Chemical Financial's (CHFC) CEO David Ramaker on Q1 2016 Results - Earnings Call Transcript

| About: Chemical Financial (CHFC)

Chemical Financial Corporation (NASDAQ:CHFC)

Q1 2016 Earnings Conference Call

April 18, 2016 10:30 AM ET

Executives

Michelle Pilaske - IR

David Ramaker - CEO

Lori Gwizdala - CFO

Analysts

Scott Siefers - Sandler O'Neill & Partners

Chris McGratty - KBW

David Long - Raymond James

Andy Stapps - Hilliard Lyons

John Rodis - FIG Partners

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Chemical Financial Corporation First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session, and instructions will be given at that time. As a reminder, today's conference is being recorded.

It is now my pleasure to introduce Michelle Pilaske from the company. Please go ahead.

Michelle Pilaske

Thank you very much. As a reminder, a copy of today's earnings release can be accessed by logging on to chemicalbankmi.com, and selecting the Investor Info tab at the top of the Web site. We've also included a slide presentation on our Investor Info page with supplemental information that will be referenced in today's call.

With me today are David Ramaker, Chairman, Chief Executive Officer and President of Chemical Financial Corporation; and Lori Gwizdala, Executive Vice President, and Chief Financial Officer. After brief comments from management, we will open the call to your questions.

Before we begin, I’d like to caution listeners that this conference call may contain forward-looking statements about Chemical, its businesses, strategies, and prospects. Please refer to our forward-looking statements disclaimer and other information on Pages 3 through 6 of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in forward-looking statements.

And now, I'd like to just turn the call over to David Ramaker.

David Ramaker

Thank you, Michelle, and good morning, everyone, thank you for joining us on today's call. As you can see on Slide 7 and 8. 2016 is off to a solid start from a financial perspective. We posted first quarter net income of 23.3 million or $0.60 per diluted share compared to 2015 fourth quarter net income of 25.5 million or $0.66 per diluted share and 2015 first quarter net income of 17.8 million or $0.54 per diluted share.

Looking at these results before the transaction expenses attributable to merger and acquisition activities in the respective quarters our net income was 24.9 million, $0.65 per diluted share in the first quarter of 2016, down 7% on a per share basis from the fourth quarter of 2015 due to seasonality, a higher effective federal tax rate and one less day in the quarter. While up 14% on a per share basis over the first quarter of 2015 due primarily to the incremental earnings from acquisitions and continued strong organic growth. Organic loan growth continued at a steady pace in the first quarter, we added net new loans of 96 million. Historically, the first quarter has been among our weakest quarters for organic loan growth, so we are encouraged by this solid start to the year and credit quality remains high.

As you are all aware in addition to the solid financial results we posted during the first quarter we also announced in late January our intention to partner with Talmer Bank Corp. In a transformation merger that will result in a $16 billion asset community bank. Talmer is a high performing southeast Michigan based banking company whose delivery footprint nicely compliments our current markets. In Talmer we are partnering with this likeminded organization which shares a conservative lending culture built by talented and experience professionals who seek to the develop and support long-term client relationships with businesses and consumers who reside in the communities they serve.

In addition to this cultural fit, combining our two organizations will add talent, scale and strong track records for acquisitive and organic growth. Consummation of this transaction which is subject to regulatory approval and satisfaction of other customary closing conditions, including approval of both Chemical and Talmer shareholders will create the largest Michigan based bank in the state, with operations in Northern Ohio and contiguous states.

Between the solid financial results of the first quarter and the announcement of Talmer merger it was the strong start to 2016 at Chemical Financial Corporation.

I'll now ask Lori to provide a more thorough review of our financial results. Lori?

Lori Gwizdala

Thank you, David. As David mentioned our 2016 financial performance is off to a good start. Let me touch on a few of the key drivers. As noted on Slide 8, diluted earnings per share excluding transaction expenses were $0.65 in the first quarter of 2016 compared to $0.70 in the fourth quarter of 2015 and $0.57 in the first quarter of 2015. Transaction expenses decreased earnings per share by $0.05 in the first quarter of this year, $0.04 in the fourth quarter of last year and $0.03 in the first quarter of last year.

Earnings per share in the first quarter of this year excluding transaction expenses were $0.05 lower than the fourth quarter of last year. As David mentioned with the reduction attributable to the impact in the first quarter of a higher federal tax rate, one less day and lower seasonal loan fees and services charges. While the fourth quarter included a semi-annual federal reserve bank dividend. The increase in 2016's first quarter earnings per share over the same period in 2015 was largely driven by acquisitions and strong organic loan growth over the past 12 months.

