Chemical Financial Corporation's (CHFC) CEO David Ramaker on Q2 2016 Results - Earnings Call Transcript

| About: Chemical Financial (CHFC)

Chemical Financial Corporation (NASDAQ:CHFC)

Q2 2016 Earnings Conference Call

July 27, 2016, 10:30 ET

Executives

Michelle Pilaske - IR

David Ramaker - CEO

Lori Gwizdala - CFO

Analysts

Chris McGratty - KBW

David Long - Raymond James

Andy Stapps - Hilliard Lyons

Operator

Welcome to the Chemical Financial Corporation Earnings Conference Call. [Operator Instructions]. At this time, I will like to turn the conference over to Michelle Pilaske. Please go ahead.

Michelle Pilaske

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 website. 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 5 of the 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 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 6 and 7 we had another solid quarter in terms of earnings and growth. We posted 2016 second quarter net income of $25.7 million or $0.67 per diluted share compared to 2016 first quarter net income of $23.3 million or $0.60 per diluted share and 2015 second quarter net income of $19 million or $0.54 per diluted share. For the six months ended June 30, 2016 net income was $49 million or a $1.27 per diluted share compared to 36.9 million or a $1.08 per diluted share for the same time period in 2015.

Obviously these results are impacted by transaction costs from multiple transactions over the past 12 months as detailed in the release. So I won't repeat those adjustments here rather I'll give you the bottom line apples to apples comparison, excluding transaction expenses net income in the second quarter of 2016 was $27.7 million or $0.72 per diluted share compared to $24.9 million or $0.65 per diluted share in the first quarter of 2016 and $21.7 million or $0.61 per diluted share in the second quarter of 2015.

Net income excluding transaction expenses was $52.6 million or $1.37 per diluted share for the six months ended June 30, 2016 compared to $40.4 million or a $1.18 per diluted share for the six months ended June 30, 2015.

To reiterate second quarter net income before transaction costs in 2016 was $0.11 or 18% higher than the second quarter of 2015. This sustained growth is not only reflective of the efforts of the extended Chemical team and the impact of our two bank acquisitions in the second quarter of 2015 but also of the reception of our products and community banking philosophy among the communities and customers we serve.

Taking into account that a significant area of senior management's focus during the quarter with on moving forward on our pending merger with Talmer Bank Corp these results are testament to our core banking teams focus on servicing our customers. I would also be remiss if I did not know that interest income in the quarter was aided by the transfer of $10 million of the credit market to accretable yield which is attributable to the higher than anticipated credit quality and early payouts of the Byron [ph] Bank and Northwestern bank acquired portfolios.

Organic loan growth continued at a solid pace in the second quarter led by strong consumer installment loan growth, we added net new loans of $280 million to the total portfolio. Credit quality remains high with non-performing loans at a very well 81 basis point of total loans. Importantly the Talmer merger remains on track, at a special meeting of the Talmer shareholders held on July 14th, Talmer shareholders approved the merger and on July 19th, Chemical shareholders also approved the merger.

Pending receipt of regulatory approval we expect the merger will close late in the third quarter or early in the fourth quarter. I'll now ask Lori to provide a more thorough review of our financial results. Lori?

Lori Gwizdala

Thank you, David. Good morning everyone. As David mentioned our 2016 earnings performance has been solid, let me cut in a few of the key drivers. As noted on slide 7, as David mentioned diluted earnings per share excluding the transaction expenses were $0.72 in the second quarter compared to $0.65 in the first quarter of this year and $0.61 in the second quarter of last year. Transaction expenses decreased earnings per share by $0.05 in both the first and second quarter of this year compared to $0.07 in the second quarter of last year.

The increase in 2016 second quarter earnings per share over the same period in 2015 was largely driven by our acquisitions and strong loan growth. While the increase over this year's first quarter was largely driven also by strong loan growth but also the higher loan interest accretion. As David previously mentioned we have experienced an improvement in the underlying credit quality of our acquired Byron Bank and Northwestern bank loan portfolios which includes reductions in past due loans, substandard and watch rated credit and lower than expected loan losses partially attributable to significant principal reductions and loan payoffs.

Accordingly, at the beginning of the second quarter we transferred approximately 250 basis points of credit discounts applicable to the Byron Bank acquired loan portfolio and approximately 150 basis points of the Northwestern Bank acquired loan portfolio to accretable yield discount which we will accrete as additional interest income on an effective yield basis over the remaining estimated lives of these portfolios.

This transfer resulted in recognition a $2.5 million of interest income attributable to loan interest attrition during the second quarter of 2016 up from approximately $700,000 in the first quarter. At June 30, 2016 the remaining credit discounts as a percentage of loan was 4.4% on the Byron Bank loan portfolio and 6.7% on the Northwestern Bank loan portfolio.

