portfolio.
Turning to deposits, you can see on Page 12 that our total deposits have grown by $15.1 million year-to-date at annual growth rate of 2%. During the second quarter, deposits fell $4.2 million on seasonally lower interest-bearing demand deposit account and decline in our money market balances.
Growth in non-interest-bearing deposits of 2% was especially strong this quarter. The increase in brokered CDs in the quarter was used to pre-fund third quarter brokered deposit maturities at attractive rates and durations. Low cost core deposits which exclude all CDS dipped 1% this quarter to 66% of the deposit book, that’s down from 67% last quarter. As I mentioned previously, the cost of our deposit base were flat during the quarter at 48 basis points.
On Page 13. You can see the changes in our net deferred tax assets. The company had $150.4 million at June 30, 2014 with a corresponding valuation reserve of $145.2 million, resulting in net deferred tax asset included in the balance sheet and other assets of $5.2 million, which represents the deferred tax asset associated with the unrealized loss on the companies available for sale in investment and securities portfolio. As we do each quarter, in the second quarter, we evaluated the continued need for some or all of the valuation allowance on our deferred taxes in accordance with generally accepted accounting practices.
Turning to Page 14. The capital ratios at CommunityOne Bank were generally improved during the second quarter as a result of the bank’s quarterly earnings and stable level of average assets. Our risk-based capital measures of the bank declined finally as a result of the strong loan growth during the quarter. The bank leverage ratio rose from 7.74% to 7.86% and the same ratio at CommunityOne Bancorp rose to 6.35%.
We do expect continued increases in capital ratios at the bank and the company as we remain profitable in coming quarters. The Bank and the Bancorp also continue to be classified as well capitalized.
Our loans-to-deposit ratio was also improved in the second quarter and improved to 72%. Remember our goal is to move this ratio to 75% by the end of the year. The bottom half of the slide rolls forward tangible shareholder’ equity for the quarter. Two key element focus on here in the rollforward are $2.8 million net income after tax for the quarter and also the $4.7 million unrealized gain on available-for-sale securities, net of deferred taxes that I mentioned earlier.
Now let me turn the presentation over to Neil.
Thank you, Dave. I’m pleased to report that again our company has turned in another solid quarter of credit performance. Turning to Page 15, you can see that we again improved asset quality during the second quarter, continuing the progress made since the closing of the recap.
Looking at the quarterly problem asset trend chart to the bottom of the page, you can see that non-performing loans decreased by $2.3 million or 7% in the quarter and now represent only 2.5% of total loans. This is a 46% reduction since the second quarter of 2013. We also continue to make steady progress in the reduction of special mention and classified loans.
Classified loans are down $11 million or 12% in the second quarter while special mentioned loans decreased $2 million or 5% in the same period. The allowance decreased by $2 million in the quarter. This reduction was influenced by number of factors, continued improvement in the originated loan portfolio led to $869,000 reduction while continued reduction in the granite purchased impaired and purchased contractual loan portfolios led to $1.2 million reduction in the purchased impaired portfolio allowance.
The combination of these factors caused the allowance to decrease to $24 million at quarter end, from $26 million at the end of the first quarter. The reduction in the allowance reflects the overall reduction in problem loan levels and the realization of loss on impaired loans overtime, leaving us with a decreasing level of loans with specific reserves.
Our general reserves are also following as we reconfigure our portfolio around loan categories with better loss experience. The allowance represents 1.89% of loans held for investment while our annualized 2014 net charge-off rate is 7 basis points. This very modest charge-off rate is evidence of the effective mark we've made to our classified loan portfolio.
Turning to Page 16, we will discuss non-performing assets. Non-performing assets fell by $5 million or 9% in the quarter and are now only 2.7% of total assets down from 4.6% a year ago. Non-performing loans comprised $2.3 million of the reduction with the balance presented by $2.8 million reduction in OREO.
Since the second quarter of 2013, non-performing assets have been reduced by 44%. Our OREO peaked in the third quarter of 2011 and is being liquidated through sale. Disposal of OREO is consistently outpacing foreclosure additions. At quarter end, we only had one property with the value exceeding $1 million and our 10 largest properties have a combined book value of $8 million, 36% of total OREO carried below our net purchase price or book value.