Moving to Slide 9 we are pleased by our ability to sustain earnings growth over time which has been facilitated by our focus on efficiency combined with our organic and acquisitive growth. As shown on Slide 10, since the beginning of 2014 we have achieved over $1.1 billion accumulative organic loan growth including $96 million so far this year. The increase in loans in the first quarter was primarily in the commercial real-estate and residential mortgage segment of the portfolio.

Turning to Slide 11, through organic and acquisitive growth we increased our loan portfolio by nearly $1.7 billion during the past year. At March 31, 2016 our portfolio was comprised of 26% commercial loan, 32% commercial real-estate loan, 20% residential mortgage loans and 22% consumer loans. We have limited exposure to energy and related industries with less than 1% of total loans to that sector at March 31, 2016. Of our energy loans approximately 1% or less than $1 million were non-performing at that day.

As you can see on Slide 12, average deposits in the first quarter of 2016 increased $1.3 billion from the first quarter of 2015 due to a combination of our acquisitive and organic growth. Our average cost of deposits during the first quarter of this year remained at an extremely low 22 basis points. Total deposits were up $193 million from year end 2015, with the increase largely attributable to higher seasonal municipal deposits. We continue to payoff maturing broker deposits and we expect to continue to do so with the remaining $186 million of broker deposits on our balance sheet at March 31, 2016.

On Slide 13, you can see that our total funding costs of 25 basis points in the first quarter of this year were just slightly higher than our average cost of deposits due to our wholesale borrowing which comprised just 6% of our overall funding.

Moving to Slide 14, net loan losses in the first quarter of this year were very similar to last year's fourth quarter. First quarter 2016 net loan losses were $4.5 million or 0.25% of average loans and included a single commercial loan charge-off totaling $2.9 million. Our non-performing loans declined almost $11 million during the first quarter of this year due largely to principal pay downs of $7.8 million and net loan charge-off, resulting in non-performing loans of less than 1% of total loans at quarter end.

Turning to Slide 15, net interest income of $74.3 million in this year's first quarter was modestly lower than the fourth quarter of 2015 due to the same net interest income differences I discussed regarding the change in earnings per share between these two quarters. We did experience some modest net interest margin compression in the first quarter of this year due partially to a three basis point decline in loan yields. Net interest income in the first quarter of 2016 was 26% higher than the same period in 2015 due primarily to organic and acquisitive loan growth.

Non-interest income as seen on Slide 16 totaled $19.4 million in the first quarter of this year, down modestly from the fourth quarter of 2015, although up slightly from the first quarter of 2015. Service charges on deposit accounts were approximately $700,000 lower in this year's first quarter compared to the fourth quarter of last year which we believe was primarily attributable to the seasonality of certain things [ph]. While the Company saw increases in a number of non-interest income categories in this year's first quarter that compares favorably to 2015’s first quarter, they was largely offset by lower investment security gains. Absent this factor, first quarter 2016 non-interest income would have increased 3.8% over the same quarter of last year.

As seen on Slide 17 operating expenses have increased from last year's first quarter to primarily to the addition of personnel and occupancy expenses associated with our 2015 acquisition. We believe we have done a good job of controlling our core operating expense growth. Our expected cost savings from the Lake Michigan Financial acquisition have been fully achieved and the modest increase in operating expenses in the first quarter of this year compared to the fourth quarter of 2015 is reflective of this achievement. We continue to be pleased with our ability to effectively manage cost with our efficiency ratio at 58.8% in the first quarter of this year compared to 57.1% in the fourth quarter of last year and 62.4% in the first quarter 2015.

I will wrap up by touching on capital. At March 31, 2016, as you can see on Slide 18, our tangible equity to asset ratios was 8.2% up slightly from year end, while our total risk-based capital ratio of 11.5% was down slightly from the year end due to our paying off the remaining $18 million of subordinated debt that we acquired in the Lake Michigan Financial acquisition that had previously been included in risk-based capital. On Slide 19 we have provided a row [ph] forward which shows the impact of our operating performance, dividends to shareholders and bank acquisitions on tangible book values during the last 12 months.

I will now turn the call back to David for some closing remarks.

David Ramaker

Thank you, Lori. Let me close by again emphasizing three things. First, we continue to execute on our strategy of being the community bank of choice in the Midwestern markets we serve. We believe that our combination of market focus, balance sheet strength, talent and convenience provides a compelling choice to consumers and businesses alike. Second, we continue to be pleased with our progress on our growth by acquisition strategy, we're moving towards consummating the previously announced Talmer merger and while our traditional focus has been on Michigan, we will add meaningful Ohio and Northern Indiana markets upon closing of the Talmer merger.