Moving to slide 8, you can see how our focus on efficiency combined with our organic and acquisitive growth has facilitated long term sustainable earnings growth. As shown on slide 9, we have achieved over $1.4 billion of cumulative our organic loan growth since the beginning of 2014 including $376 million so far this year. This growth continues to be achieved through a combination of customer business expansion and increased market share. The increase in loans in this year's second quarter, a $280 million or 3.8% occurred in all loan segments were almost predominantly in the consumer installment area. Historically, the second quarter of each year is our strongest quarter of consumer installment loan growth as a summer months motivate our customers to purchasing cars or recreational vehicles and boats.

On slide 10, the average cost of our deposits remains low at 23 basis points in the second quarter just one basis point higher than the first quarter. Total deposits were down $185 million during the second quarter with the decrease attributable to declines in seasonal municipal deposit,. However our average deposits in the second quarter were approximately the same as the first quarter. Core deposits excluding the impact of mature broker deposit were up $268 million or 3.8% during the last 12 months. We do expect to continue to pay down the remaining $173 million of acquired brokers deposit as they mature.

On slide 11, our total funding cost of 27 basis point in the second quarter were up two basis points over the first quarter due to the increase in our level of wholesale borrowings, the increase in our wholesale borrowings was due to increases in the level of our FHLB advances used to meet liquidity needs primarily over loan r.

We borrowed $100 million at fixed rate three year FHLB advances at 1% during the second quarter. Wholesale borrowings comprised 10% of our overall funding since June 30, 2016 compared to 8% at June 30, 2015.

Moving to slide 2, net loan losses in the second quarter were remarkably lower than the prior two quarters. Second quarter net loan charge offs were $1.8 million or just 10 basis points of average loans. The provision for loan losses of $3 million in the second quarter was higher than the first quarter and was attributable to the strong growth in our originated loan portfolio of $377 million and not due to credit quality concerns.

We made significant progress in the credit quality area in the second quarter resulting in our non-performing loans declining $11 million or 15% with over one half of the reduction from loan payments and payoffs and resulting as David mentioned in a ratio of non-performing loans to total loans. Of a very low 81 basis point at quarter end, and the ratio of the allowance for losses to non-performing loans of 115%.

Turning to slide 13, net interest income of $77.5 million in this year's second quarter was $3.2 million higher than the first quarter due to loan growth, $1.7 million of higher acquired loan interest accretion and $500,000 in dividends on our Federal Reserve Bank stocks. The net interest margin on effect full run basis was 3.70% in the second quarter compared to 3.60% in the first quarter and 3.59% in the second quarter of last year.

A primary driver of the increase in our margin was the higher interest accretion on acquired loans which contributed 11 basis points to our net interest margin in the second quarter of this year compared to three basis points in the first quarter of this year and four basis points in the second quarter of last year. The interest accretion on acquired loans contributed thirteen basis points to our loan yields in the second quarter compared to four basis points in the first quarter of this year and five basis points in the second quarter of last year.

Non-interest income as seen on slide 14, totaled $20.9 million in the second quarter of this year up slightly from the first quarter of this year and the second quarter of last year. The increase in the first quarter was due primarily the higher seasonal trust fees from the preparation of trust tax returns and higher student overdraft fees.

Mortgage banking revenue was $200,000 higher in the second quarter of 2016 compared to the first quarter. Due to an increase in gains from increased sales of residential mortgages that were partially offset by $400 impairments of the corporations mortgage servicing asset resulting from a recent decline in market interest rate. As seen on slide 15, operating expenses excluding transaction expenses were $56 million in the second quarter of 2016, $300,000 lower than the first quarter while the release details the combination of factors that has resulted in the generally consistent orderly run rate in operating expenses during the last three quarters the key takeaway is that we continue to focus on and drive efficiency. The corporation's efficiency ratio was 55.1% in the second quarter 2016s compared to 58.8% in the first quarter of this year and 60.5% in the second quarter of last year.

At June 30, 2016 as detailed on slide 16, the corporations tangible equity assets ratio was 8.2% unchanged from March 31, 2016 and our total risk based capital ratio was 11.4% down just slightly during the quarter due to strong loan growth and their foreign increase in the corporation's risk weighted assets.

On slide 17, we have provided a roll forward which shows the impact of our operating performance and dividends to shareholders and tangible book value per shares during the last 12 months which have resulted in a 10% increase in tangible book value per share to $19.58 at quarter end.

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 be pleased with our progress on our strategy of organic and acquisitive growth, we are moving towards consummating the Talmer merger and we will continue to keep our focus on other potential opportunities for growth. Pending regulatory approval we look forward to adding the highly qualified Talmer team to our growing franchise.

