Capital Bank Financial's (CBF) CEO Gene Taylor on Q2 2016 Results - Earnings Call Transcript

| About: Capital Bank (CBF)

Capital Bank Financial (NASDAQ:CBF)

Q2 2016 Earnings Conference Call

July 21, 2016 10:00 AM ET

Executives

Ken Posner - Chief of Strategic Planning, Investor Relations

Gene Taylor - Chairman and Chief Executive Officer

Chris Marshall - Executive Vice President and Chief Financial Officer

Bruce Singletary - Chief Credit Officer

Jaime Gow - Chief Accounting Officer

Analysts

Jill Shea - Credit Suisse

Erika Najaran - Bank of America.

Paul Miller - FBR Capital Markets & Co.

Brady Gailey - KBW

Nancy Bush - NAB Research

Presentation

Operator

Please standby we are ready to begin.

Ken Posner

Thank you, Cody. Good morning, everyone. I'm Ken Posner, Chief of Strategic Planning and Investor Relations for Capital Bank Financial Corp. Welcome to our Second Quarter 2016 Conference Call which is being recorded.

During the call, we'll refer to a slide deck on the Investor’s page of our website www.capitalbank-us.com. The slide deck and the press release contain a reconciliation of non-GAAP financial measures to GAAP results. This call contains forward-looking statements regarding expected operating and financial performance. Statements that are not of historical facts may be deemed to be forward-looking. The words believes, anticipates, plans, expects and similar expressions are meant to identify forward-looking statements.

We caution that forward-looking statements may be affected by risk factors, including those set forth in Capital Bank's SEC filings and actual operations and results may differ materially. The Company undertakes no obligation to publicly update any forward-looking statements.

At this time, I'll turn the call over to the Company's Chairman and Chief Executive Officer, Gene Taylor.

Gene Taylor

Thanks, Ken. Good morning to each of you and thanks for joining us today. In addition to Ken, I am here this morning with our Chief Financial Officer, Chris Marshall; our Chief Credit Officer, Bruce Singletary; and our Chief Accounting Officer, Jaime Gow.

We’ll discuss the Company's results and then answer your questions. As an overview, let me start by saying that we are very pleased with the company's continued strong performance in the challenging interest rate environment and in competitive markets. Our strategic focus on attractive growth market has supported our solid loan growth but the growth in our bottom line also reflects focused cost control discipline and a fundamental commitment to maintain excellent credit quality. You've seen us executing very deliberate strategies and consistently meeting the goals that we set for the company. We have plenty of work to do to achieve our profitability and return targets for 2017. But we believe we have strong momentum and we're well positioned in attractive markets. And as you know we have a culture of meeting our commitments.

Now let's turn to the quarter's highlight on Slide 5. Our second quarter EPS was $0.40 which is up 43% year-over-year and core EPS was $0.42 which is up 40% year-over-year. We had a very good quarter for new loan production at $473 million, much stronger than our seasonally light first quarter results and we had healthy volumes in all of our geographies. As you recall, we decided to exit the prime indirect auto business late last year and that portfolio is now in runoff. Excluding prime auto, new loans were up for very solid 12% year-over-year which reflects a consistent focus on sales force productivity and our continuing efforts on recruiting and retaining best in class talent. In the quarter, we recruited a new market president for Middle Tennessee who is well known in the market having held senior executive positions in Tennessee for many years. He is already having an impact and I expect that we will see even stronger results from our Tennessee team over time.

Thanks to good production the loan portfolio increased to an 8% annualized pace during the quarter and is up 10% year-over-year which we view as a sustainable growth rate for a competitive environment. The quality of the new loan production is excellent. Non-accruals in the new loan portfolio were 12 basis points which were up one basis point sequentially but down year-over-year. In the legacy acquired portfolio, we benefited from an $800,000 reversal of impairment, thanks to outstanding collection work by special assets team.