Given our pro forma penetration in Michigan with the Talmer transaction, we expect to increasingly look to similar markets in contiguous Midwestern states as potential sources of future growth. We have been pleased over the past 18 months to add talent bankers from Northwestern Bancorp, Monarch Community Bancorp and Lake Michigan Financial Corporation to the Chemical Bank family, enhancing our franchise significantly and increasing our penetration, market share and relationship in key Michigan markets.

We have growth roughly 2,100 employees in 175 branches across the 47 Michigan counties. We look forward to welcoming the highly qualified Talmer team later this year. And finally we believe that the key to translating our organic and acquisitive growth into shareholder values is to remain focused on the things we can control.

Two key ingredients will drive future earnings success, revenue growth and cost discipline. We believe we continue to make good progress across these fronts. As always we appreciate your time and interest in Chemical Financial Corporation.

On that note Cynthia, let's open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we'll take our first question from Scott Siefers from Sandler O'Neill & Partners.

Scott Siefers

David, Lori, I was hoping you could spend just moment or so with going over little more color on the commercial charge-offs, there was about two-thirds of the total, just I guess any broad, topical commentary you could make on it like industry level that kind of things, and then is there any reason to believe you're expecting additional loss content on that credit?

David Ramaker

No we don’t anticipate any future loss on that, we think we've been conservative in the write-down from that standpoint. It is a manufacturing entity on the West side of the state and again we feel it's more representative of a one-off versus the quality of the portfolio.

Scott Siefers

And then if I could switch gears for just second Lori, just curious to get your thoughts on how you might see the margin trending here, you should of course get some near term relief from the semi-annual income from the Fed dividend but the curve is getting a little tougher so, I’d imagine ongoing pressure on yields. As you see them, what are the main puts and takes to the margin here in the coming quarter or two?

Lori Gwizdala

Scott, we don’t provide guidance, but obviously what -- where we have been successful over the past three years is significant long growth that has driven a stable net interest margin. So we would expect to continue if things look good in the first quarter, as Dave said we usually have a pretty weak quarter and for the first quarter, 96 million, we are off to a good start. So we would foresee that trend continuing on that, the growth of our loan portfolio would offset any reduction due to any decline -- slight decline in long yields. So having said that we’ve kept a stable net interest margin and there probably isn’t any reason to think that we won’t continue too.

Operator

And our next question is from Chris McGratty from KBW.

Chris McGratty

David or Lori, on the expenses, I think your comments Lori were that the Lake Michigan, were all in the number, the last couple of quarters have been around 56 million. If we are thinking about just Legacy Chemical here, what are the factors that we should be considering for near term expense pressure and relief with seasonality a factor? Thanks.

Lori Gwizdala

Well, as you said that now that’s acquisition stating are all in the numbers. The run rate should be pretty close to what we are -- where we are at. Expect the seasonality there, I would say for our Company is -- there is some higher end of the year auditing expenses and the like in the numbers. But I don’t think there should be any expectation that operating expenses will be significantly higher or lower than our first quarter.

Chris McGratty

Understood okay thanks. Maybe a question on gross, I think you guys mentioned in your prepared remarks around $100 million for the first quarter is a good start. But if you look back at a last year, it's roughly about 500 organic over the past couple of years, with the transformational deal David, sometimes we see bank account kind of take a step off the growth, paddle a little bit, but can you help us get comfortable with the near term growth outlook with the merger being a reconsideration?

David Ramaker

Sure, I think that what we continue to talk to our teams about is that they need to continue to focus on their customers and on their markets. And that we need to let typically senior management and the department has really focused on the Talmer transactions. So from that standpoint, we are pushing forward to achieve our goals in 2016, not unlike what we would have done in 2015 or 2014. And I think really if you go back and look at that -- over that, that two year period of time and the three transactions that we did then. We were able to continue to grow the portfolio despite the activities that we needed to do from a merger standpoint. So I think that’s -- it's my intension, it’s our intension that we will continue to focus on the customer and achieve our totals for 2016.

Chris McGratty

Great, thank you very much. And maybe one more if I could, on Slide -- I guess it's 18, your total risk-based capital is at 11.5% Lori, obviously you are still above where you need to be, but is there any thought of where this ratio again -- can you remind us where it goes with the deal because it seems like that’s your constraining ratio, if here is one?

Lori Gwizdala

Yes, we would agree with you. And we are going to be in that 11.5% to 11.8% range.