Second, we continue to execute on our strategy of creating the preeminent Midwest community bank, we believe that our combination of market focused balance sheet strength, talent and convenience provides a compelling choice to consumers and businesses alike. Strong organic growth in our core banking franchise during the quarter as well as our solid financial performance is suggestive not only of the attractiveness of our strategy but also of our teams ability to execute it.

Our traditional focus as you know is been on Michigan but we look forward to adding meaningful out of state markets upon closing of the Talmer merger. Finally and I've said this before we believe that the key to translating our organic and acquisitive growth into shareholder value that to remain focused on the things we can't control. Two key ingredients will drive future earnings success, revenue growth and cost discipline.

We continue to make good progress across these fronts. As always we appreciate your time and interest in Chemical Financial Corporation. On that note Kyle, let's open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. And we will take our first question from Chris McGratty with KBW.

Chris McGratty

I'm looking at slide 9 with the organic loan trends over the past couple of years, certainly there's some seasonality in this quarter but if we look at the prior years. There's a big step that’s going on in terms of organic growth. David, can you comment on kind of what you're seeing in the Michigan market? Is it all market share or are you seeing line utilizations change at all?

David Ramaker

Well I think that from an economic perspective we're still seeing some solid opportunities for continued growth in a lot of the markets that we operate in but there's no doubt that the real key for us has been market share grab and the recognition of our strategy and how we treat customers in the personalized individual solutions that we provide. But the market's been good as always as we talk about this when car sales are good nationwide it's good obviously for the State of Michigan.

Chris McGratty

Maybe if I could follow up on that you know where pipelines might stand today versus a quarter ago and what we should be thinking about in terms of the back half of the year. I think our pipeline continue to remain strong. We obviously typically as you have noted have some seasonality in the growth that we do but those pipeline should be strong again in the third quarter. We have lots of transactions that are sitting waiting to close and quite frankly we have a lot of transactions that we closed from a construction standpoint that we're waiting for advances on those loans to occur. So, all of that should transcend into another good quarter.

Chris McGratty

Okay. Maybe I could go the accretive Lori, you gave some color on the percentage marks that are left on the two acquisitions. What's the dollar amount of loan discount that we should be thinking about that will flow through the margin? And I guess it's over the next several years.

Lori Gwizdala

As I mentioned in the second quarter it's 2.5 million and because we're taking that $10 million over the estimated lives of those portfolios, we’re estimating that to come down about $200,000 in each of the next 3 or 4 quarters, so 2.3 million in the third, 2.1 million in the fourth and it walks down each quarter thereafter.

Chris McGratty

In terms of the pool of the dollar amount is that roughly 2 million to 2.5 million over the next couple of year? I assume there is a step down, just trying to get a size of that 10 million with an addition to what exactly as of the prior quarter?

Lori Gwizdala

Yes the prior quarter was about $700,000. So the step up was about 1.7 million. So you will expect to see like next quarter you won't see 2.5 it will be a couple $100,000 less than that. So on a basis point it will contribute about one less basis point forecasted and that’s three quarters, so 10 basis point next quarter, nine basis point in Q4, now that assumes that we don't have any further increase in expected cash flow other than the other portfolios that we move.

Operator

We will take our next question from David Long with Raymond James.

David Long

Thanks for providing the update on the Talmer close timing, if we do get the end of the third quarter beginning of fourth quarter close when do you anticipate the actual integration happening?

David Ramaker

The conversion of systems which is the major component of that is scheduled for the second weekend in November and so you will see obviously at that juncture Talmer Bank and Trust will be a separate subsidiary from some financial close until that conversion that we can and at that juncture that next Monday we only will have one subsidiary Chemical Bank. From a cost perspective we should still bring through a majority of the cost saves before the end of the year. There will still be some trick lower into the first quarter but for the most part the majority will be in the fourth quarter.

David Long

And then as you are preparing to close this merger any liquidity created on the balance sheet or should we be thinking about -- was there any net interest margin impact to create liquidity here or anything like that as you prepare for this?

Lori Gwizdala

Well I would say David that as far as there is nothing that we’re doing to create liquidity but I think as we explained after their merger announcement you know there will be a reset of the overall credit discount allowance for loan loss within the day one accounting and we would expect on that restart that the contribution the excretion and the current Talmer side will decline and that was modeled through our EPS accretion forecast. So you'll see there will be a reduction in margin because of that reduction in accretable yield initially.

Operator

[Operator Instructions]. And we will take our next question from Andy Stapps with Hilliard Lyons.

Andy Stapps

How much do you expect in merger related expenses during the back half of the year?