The net interest margin was stronger than expected this quarter and relatively stable with the decline of only two basis points sequentially. We are very pleased to see the efficiency ratio improve to 61% and the core efficiency to 59%. You'll note that noninterest expense has been trending down about 10% year-over-year for the second consecutive quarter result of numerous cost reduction initiatives across the company as well as lower legacy credit expenses.

As you know, we've established financial targets for year end 2017 that include a 1.1% core ROA and double digit core ROTCE. Efficiency is one of the key leverage for achieving these targets.

Switching gears to CommunityOne. The regulatory review process still ongoing. As a reminder, we moved from the OCC to the state of North Carolina and the FDIC in early November of last year and it was until late February that the FDIC began its own side examination process. Just like last quarter, we are not giving guidance on timing except to say that we believe the process is moving forward and we expect to hear something in the near term.

We are very excited about the combination of our two companies. And I feel very good about executing on the conversion, delivering the cost savings and achieving the financial targets we laid out for the transaction.

I'll now turn the call over to Chris.

Chris Marshall

Thanks, Gene. And good morning, everyone. Let's start on Slide 6 with the summary of the quarter. Capital Bank reported net income of $17.4 million, or $0.40 a share, which is up 43% year-over-year. And core net income of $18.2 million, or $0.42 per share which is up 40% year-over-year. Core adjustments totaled $1.1 million, pre-tax an $830,000 after-tax of which the largest component was merger related restructuring and legal expenses. And you can see summary of these adjustments at the bottom of the slide and the appendix contains a full reconciliation of both GAAP and core net income.

Now, let me summarize the major items in the income statement. Net interest income increased by approximately $100,000 sequentially and $800,000 year-over-year, thanks to solid portfolio growth and relative stability in the NIM this quarter which compressed by only two basis points.

We recorded a provision of $1.2 million which including $2 million for new loan production partially offset by an $800,000 reversal of impairment for the legacy acquired portfolio. Noninterest income was largely flat sequentially and was up 14% year-over-year. Noninterest expenses were down 5% sequentially and 10% year-over-year and as Gene mentioned we are pleased to see efficiency ratio decline to 60.6% and the core efficiency ratio drop back down to 59.1%, which is a big improvement from the 67% ratio we recorded this time last year. And finally tangible book value rose by $0.45 to $20.22 per share.

Now let's drill down into little more details starting with new loans. So turning to Slide 7. You can see that new loan production was a healthy $473 million in the quarter which is up 12% year-over-year, if you exclude the prime auto business unit which is in runoff. As a reminder, last year $64 million of our new loan production came from the indirect unit. As you can see from the two charts, we are showing consistent production in each of geographic markets. We are pleased with the trends in both commercial lending which is our bread and butter product and commercial real estate where we have plenty of room for prudent growth as the portfolio is only 22% of loans and only 158% of our regulatory capital. The loan portfolio grew by 7.8% on an annualized pace during the second quarter and is up 10.3% year-over-year. As a reminder, we are planning to finish the year pro forma for CommunityOne at just under $10 billion in total assets. And as such you should see a moderation in loan portfolio growth after closing the deal, most likely through the sale of some corporate participation. However, the underlying growth trends in our markets are very good. And we are pleased with the productivity of our lending teams, and so we would continue to target low double digit portfolio growth once we are passed the $10 billion threshold.

Now turning to Slide 8. We are happy with total deposit costs which declined by a basis point during the quarter which is little bit better than the guidance we previously offered. Over the last year, total deposit costs on a contractual basis are up only three basis points. During the second quarter, we did experience a single basis point increase in core deposit costs as we continue to add success with targeted money market offerings which is grown slightly in terms of mix. But we made up with this pulling back on CDs with legacy high- cost accounts mature as our strategies to attract and retain customers based on service rather than price. In terms of balances, total deposits were down a little bit sequentially not just due to the fact that the second quarter was seasonally light for us. And also the second quarter ended on Thursday right before a pay day. But if you look at average quarterly balances that smoothes out some of these day to day effects and on this basis total deposits were up 8% year-over-year. Now that level of growth with only a three basis point increase in contractual cost reflects positively on the customer service and sales activities of our retail teammates as well as our treasury management and commercial teams.

