Cascade Bancorp (NASDAQ:CACB)
Q1 2016 Earnings Conference Call
April 27, 2016, 17:00 ET
Andrew Gerlicher - General Counsel & Secretary
Terry Zink - CEO
Chip Reeves - President & Chief Operating Officer
Greg Newton - CFO
Jeff Rulis - D.A. Davidson
Russell Gunther - Macquarie
Jacque Chimera - KBW
Welcome to Cascade Bancorp’s First Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to your host Andrew Gerlicher, General Counsel. Thank you. You may begin.
Good afternoon and welcome to Cascade Bancorp’s First Quarter 2016 Earnings Conference Call. Our presentation today will include forward-looking statements. Those statements include descriptions of management’s plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures and statements about Cascade’s general outlook for economic and other conditions.
We also may make other forward-looking statements in the question-and-answer period following management’s discussion. These forward-looking statements are subject to a number of risks and uncertainties and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are contained in the press release that was released today as well as in the Risk Factors section of Cascade’s most recent Annual Report on Form 10-K filed with the SEC. Forward-looking statements are effective only as of the date they are made and Cascade assumes no obligation to update or publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof.
Now, let me turn today’s call over to our CEO, Terry Zink. Terry?
Thanks, Andy. Good afternoon everyone and thanks for joining Cascade's first quarter 2016 earnings call. With me today in the room is Andy Gerlicher who you just heard from, our General counsel and Secretary, Chip Reeves, our President and Chief Operating Officer and Greg Newton, Chief Financial Officer.
After our prepared remarks we will open the call to your questions. Before we begin I would like to comment on the strategy behind yesterday's announcement regarding our planned acquisition of Prime Pacific Bank located in the Greater Seattle market. This transaction will complement our downtown commercial lending center and will expand our venture into a larger SBA strategy. We have agreed to a stock deal we're going to pay approximately 115% of book subject to certain conditions and we also expect the deal to be about 5% accretive in 2017 with no revenue synergies.
Prime is currently a $120 million asset bank with a loan deposit ratio well above 90%. They're located in the fast growing Snohomish County just north of downtown Seattle. For folks who are not familiar with the area it's where Boeing employees 38,000 employees to assemble aircraft as well as other large importers ranging from the U.S. Navy to Wal-Mart.
We're very excited about this partnership given that Prime Pacific is constrained in its growth by capital and core deposits. It plays directly into our strategy of supporting metro commercial lending growth by leveraging our abundant low cost deposits. A second opportunity with Prime is their well-established niche in the SBA lending. As I’ve said in the past one component of our diversification strategy is to enhance the non-interest revenue streams. Our deal [ph] will enable Prime to build that business and accelerate revenue growth looking forward. Greg is going to have a few more details on this transaction in just a moment.
Now to turn to our first quarter 2016 results. Net income was 1.9 million or $0.03 per share and that compares to 5.6 million or $0.08 per share for the linked quarter. Q1 included non-recurring items totaling 3.1 million pretax or $0.03 per share after tax largely related to the acquisition and integration of Bank of America branches.
The organic loan growth was extremely solid at 14% annualized. We ended the quarter with 1.8 billion of loans and the underlying strength was really very broad based. Looking to the balance of 2016 we continue to expect our core franchise to generate low double digit organic loan growth with our new Seattle commercial loan office adding to that upside. Total deposits rose 493 million or about 24% to 2.6 billion. This is largely as a result of approximately 470 million in acquired deposits from [indiscernible]. The cost of funds were steady at 9 basis points that would compares to 8 basis points on a linked quarter and one of the areas we’re really proud of is total checking balances still represents over 55% of total deposits.
Our deposit franchise remains a very key competitive advantage. Credit quality remain solid with NPAs of 0.49%, a modest increase from the fourth quarter level of 0.34%. The first quarter saw an off-setting recovery and a charge off which Greg will review in more detail in a moment. We remain very well reserved for the balance of 2016.
I would like to spend the remainder of my comments reviewing the strategic initiatives put into place to drive growth through 2016 and beyond. As a reminder the two drivers of the bank's growth are organic growth and strategic M&A. The Pacific Northwest is one of the best performing regions in the country. In a recent survey both Seattle and Portland landed in the Top 10 best performing MSAs with Seattle ranked number seven and Portland ranked eight. While [indiscernible] didn’t crack the Top 10 it did move up 48 spots to land at number 33 from where it was a year ago at 81.