Chris McGratty

Okay, so you’re still fine with that, no change in needs to address capital?

David Ramaker

Not at this point Chris, no.

Operator

And our next question comes from David Long from Raymond James.

David Long

Question regarding the loan pipeline, can you maybe provide some color on the commercial loan pipeline, how it looks today versus maybe a quarter ago and then also a year ago?

David Ramaker

I would say it's probably relatively similar to a year ago. We did pass to first quarter and things seem to ramp up for us pretty well. We’ve done some rather significant commercial construction transactions in the first quarter and we will obviously start to see those advances take place in the second quarter. And we’ve got some pent up things that are in the pipeline that have been approved and we just haven't closed yet. So it's actually a very similar start from that regard in 2016 versus 2015.

David Long

Okay. And then any tangible benefits yet, have you seen any tangible benefits yet from the Talmer merger announcement when it comes to just year-to-loan pipeline and what you are seeing on the commercial side?

David Ramaker

Well, I think that as we have expressed when we were out talking to investors, we are starting to see some synergies related to referring business from a potential participation basis between the two banks, those kinds of things. So a little bit larger transaction, I wouldn’t say it's outside our normal in house limit at this point in time, but we are starting to see some benefits from that standpoint.

David Long

Okay. And then lastly regarding the merger, when do you expect that to close? And what are the hurdles that you still need to get over in order to make that happen?

David Ramaker

Well, the same hurdles that we announced initially, obviously we now filed our application with both the SEC and with the Fed and the State of Michigan, and we’re proceeding through that process at this point in time. The comment period ends in the first part of May. And so we’ll wait to see what happens from that standpoint. We would anticipate still a mid-to-late summer closing at this point given the indications that we have at this point. I would assume that shareholder meetings will be probably the first part of July.

Operator

[Operator Instructions] Our next question comes from Andy Stapps from Hilliard Lyons.

Andy Stapps

With the seasonally strong loan growth that you enjoyed, do I assume correctly that there has been no material impact on customer sentiment or loan demand with the negative news that’s out there, economic news, I should say?

David Ramaker

No, I would say not. We went through that period of time where there was some concern about a considerable decrease in interest rates. I think the market responded appropriately from that standpoint. And I don’t see any headwind from this point in time from a Michigan economy standpoint.

Andy Stapps

Okay. And my other questions have been asked and answered. So, thank you.

Operator

And our next question comes from John Rodis from FIG Partners.

John Rodis

Most of my questions were asked and answered. But Lori maybe just the tax rate going forward, will it sort of be in this 30%-31% range?

Lori Gwizdala

It will.

John Rodis

Okay and then with the combined institution, where do you expect that to be?

Lori Gwizdala

That’s a great question, I haven’t gone into that much specificity yet, so we’ll have to do something -- we’ll look into as we get closer to this date. But, I wouldn’t think that my knowledge of Talmer, it’s not going to -- it's going to be 30% plus. So obviously it's got to be between 30% and 35%, so that’s 30% plus.

Operator

And we’ll take a follow up question from Chris McGratty from KBW.

Chris McGratty

The one timers Lori, can you remind us the timing, I think you had [ph] some of those quarter, but with the deal, how many will be in the numbers before it’s closed and post?

Lori Gwizdala

As far as the one-time acquisition transaction expenses --.

Chris McGratty

That’s right, yes.

Lori Gwizdala

Okay. Well, we’ve estimated collectively 62 million, those will get split between the two of us, and you will see a measurable amount next quarter as we continue through the process. But I would say the majority of them will come in the quarter that we close and the immediate subsequent quarter after that. So we will see the majority of that in the second quarter.

Chris McGratty

In those 62, do you have any idea of how much will be shared by -- is it 50-50, is it -- how should we be thinking? I am just looking for book value.

Lori Gwizdala

I mean when we were doing the modelling process and our models had them about 50-50. Now that doesn’t mean it won’t be 40-60 rate, but it won’t 30-70.

Operator

[Operator Instructions] And there are no further questions in the queue at this time.

David Ramaker

Thank you, Cynthia. And thank you for the questions. Again, we appreciate your time and interest in Chemical Financial Corporation, we remain confident in our prospects going forward. By making Chemical Banks a community oriented financial institution of choice in the markets we serve and seeking to partner with likeminded institutions in the Mid-West. We believe we are well positioned to achieve additional competitive and acquisitive market share gains as we move forward.

Thank you again, and have a great day.

Operator

This concludes today’s call. Thank you for your participation. You may now disconnect.

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