Now turning to Slide 9. Let me take a minute to discuss the net interest margin. The story this quarter was a very modest two basis points compression to 3.62% which was significantly better than planned. A runoff of high yielding loans in the legacy acquired book represents an ongoing negative. And additionally, we continue to book a very high proportion of floating rate loans which were 71% of our production this quarter. These negative trends were largely offset this quarter by runoff in prime auto. And recoveries on charged off loans and of course the small improvement in deposit costs. And while this quarter NIM trends were positive, reality of interest environment and the implication of repricing, keeps us very cautious and therefore we continue to project about 5 to 10 basis points in NIM compression for quarter going forward.

Slide 10 gives you snapshot of noninterest income and I will merely address that in passing as there really isn't a whole lot to say except that excluding the charge for the termination of the loss share agreement that we took in the first quarter of the second quarter was relatively flat in total and for all individual line items.

Slide 11 shows you the trend in noninterest expense. And as I mentioned earlier, we are very pleased with the core efficiency ratio compressing back down to 59.1% which is a big improvement from the 67% we recorded a year ago. And reflects a favorable 10% decline in year-over-year expenses. Expenses also declined sequentially and partly this is the seasonal, typical seasonal pattern you'd expect with first quarter frontloading some of our tax and benefit accruals.

Now in addition to these improvements, in the last week of the quarter we completed the transition to our new debit card processing platform which will provide us with improved technology while generating significant cost efficiencies. The new debit card system is part of comprehensive revamping of Capital Bank's payments platform that we've been working on for the past two years. Last week we announced the deal that gives improved merchant services capabilities with an attractive profit sharing structure. And just yesterday we finalized the new credit card agreement. We are working on a number of other projects including enhanced internet mobile banking capabilities and a new check processing contract. All of which will be completed by year end. These projects will significantly improve our customers experience and will also help us to continue to improve our cost structure.

On Slide 12 summarize our capital and liquidity positions which remain strong. The consolidated Tier 1 leverage ratio increased sequentially from 12.5% to 12.6% primarily due to retained earnings. With the CommunityOne proxy outstanding we did not repurchase any shares during the quarter. But as a reminder, our remaining Board-approved stock repurchases authorizations stands at just over $100 million. There has been no material change in the composition of securities portfolio which remains concentrated in highly liquid instruments with moderate duration.

So with that I'll now turn the call over to Bruce to discuss credit trends.

Bruce Singletary

Thanks, Chris. Let’s start by reviewing the performance of the new loan portfolio on Slide 13. And you can see credit metric are quite strong, past due remained very low at 17 basis points, non-accruals were 12 basis points which is actually down year-over-year. Criticized and classified were at a solid level of 122 basis points which is flat year-over-year. Net charge-offs were 15 basis points annualized. However, bear in mind that recoveries for legacy acquired loans are not included in the net charge-offs report but rather up in the net interest margin or in provision as reversal of impairment.

Couple comments on our reserve. Allowance for new loans is 46 basis points which given the low level of charge-offs represents a coverage ratio of slightly more than three years. Furthermore, if you look at reserves relative to nonaccrual, the coverage is healthy 3.7x.

Going to Slide 14, will provide you an update on special assets activity. For the portfolio, nonperforming loans declined from 1.2% in March 31 to 1.1% at quarter end. We do continue to reduce special assets portfolio which is down 74% from its peak. Legacy credit expenses have fallen significantly as well and remain less than $1 million this quarter, thanks to lower evaluation, workout and compensation expenses and gained in OREO sales. Clearly, there isn't much room for further decline in legacy credit expense. However, based on performance of our portfolio, we expect credit expenses to remain relatively low levels for the foreseeable future.