The second area of our growth has been strategic and disciplined acquisition. We have quickly built a track record of success having successfully acquired and integrated, Home Federal Bank in 2014 and on March 4, we closed on the acquisition of 15 Bank of America branches 12 of those branches being in Oregon and three of those branches in the Southwest corner of Washington.
When we acquired the branches we assumed 22% deposit attrition by closing an additional 10% right after and we didn’t really build into our model any real increase in fee income. What we have experienced is approximately 30% of attrition by closing which is a little more than expected but then deposits have remained stable since closing which is less than what we expected. Importantly, fee income has been much better than we anticipated, with a lot of the increase coming from credit cards and merchant processing. Additionally the costs have been much better than we modeled. As I’ve discussed we are opportunistic in the announced acquisition of Prime Pacific bank, this underscores our strategy to increase scale through opportunistic acquisitions.
Additionally the Prime acquisition complements our branch acquisition. Instead of deploying all the funds that we gathered in the [indiscernible] into lower yielding securities we can replace a relatively higher cost of deposits from Prime Pacific and at the same time accelerated revenue. We will continue to be opportunistic as we look for acquisitions that will enhance the franchise value of the bank and also provide attractive return profiles.
Importantly our infrastructure continues to have capacity to handle the requirements for a larger bank and this does provide leverage for us. In conclusion our goal remains consistent, deliver region leading organic loan growth and market share, achieve regional leaning return on assets, grow Cascade to a 5 billion in assets community bank and ultimately to create a very valuable franchise in one of the fastest growing regions in the country.
I would like to turn the call over now to Chip Reeves, our President and Chief Operating Officer.
Thanks, Terry. I'm pleased with the progress we've made through the first quarter across all of our business lines. Our team of talented bankers continue to execute on our business strategies and our value proposition leading to increased customer acquisition. First quarter is typically soft across our industry and business and in fact we experienced better than expected growth across all of our product lines providing strong confidence and visibility for the balance of 2016.
For review of my comments let's start with our lending operations which delivered organic originations across all platforms totaling $210 million leading to the 14% annualized organic growth that Terry mentioned. A little bit more color here, we experienced significant organic growth in C&I to CRE and our construction platforms and that growth was broad based byproduct set and also by geography. And the originations were evenly balanced between what we consider a dominant community bank markets of Central Oregon at Idaho and our metropolitan commercial banking centers in Portland and Seattle.
We mentioned those metropolitan commercial banking centers and as we've discussed in prior calls there are an extremely important driver for our organic growth. In the Q1 our Portland office which has been just a terrific success delivered once again with loan growth rates in the high teens. The Seattle office that Terry mentioned opened in October of 2015 with a team of six seasoned bankers and we continue to be impressed with their early success, their loan pipeline and their Q1 closings. Right now it's running about a quarter ahead of our internal projections and our previously we stated that we expect the Seattle office to contribute $50 million to $60 million of 2016 loan fundings and we remain very comfortable with that forecast.
And with the success of our Seattle office and the announcement of the Prime Pacific merger we’re well on our way to our aspirational goal of building a $1 billion bank in this attractive market.
Now turning to one of our community bank markets, Idaho. Mike Mooney, our Region President retired after many years of successful service and we wish him all the best. We do feel very fortunate to have recruited Rob Perez as our new Idaho President. Rob brings 35 years of experience in the treasure valley back of the Cascades and in addition he was able to bring five season bankers with them to his new role. We also expanded our mortgage group in Idaho by recruiting a new residential mortgage sales manager who brought with him four new mortgage loan officers. We look forward to Rob and our combined Idaho team to strengthen our dominant community bank share in this vibrant Northwest market.
Let's turn our attention to a post- BofA branch acquisition. First a true thank you to our bankers and support teams who performed extremely well as we experienced a seamless integration process leading to very high post-conversion retention rates. Strategically the combined deposit franchise remains an enviable asset where the cost of funds have only nine basis points, this will provide our bankers with ample low cost deposits to grow quality loans over the medium term. Terry, mentioned this as well, and in addition we've been quite pleased with the retention of the BofA annuity stream non-interest income and our initial branch sales. Just a quick note there, in March we have BofA since March 4. We more than doubled our credit card production from January and February results. So looking forward, card and account service income will comprise 55% to 60% of our overall fee base.
To conclude I'm very pleased with the progress made in this first quarter. Our commercial banking deposit and mortgage pipelines are all at robust levels and we reiterate our low double digit loan growth expectations for the remainder of the year. We will continue to expand our banking team, our product set and our geographic reach providing the opportunity for further growth and share gain.