Lori Gwizdala

We expect the combination of between Talmer and ourselves still over $60 million. Andy, I don't think that we're prepared because we exclude those from our core earnings. They will be significant. They will be -- I'm doing the math in my head here, you know they'll probably be upwards of $20 million, $15 million to $20 million in the back half of the year.

Andy Stapps

And could you talk about the growth you enjoyed in the wealth management?

Lori Gwizdala

The growth in wealth management is not just applicable to new growth, I mean this is seasonal tax revenue, choose wealth management department does tax returns for its clients and so this amount of revenue is revenue that we do receive or recognize each Q2 annually. So you potentially could see a little bit of drop in that those that revenue in Q3 but then in Q2 of 2017 it will repeat itself.

Andy Stapps

Okay. And what do you expect the effective tax rate to be in coming quarters?

Lori Gwizdala

The effective tax rate in the second half of the year I'm forecasting to be 29.7%.

Operator

[Operator Instructions]. We will take our next question from [indiscernible].

Unidentified Analyst

I was wondering if you could talk about just how you're thinking about the larger lending limit post-Talmer, what did all in the second quarter did you potentially kind of move kind of up-market and did that have any impact on loan trends last quarter?

David Ramaker

No it really hasn’t, because we've been obviously operating as two separate companies. We also have been enjoyed to some extent some participation between both of our companies but as to the total taking into account the new in-house limit we really haven't been forcing that issue at all and won't until we actually close the transaction.

Operator

We will take a follow-up from Chris McGratty with KBW.

Chris McGratty

The loan to deposit ratio, I know you talked about some movements in the funding sources in the quarter but it seems if you have the organic growth that you’re communicating that you're going to have to step up on a little bit on the deposit growth, I'm wondering what you guys might be doing there to grow deposit a little bit quicker?

David Ramaker

I think that where we are headed is we just need to continue to move on trying to get a greater share of the wallet of our customer base. We think that there is significant opportunity there and our focus is really on establishing some processes that help us manage that better. We don't think that we need to necessarily increase interest rates in order to start to achieve some more deposit growth. Obviously if you know there's a lot of seasonality to our deposit, we will see a significant increase in deposit here in the third quarter as taxes are paid and that will give us some time to continue to push forward on our initiatives and relationship to greater share of wallet.

Chris McGratty

If I could on the roughly [indiscernible] consumer book, can you remind us what that mix looks like today and what yields new origination yield might be?

Lori Gwizdala

So on that consumer book about there's about a $1 billion of consumer installment and about $800 million of that is the indirect loan portfolio and the other $200,000 is direct consumer loans made up of about equally [indiscernible] portfolio is the mix approximately 65% auto loans and then about 20% RV loans and the rest both and other and the overall yield on the installment loan portfolio including the home equity and home equity lines of credit is about 340, the new origination on both the direct and indirect consumer installment loans in the second quarter was about -- an effectively yield of about 262.

Chris McGratty

Okay. So that's you’ve -- I guess some pressure coming in that portfolio is that the right way to think about?

Lori Gwizdala

Yes, I would say that’s a great follow up and I said no because in that average yield of 340 there are obviously higher rates and lower rates and what we're finding and seeing is that rates have been low for a very, very long time. So the loans that are maturing and paying off are at similar yields to what we're putting loans on the books and in fact when we look at the detail in the second quarter they were up just slightly over what had rolled off.

David Ramaker

And then Chris I will just remind you that obviously that portfolio churned very quickly and the other component of that is that the credit quality 85% and slightly over 85% is credit score of 720 and greater, so it's a high quality portfolio.

Chris McGratty

Maybe if I could David, last one on the conversion in November and the cost saves by year end. Similarly if it goes smoothly you guys would be prepared to maybe consider another deal shortly thereafter, is that fair? Or is it too soon?

David Ramaker

I think well defined shortly but I think that what will happen is that we will be out knocking on doors and establishing reports with management teams and you know Iowa and Indiana, whether that leads to a potential opportunity or not it's hard to say at this point. We have to -- we’re jumping significantly here obviously from 9 billion to roughly 17 billion and we need to make sure that we've got all of our risk management characteristics established and those kinds of things before we really jump to the next deal, but we'll obviously be looking in and making sure that we're still cultivating it.

Operator

We have no further questions in queue. I will now turn the questions back to David Ramaker for any additional or closing remarks.

David Ramaker

Thank you. Again we appreciate your time and interest in Chemical Financial Corporation. We remain confident in our prospects going forward. By making Chemical Bank a community oriented financial institution of choice in the markets we serve and seeking to partner with likeminded institutions in the Midwest. We believe we’re well-positioned to achieve additional competitive and acquisitive market share gains as we move forward. Again thank you all for your time today and we'll talk to you soon. Thank you.

Operator

And this does conclude today's conference call. Thank you all for your participation and you may now disconnect.

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