Also 19% of total OREO inventory was under contract for sale. Gains, if any, on the disposal of these assets are recorded when proceeds are received. With the successful completion of these sales, our OREO inventory will only have four properties with values exceeding $600,000. If you recall, we appraise our OREO in classified asset portfolio last year in the second quarter, in order to properly mark these assets.
As the year has passed since the appraisal effort, a number of these assets need to be reappraised and these appraisals were ordered and received in the past quarter. While we are finding price stability in larger metropolitan markets such as Charlotte, secondary markets continue to experience some price softness, especially in land values.
Approximately, half of our OREO portfolio consists of smaller value land parcels in secondary markets. The new appraisals resulted in net write downs of $660,000, of which only one exceeded a $100,000. With most appraisals ordered, we believe the risk of write downs from new appraisals is modest for the remainder of the year.
Moving to Page 17, you can see our loan portfolio breakdown and associated loss reserves. As we've discussed in prior calls, our loans and the related accounting methodology fall into three buckets. Legacy CommunityOne loans and all new loan production at CommunityOne since the acquisition are accounted for under ASC 310-20 using traditional provision, allowance and charge-off approaches.
The originated loan ALL was $19.4 million at quarter end. Approximately $28 million of purchased contractual loans, consisting of performing, revolving, commercial and home equity loans are accounted for under ASC 310-20. The granite purchased contractual loan ALL was $435,000 at June 30, 2014. The remaining granite loans are categorized as purchased impaired loans and accounted for under ASC 310-30.
These $142 million of loans are excluded from familiar provision, allowance and charge-off treatment. Instead, any cash flow deficits below carrying value are recorded as provision and charge-offs through the P&L. These loans were recorded at fair market value at the acquisition date with a $35 million non-accretable difference available to absorb credit losses. The remaining allowance is $4.1 million.
On this page, you can compare the sizes of these portfolios and also the size of the associated allowance. As you can see, we are experiencing a noticeable reduction in the balance of granite purchased impaired loans, largely conforming to our expectations.
Now I'd like to turn the presentation back over to Brian.
Thanks Neil, and congratulations on your teams continued good work in the quarter.
Turning to page 18, I’d like to recap the progress we’ve made during the second quarter on our key goals for 2014. First, we drew loans 16% annualized overall and 14% organically during the quarter and our position to build on this growth with new LPOs in Raleigh and Winston Salem and expanded team in Greensboro and a new non-branch residential mortgage origination channel. In addition, the Charlotte market is seeing improved levels of economic activity, which should drive increased banking opportunities.
Second, increased deposit growth is a key focus for the second half of 2014. Several deposit oriented initiatives, our investments in treasury management capabilities and mobile banking infrastructure and commercial relationship growth should support higher levels of deposit growth going forward.
Third, we expect additional expense savings of greater than a $1 million run rate on a decline in FDIC insurance and other regulatory expenses. In addition, we anticipate vendor cost reductions in the second half of 2014, accelerating in 2015 and 2016.
And fourth, we’re ahead of schedule on a resolution activities with very low credit cost in the quarter. NPAs were down from 3.2% at year end to 2.7% at quarter end versus our full year goal of 2.3%. Classified assets are down $22 million compared to our full year goal of a $40 million reduction. And our classified asset ratio continues to drop down from 70% to 56% at quarter end, well on track to 40% at year end.
All of these metrics are better than planned. Importantly, we’ve made this progress with very little credit cost as Neil highlighted, but only 12 basis points in annualized net charge-offs. We made solid progress on our goals during the quarter and we believe that continued achievement of these goals will drive increased profitability in 2014 and beyond.
Thank you for your continued support and interest in CommunityOne and thanks for joining our call.
Thank you. To access the replay of this conference, you may dial 1-877-344-7529 or 1-412-317-0088, beginning around 1 PM Eastern Time today. You’ll be prompted to enter a conference number which will be 10048912. You will be prompted to record your name and company when joining. The conference is now concluded. Thanks for attending today’s presentation. You may now disconnect.
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