Now I would like to turn the call over to Greg Newton, our Chief Financial Officer. Greg?
Thank you, Chip and good afternoon. As included in our press release the quarter was a little noisy and included net non-recurring items of about 3.1 million. Importantly these include approximately 4.6 million in non-recurring expenses related to the BofA acquisition and systems conversion as well as costs related to a further branch consolidation. These costs were partially offset by 1.5 million in accelerated interest income from our securities portfolio.
This occurred because our veteran treasurer [indiscernible] had earlier purchased an investment grade security that was carried at a significant discount and that bond was called at par. So next I would like to embark on that conversation around the financial aspects of the Bank of America deal. We are really enthusiastic about the accelerating revenue story that this transaction represents. First, net interest income will accelerate as we deploy the nearly 470 million in acquired deposits into investment securities. We will be buying a combination of floating rate, mortgage backed securities and residential arms. This portfolio should be in place by the fourth quarter and we're comfortable with our stated over yield, our overall yield target of two and a quarter percent.
You will also note that our securities portfolio increased by 120 million since year end as we commenced our program by starting out with a floating rate securities portfolio. Now it's important to realize that this wholesale portfolio is tactically just a placeholder. Our goal for the BofA deposits and our end game strategy is to redeploy those funds into commercial and consumer loans over time. We see this as being accomplished not only through organic loan growth but also by strategic M&A transactions. The Prime Pacific transaction is an excellent example of that, instead of deploying those funds into lower yielding securities we will acquire a higher yielding loan portfolio and we will also be able to replace Prime's relatively higher cost of deposits thereby accelerating revit [ph].
Next I wanted to look forward and talk about the impact of BofA on the net interest margin. Our NIM will decline due to the lower spread on these new wholesale assets. So I expect the NIM to trough in the second quarter at around 3.2% and then gradually increase through the back half of the year. I'm estimating year-end NIM to be in the range of 3.3% that is excluding any effect of the Prime Pacific transaction.
Now also in the area of Bank of America and its potential to accelerate our revenue, Chip talked about fee income. BofA customers are relatively higher usage customers for banking transactions and as Chip noted particularly in card and banking service fee income. So if those favorable trends continue we believe noninterest income could accelerate to an annualized run rate of nearly 30 million a year or over ninety basis points of average assets.
Of course the integration of new branches and new employees increases our non-interest expense. As we said in the press release the first quarter include about one month BofA salary and benefit expense where we expect a run rate cost of about $1 million per quarter. And you'll notice some slight upticks in occupancy and transaction processing costs. That said, our goal is to achieve a run rate for non-interest expense in the 2.60% of average assets range by year-end. And accomplishing those ends, our efficiency ratio should hover around the mid 60% range by the fourth quarter.
Another important item worthy of highlighting is our asset sensitivity profile. We previously indicated that the Bank would benefit from higher Fed funds rate to the tune of about $1 million a year for each 25 basis points increase in the Fed funds rate. With the incremental leverage that we get with Bank of America, we see that sensitivity advantage almost doubling whereby we could accelerate net interest income to the tune of $2 million a year for each 25 basis point Fed funds increase.
Turning to credit quality and I'd highlight continuing favorable trends in our community bank and commercial loan portfolios. As noted in the press release, we have now recorded eight successive quarters of net recoveries. During the first quarter of 2016, we benefited from another B note recovery and this recovery was largely offset by related downgrades and the charge-offs in our mining and energy segment in our shared national credit portfolio. I would underscore a couple of points. One, that these downgrades and related charge-offs are isolated to the small mining and energy sector of our portfolio that is less than 1% of gross loans. And second, we have taken steps to have an ample reserve to buffer future issues in that sector.
You will note our increase in NPA's for the quarter to 49 basis points of average assets was directly affected by that downgrades, but despite those, our ratio remains more favorable when compared to our peers. Lastly on our tax rate, it was 37.4% for the first quarter, but we're expecting 38.5% to 38.7% for the year.
Now couple of comments on the Prime Pacific acquisition that was just announced, under the terms of the definitive agreement, holders of Prime Pacific common stock will have the right to receive 0.305 shares of Cascade common for each Prime Pacific share owned. This is subject to certain adjustments including a possible pre-close dividend.