I'll now turn the call over to Ken for questions and answers.

Ken Posner

Thanks, Bruce. This completes our prepared remarks. And Cody would you please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

We will take our first question from [Jill Shea with Credit Suisse]

Jill Shea

Good morning. How are you guys? So the NIM held up nicely this quarter and you mentioned we could see 5 to 10 basis points as NIM pressure going forward. Could you just dig into that guidance a little bit in terms of what you expect on the deposit cost side which held up little up better and perhaps how to think about asset yield?

Chris Marshall

Yes, sure. Jill. In the past we expected deposit cost to rise above a basis point a quarter, this quarter we saw them fall a basis point. So that's about two basis points that could have swung the other way. And just maybe our guidance has been a little conservative in the past but again we've got three things that are happening this expectation that deposit costs might may rise, there is effect of repricing which everybody feels and then there is burn off of purchase accounting. As a result of all that we have been forecasting 5 to 10 basis points a quarter until the purchase accounting completely burns off over the next several years.

Jill Shea

And then maybe just a follow up on the margin as well. Could you just frame out for us how to think about any impact from the 10 year being lower, just how to think about a lower long end of the curve?

Chris Marshall

Well, actually because of the duration of our securities portfolio we got minimal impact of the 10 year although in general given all interest rates have been down, reinvestment is attracted but it has been very slight for us and in fact in last quarter we actually improve the just from some minor repositioning we were able to squeeze out another two basis points from the securities portfolio. So we haven't seen much and we don't do much long-term lending. And again the duration of our securities books is relatively short. So 10 year hasn't affected us very much and we don't expect it to do.

Jill Shea

Okay. That's helpful. And then maybe just one last one. Really nice job on expenses this quarter down 10% year-over-year. And with efficiency being a key element to your path forward improved profitability, can you just walk us through your expectations in terms of cost control and efficiency going forward?

Chris Marshall

Sure. Well, we have since inception guided people to expect us to eventually drive the company to a minimum efficiency ratio of 60% or I should say a maximum efficiency ratio of 60%. And we hit that for the first time in the fourth quarter last year. And we expect to now settle in at that level. Certainly as we integrate CommunityOne and continue to grow our revenue is we think we do have room for further improvement. But for now our guidance is still in the near term of over 60% efficiency ratio.

Operator

Thank you. I now move on to our next question from Erika Najaran with Bank of America.

Erika Najaran

Hi. Good morning. I just wanted to -- I know you are limited in what you can say but in terms of the closing process, I just wanted to make sure that we got the right message in that the delay relative to your previous expectation for closing really has to do with the move from being regulated by the OCC to the FDIC rather than anything deficient in the integration or merger planning.

Chris Marshall

I think that is absolutely correct. We made the mistake of not forecasting the need to go through a full safety and soundness, examination from the FDIC. And we should have known that. Having said that as Gene said of the FDIC began their exam on February 22 and that was a completely comprehensive exam. We do expect to hear something very soon, but it is in no way a reflection of our integration planning or anything like that. I think the positive here if there is one is that while the delay was something we had hoped to avoid it's given us plenty of time to do very intensive testing of our systems, so pre integration we expect that process to go very smoothly. And it has enabled us to really complete all integration planning so we feel very highly confident that we will meet all the financial projections that we laid out for that transaction.

Erika Najaran

Got it. And just as a follow-up to Jill's question, as we think about maintaining a 60% efficiency ratio going into next year and the integration of CommunityOne, even if we don't have any assist from rates as an industry and let's say the yield curve stays where it is, your goal of exiting 2017 with a 1.10% ROA is still intact?

Chris Marshall

Absolutely. We have no projection for rate increase in any of our guidance or any of our internal planning.

Operator

Thank you. I'll now move on to Paul Miller with FBR & Co.