Based on the $5.86 closing price of Cascade common on April 22, the aggregate merger consideration is approximately $17.1 million or $1.79 per share for each Prime Pacific common stock share. Given effect to the transaction and based upon the exchange ratio, Prime Pacific shareholders will own approximately 3.8% of the standing shares of the company.
The Boards of Directors of each company has approved this transaction. The acquisition is subject to customary conditions including shareholder and bank regulatory approval and is expected to close in the third quarter. For additional information, please carefully read the definitive agreement that's filed with the SEC along with our press release from yesterday. Back to you Terry.
Thanks, Greg. Well in conclusion I hope that couple of things came across clear. Our markets are incredibly robust. Seattle is off to a much stronger start than we had anticipated. The BofA branch acquisition is going to drive earnings accretion in Q2. Our low-cost deposit base remains a very competitive advantage and finally, our credit metrics remained very strong.
With that what I'd like to do is operator, if you could open it up questions that would be great.
[Operator Instructions]. Our first question comes from the line of Jeffrey Rulis of DA Davidson. Please proceed.
The question on the mining and energy downgrades, I guess what is the specific reserve to that amount and what is the total mining and energy in loan balance?
The total mining and energy is actually just under 1% of our loan portfolio. And what we've done Jeff actually is gone through and as far as looking at reserve, we did some qualitative analysis around our reserves and I believe that we ended up taking of waiting 30% on that category. So as we look at it now, we believe with the charge off that we had, they're very, very limited exposure that we have in energy that really isn't much in the future, that's going to happen there.
And to revisit the strategy on the [indiscernible] that was the vehicle for excess funds to place into those at the time and you're looking to one down going forward, if you could refresh us? Is that the case?
That's still the case. We initially we went into as part of interest rate risk management strategy as you know the SNCs are floaters they are all, at one point we were up to, I think about $240 million in that, it's a very diversified portfolio as I said we really had two credits in there that one had exposure to oil and gas, the other one actually has a peripheral exposure but is still trading almost close to par, so we're not, other than that, we don't have any other exposure there. We've wound it down as we used to fund our double-digit organic loan growth and now we're down I think somewhere in a neighbor of about $150 million in that portfolio.
We closed the quarter at abut $160 million and we've seen further decline here as we move into Q2 and we'll continue to reduce that going forward.
And Greg, can you break out 4.6 in expense in the release that sort of get lost with the numbers there, but if you could just, I guess by line item just point out what those expenses were, like comps?
So the HR Block if you will included almost 800,000 and then in professional fees and services I think that was 600 or 800 including just some [indiscernible] things. And then the other big part was about a 1.3 million for the branch consolidation.
That’s just other, okay.
And so that shows up in occupancy because we basically prepaid leases on some of those properties.
Okay. And then maybe one last one on the portfolio that announcement of the acquisition on, were there credit or any loan marks taken against that loan portfolio?
That, we're estimating and had a good experience with them on our due intelligence, we hired a third party to contribute to the effort and we think they are ALLL is pretty much sufficient.
So no mark was taken or there was a mark?
That would be essentially the mark about a $1 million or a $1.2 million thereabouts.
Our next question comes from the line of Russell Gunther with Macquarie. Please proceed.
I just wanted to start if I could on circling back to the Boise-Idaho initiative. Maybe just a little bit more color in terms of the new team, when they signed up and then if you could kind of similar to how you lay out your Seattle LPO strategies there, so the target in mind in terms of what these guys might be able to do and timing?
We are in the Treasure Valley/Boise-Idaho area from a retail perspective, we have dominant community bank market share. But I would say that our commercial activities there are quite is commensurate with our retail sharing. So ultimately what we did is, went and added to our current team here in Idaho, gentlemen named Rob Perez, which we noted in the prepared comments joined us at the very beginning of March and then five additional bankers joined shortly thereafter.
We also in March to early April added a new mortgage sales manager and another four mortgage loan officers in that marketplace. What we expect -- I'd probably go from a loan growth perspective there, the Idaho marketplace, we've guided as an organization to essentially low double-digit. We would expect Idaho to be performing at that level as well. And frankly, before that they were such below that. So we do think it will be accretive to us here this year.
And then I guess just a follow-up, the Idaho growth rate you just provided, is that going to be more commercial related given the hires or how would you breakout that mix?
Yes, absolutely. Commercial related.
And then just remind me on the healthcare practice group that's coming online, I believe it's in the next quarter. Just some color on those folks and expectations.
Ultimately there I would say, we have hired the individual that will be our program manager and they joined just at the end of Q1, Russell. We'll begin program rollout later here in Q2 and do think it will have an impact for us in the latter half of the year. But frankly since we haven't gone completely public with the rollout and the strategy, I think I'll keep my comments to just that.
Okay and then just last question for me just tailend here and the growth you guys reiterated the low-double digit for 2016. As you kind of round out expectations on Boise, this healthcare group, the deal coming on, just how accretive to that low-double digit could all this be as we look to 2017.
You're right. I think I'd say there is, we feel very comfortable with our low-double digit and that there could be some upside to [indiscernible] if these groups come strong as we anticipated.
[Operator Instructions]. Our next question comes from the line of Jacque Chimera with KBW. Please proceed.
I was wondering if we could touch back on expenses. I missed a little bit of what you were saying about the Bank of America branches and what you anticipate in terms of future quarters. I am not sure how much to pull out for one time cost in the quarter because I don't want to just look at the delta from 4Q up to 1Q and assume about one month of bankers. I know that's not right.
And I would -- basically that said, my sense is that it will the best way to do that right now is to go ahead and use that guidance around 2.6% of Q4 and it will probably be a bit of slide down to that number over the course of that period of time.
So increase Q4 by around 2.6% and that's a good run rate?
Yes, there you go, the 2.6% of average assets.
Average asset? Okay. I didn’t had chance to do my calculation. And then secondly, with the cash deployed, so it sounds like you're going to do the bulk of that in 2Q into the securities and arms that you mentioned and then Q3, all just to be kind of some clean-up as you consolidate, and will it be at a good run rate in Q4. Is that a good way to think?
Jackie, back to your question on the expenses, I think probably the best way to look at without having to do all the math is just to figure on about $21 million of run rate.
Okay. That's a lot easier.
Yes. That's what we're expecting. And I am sorry, I was talking to Greg when you asked your questions, so I didn't quite understand at all.
No, not at all. I mean you addressed in your prepared remarks, I just missed it, I was writing down what you were saying earlier. And so on the cash deploy, is that a good way to think about the timing of it?
I would say we should be largely complete by the beginning of the fourth quarter, so it should be representative of the full portfolio having been deployed.
Okay, but you're looking to do it sooner or rather than later?
Well we're trying to time it a little bit, so we don't lock in some rates in the environment we've had. So we're basically saying to ourselves we get opportunities with the tenure around 2%. We play north of that, but we have been a little reluctant to do with that when we were down in the 170%. So I would say two-thirds, to three quarters are probably been done by mid-year and then we'll have another quarter with 25% of that so another $80 million or $100 million that we will try in time.
The other there is in the Prime Pacific merger that was just announced yesterday evening, the loan to deposit ratio in the 90% range and some of the deposit base is what we may end up considering to be more of a wholesale funding. So we will also utilize some of our cash there on the product specific essentially with higher than 100% loan to deposit ratio.
Okay, kind of use that to ensure you get some run-off from that deposit book and that'll be additive as well?
Okay. And then just last one, just wanted to clarify, was the uptick in non-performing loans in the quarter? Was that related to the credit downgrades in energy?
It was entirely that we had one credit in the SNC portfolio that was downgraded by the FDIC. We followed a suite in downgraded [indiscernible] and we had a recovery that kind of offsetting charge-off on that, but at end of the day, all of that was related just to that.
The balance of the portfolio really is continuing to perform and improving trajectory. So it's quite isolated.
[Operator Instructions]. Thank you. It appears we have no questions in queue at this time. I'd like to hand the floor back over to management for closing remarks.
Thank you. Once again thank you for joining the call, but one thing I would like to stress when we look at the performance in first quarter. We talked about double-digits loan growth which came in right around 14%. We also and we didn't talk much about it during the Q&A time but I think it's something that I would like to stress, we had 18.5% revenue growth and that excluded all of the one-time items and so that had BofA branches in the mix for about 20 days.
So, we believe that you're going to see continued high-teen double-digit revenue growth as we move into the remainder of the year. And so we feel pretty good about where we are, we could always use a rate increase that will make us feel even better, but overall we feel that the bank is positioned very well going forward. We're excited about the Prime Pacific acquisition as that really does add to our Seattle market and we continue to believe that our strategy of generating low cost deposits and deploying those into the larger metropolitan areas has proven to be a very strong success for us.
So thanks for taking the time to listen to us this afternoon and we look forward to talking to you next time. Bye.
Thank you, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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