Paul Miller

Yes. Quick M&A question. We've seen with BREXIT rates taking another leg down and a lot of people feel now that the Fed will not raise rates at least this year, but you never know when that conversation comes back. Have you seen increased interest in some of your M&A talks where banks that are really struggling with these low rates are ready to tap out?

Chris Marshall

I think it's too early Paul to say that there is any one who is reacting to Brexit and the last leg down. I think most of the people that we have talked to over the last few years have been feeling they continue strain and the longer it goes the harder it is. I don't think there is any real change in the tone of M&A talks. I think there are plenty of targets out there. And we continue to talk to them and I think for the reasons you mentioned I am just not sure we've seen anything change in the last 30 days.

Paul Miller

And could we expect a -- I guess this is a tough question but with this acquisition -- this current acquisition being dragged out a little bit longer than you guys would like it, because I think you originally targeted this thing to close in March, is there another M&A thing right behind this, or everything is on hold until you get the FDIC examination completely through?

Chris Marshall

Yes. We don't want to comment on anything before we get our approval from our regulator here. But we remain very active in terms of discussions. I think we have not changed our -- the amount of time we spend on meeting with and analyzing acquisition targets, clearly we still have excess capital that we intend to deploy and I think we leave at that.

Paul Miller

Okay. I know it's a tough question. And the other is you talk about low double-digit loan growth. Does that include acquisitions, or that's all natural?

Chris Marshall

No. That's all natural.

Paul Miller

Organic. And then last question real quick just on your provision. You talk about having an $800,000 reversal. Should we be looking at about a $2 million provision going forward?

Chris Marshall

Well, yes. I'd say absent any reversals. So with our normal provision level this quarter we grew at 8%. The provision was $2 million. We expect to grow again after we get passed year end and go through the $10 billion level. We would expect to grow a little bit higher rate. And therefore the provision would be a little higher. What we saw this quarter was a reversal of impairment and really what it was prepayment of mortgage loans acquired in the resi portfolio where we still have about $8 million of impairment. So there is -- and that's just a resi pool. So we got about $25 million still in impaired pools and another $35 million or so mark. So as those loans pretty pay and these portfolios have been behaving very nicely. We'd expect some level of reversal but we don't forecast any of that in the margin guidance that we shared with you. So, yes, we would expect that portfolio, I mean that provision to be about that level ex any reversals. Having said that, we do expect some level of reversals over time.

Operator

We will now take our next question from Brady Gailey with KBW.

Brady Gailey

Hey, good morning, guys. Can you just remind us, as you all cross through $10 billion -- it won't be this year, it will be next year, which means you really won't have an impact until kind of mid 2018 -- but what's the revenue impact and the expense impact from crossing that threshold? Basically what's Durbin and what's the cost of the stress test?

Chris Marshall

Revenue impact, there is no expense impact forecasted because we build out an infrastructure, we are required to do that for last several years. So we are carrying an expense structure that reflects a bank that's bigger than $10 billion. The revenue impact is tied to Durbin and that's about $4 million net income impact and that fully phases the year I guess the mid point of the year after we go past $10 billion.

Brady Gailey

Okay. So [Multiple Speakers]

Chris Marshall

2017 you would expect $2 million of impact in 2018, $4 million in 2019.

Brady Gailey

Got you. And those are [Multiple Speakers]

Chris Marshall

-- More we, the more debit interchange we have.

Brady Gailey

Yes, okay. And those are post-tax numbers that you just gave?

Chris Marshall

Those are -- actually -- I am sorry that's Capital Bank's number. I think the CommunityOne would be another $1 million roughly.

Brady Gailey

Okay. Is that a pretax or post tax number?

Chris Marshall

Those are both after tax numbers.

Brady Gailey

Okay. Sorry if I missed it, but service charges have been coming down. Can you just give any color on how you think those will trend going forward?

Chris Marshall

I think service charges; they were down a little bit this quarter. But I think on a seasonal basis we see them flattening out. We've seen some continued attrition in legacy free accounts or high or very low balance, high overdraft accounts and that's fine with us. But in general we see service charges that are flattening out.

Brady Gailey

So you think $4.5 million will be a pretty stable run rate going forward? Obviously CommunityOne will close that number up.

Chris Marshall

Yes. Again that's pre acquisition.

Brady Gailey

Yes, yes, okay. Then lastly from me, what's the size of the indirect auto book nowadays?

Chris Marshall

280, right about 280, it peaked right about 3 and 3.5, it is running off about $30 million a quarter.

Operator

[Operator Instructions]

I'll now move on to Nancy Bush with NAB Research.

Nancy Bush

Good morning, gentlemen. And two questions for you. The special asset portfolio which is what $257 million, down pretty dramatically from the peak. Any thoughts about just sort of clearing that off the books, or are you satisfied with the returns you are getting there? Any thoughts about bulk sale, et cetera?

Bruce Singletary

Yes. Nancy, this is Bruce Singletary. We hadn't done bulk sales and don't anticipate any. We have -- there are group of people that I mentioned that and we feel like it has been pretty effective with it and have realized some recoveries out of it, so we don't anticipate selling that off at all.

Nancy Bush

And that's composed mostly of what? I see that there's $44 million in OREO. What would the predominant rest of it be?

Bruce Singletary

Well, OREO is 44 and the rest of are just impaired loans criticized and classified loans that we are working out.

Nancy Bush

Primarily commercial or --?

Bruce Singletary

Yes. I mean it is split pretty evenly between commercial and CRE

Nancy Bush

Okay, great. Secondly, on the subject of CRE, I know you guys are transitioning from OCC to FDIC but the OCC has issued some pretty tough guidance about CRE concentrations, et cetera and that's likely to become a standard I think for all regulators. Can you just comment on that and about what you are seeing and whether that guidance will impact what you are doing in the future?

Bruce Singletary

Yes. Well, two things I'd say to it. First of all, our CRE portfolio is currently 22% - is 22% year ago so we have not really grown that portfolio and the guidance out there is not exceed 300% of capital, we are about half of that, 150% roughly there about. And so we are not feeling those pressures. And to the extent that there are opportunities out there we will continue to be disciplined lender in that arena.

Nancy Bush

Are you seeing any sort of pullback by some of your competition who are getting concerned about their exposures? Are you seeing opportunities that you can dive in?

Bruce Singletary

We have been talking pull back but I really haven't seen them pull back yet. That quite frankly could be an opportunity for us to given that we've got room to grow that portfolio and we can do it with the right kinds of equity, with the right kind of developers that could become an opportunity in future for us.

Nancy Bush

Okay. Thank you.

Gene Taylor

Hey, Nancy, Gene. I would comment, you know this as well as anybody on the call but the thing that took down every bank that we bought was commercial real estate at the time of acquisition they were all at about 50%, we dropped as Bruce said to the 22 number. I have no qualms about growing it. We actually have people through the banks we acquired with that skill set and they are good but we tend to be a very conservative commercial real estate lender as evidenced in every single number that we have. And I agree with Bruce. If opportunities present themselves with proven developers with great cash flows and great history that are consistent, predictable, sustainable we will do it. But you won't see us doing a lot of lending that is at the margin.

Nancy Bush

Yes, Gene, but I'm from the southeast and I always get nervous.

Gene Taylor

I do too. I agree with you. That's why I made my comment, Nancy. See I got -- I can assure in South Florida we have the minimus exposure. We going out of our way I mean the number of transactions we've done versus the number we had put in front of us is stunningly low.

Operator

Thank you. And that does conclude today's question-and-answer session. I'd now like to turn the conference back over to Mr. Taylor for any additional or closing remarks.

Gene Taylor

Thanks very much. Thanks each of you for your participation. Jill we were delighted to hear from you and welcome and to my teammates that help make all this possible that happen to be listening, a big thank you.

Operator

Thank you. That does conclude today's conference. Thank you for your participation. And you may now disconnect.