Capital Bank Financial Corp. (NASDAQ:CBF)
Q3 2016 Earnings Conference Call
October 20, 2016 10:00 AM ET
Ken Posner - Chief of Strategic Planning, IR
Gene Taylor - Chairman & CEO
Chris Marshall - EVP & CFO
Bruce Singletary - CCO
Jaime Gow - CAO
Erika Najaran - Bank of America
Paul Miller - FBR Company
Jill Shea - Credit Suisse
Please standby we are about to begin.
Thank you, Gareth and good morning. I'm Ken Posner, Chief of Strategic Planning and Investor Relations for Capital Bank Financial Corp. Welcome to our Third 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.
Good morning, thanks for joining us today. In addition to Ken Posner, 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. Let’s start with the third quarter highlights on slide 5. First of all, as you know, last week we received final regulatory approvals for the merger with CommunityOne. This transaction brings us attractive running assets and core deposits, viable customer relationships, talented employees and a strategically important [no time] network which complements our existing footprint. We’re very excited to be welcoming our teammates and their customers to Capital Bank. I’m looking forward to smooth integration early next year, we expect the transition to be accretive to EPS, ROA and return on tangible common equity once we realize the associated cost savings.
Turning to Capital Bank’s third quarter results I’m pleased with the consistency of our execution and the sustained improvement in profitability reproduce since going public in 2012. Third EPS was $0.42 up 27% year-over-year and the Board of Directors has authorized an increase in the quarterly dividend to $0.12 per share payable on November 23, to shareholders of record on November 9.
Core ROA was 97 basis points up a 11 basis points year-over-year. Third quarter new loans totaled $471 million, the portfolio at an annualized 13 rate sequentially and is up also 13% in the new loans thanks to client selection and how we diversify a portfolio without material concentrations in any loan category, borrower type or geography. The NIM was relatively stable during the quarter compressing by only four bips. Thanks in part to our strategy of re-pricing loan portfolio by de-emphasizing [Indiscernible] margin segments like prime indirect auto.
The core efficiency ratio increased slightly this quarter to 61%, but for some perspective on the long term trend, its down from 66% a year ago. During the third quarter, we introduced a number of new products including new debit and credit cards and a new website and during the fourth quarter we're rolling out new purchase cards, merchant services capabilities and online and mobile banking platforms. We expect these products and services to contribute the revenue growth overtime and of course we're delighted, we can make them available to CommunityOne customers following conversion.
Now, let me anticipate a couple of questions that were frequently asked these days. In regards to CRE concentration the ratio for Capital Bank in quarter end was 161% of Risk-Based capital, which is obviously way below the 300% threshold for intensified regulatory scrutiny. After many years of working out of acquired commercial real estate we are now going to [Indiscernible] that class prudently working with established developers on high quality projects.
In regards to the recent controversy on cost settle ratios and unauthorized account sales, you should know that since inception at Capital Bank we never incented retail teammates on unit sales, rather we’ve used deposit in loan, balance growth target with a goal of minimizing the risk of inappropriate sales activity and maximizing revenues.
In summary, we had a great quarter and we approach the end of the year with momentum in both our organic growth and acquisition strategies, which set higher targets for our sales so we have a lot of work to do to reach those high goals, however, our progress is unmistakable and we are looking forward to new opportunities that the CommunityOne transaction will present.
I'll now turn the call over to Chris.
Thanks, Gene. And good morning, everyone. I'll begin by admiring Gene's comments, so we're really excited about closing the CommunityOne merger next week and then completing the seamless systems conversion early next year and then delivering on the cost savings in EPS accretion that we guided you to expect. I would also like to extend a warm personal welcome to all of our new teammates and our new customers.
Now to summarize Capital Bank's results, third quarter was broadly in-line with plan. Both net income and core net income were $18.5 million or $0.42 per share, both of which were up 27% year-over-year. Core adjustments included a $1.5 million legal settlement, $1.1 million tax adjustment as well as merger conversion and legal expenses in a small securities gain. You can see a summary of these adjustments at the bottom of the slide and the appendix contains a full reconciliation of GAAP and core income.
Now, let me summarize the major items in the income statement beginning with net interest income which was up roughly $1.1 million sequentially and year-over-year as our consistent loan growth offset modest pressure on the NIM. We recorded a provision of $600,000 which included an $830,000 reserve release due to the reclassification of certain loans that held for sale as well as continued strong market trends.
Core noninterest income was up $500,000 sequentially or modestly higher service charge in debit card income. Noninterest expense was up $3 million sequentially due to both the legal settlement and cost associated with the rollout of the new payments platform. And finally, tangible book value rose by $0.31 to $20.53 per share.
Now let's take a look at new loans. Turning to Slide 7. You can see that we generated $471 million of new loans roughly on par with the last quarter with the larger contribution coming from consumer due to opportunistic purchases of $126 million of prime five and seven year residential mortgages, all of which were in footprint. I mentioned earlier that we reclassified some loans that held for sale and you will recall that in the beginning of the year we stated our intent to sell approximately $200 million of loans in order to end the year at $110 billion in total assets. We reached agreement to sell $100 million of these loans late in the quarter and closed the sale early in Q4. We expect to complete the second $100 million sale later this quarter which should keep the combined portfolio roughly flat.
Now turning to Slide 8, you'll see that we generated roughly 7% year-over-year growth in total deposits with core deposits of 10% year-over-year. As expected, the cost of deposits has drifted up slightly over last year reflecting the Fed's rate high class December and a higher contribution of money market that now checked in.
I point out that CommunityOne brings us a low established deposit franchise in North Carolina including 14 branches in the Sharoline MSA. Now they are currently operating with the loan deposit ratio of around 80%. So the acquisition will enhance both our funding and our liquidity profile.
Now if you turn to Slide 9. Let me touch on the NIM which compressed by 4 basis points during the quarter to 358 which was slightly better than the 5 to 10 basis points in compression -- expect and anticipate the question we didn't get any material benefit in the quarter from fluctuations and LIBOR, but the NIM did benefit from some recoveries on the purchase credit impaired portfolio during the quarter, which were roughly at the same levels as last quarter. We also noticed that the securities portfolio was slightly higher as a result of some pre-payment penalties as CNBS securities paid off. Those pre-payment penalties offset compression by roughly 3 basis points.
As we discussed in the past we have been following a strategy or re-pricing the loan portfolio by de-emphasizing loans within margins such as prime and direct auto which we put in the runoff late last year. The benefit and the strategy can be seen in new loan yields just to give you a sense are up to 3.8% and 3.5% at the beginning of the year. Now this strategy will help slow the rate of NIM compression over time although as long as interest rates remain at current levels our NIM will continue to compress at approximately 5 to 10 basis points a quarter.
Now let's turn to slide 10 and review non-interest income. On a core basis, non-interest income was up $500,000 sequentially in the third quarter, thanks to somewhat higher deposit service charges, debit card fees and mortgage income. As Gene mentioned we had a very busy quarter in terms of new product introductions. During in the quarter we rolled out new debit and credit cards as well as a new website. And during the fourth quarter, we introduced corporate purchasing cards, new merchant service, processing products and a new mobile and internet banking platform. None of these technologies are proprietary because they are best in class products that we selected from the leading vendors in the industry. And we think they will help differentiate Capital Bank from other community banks and other mid size banks overtime.
I want to be careful not to create any unrealistic expectations about near term fee income growth because this is going to take some time to develop sales momentum with these products. But overtime we are very optimistic that this suite of capabilities will help us track and retain customers as well as grow revenues.
Slide 11, shows you the trend and expenses. Non-interest expense was down 2% year-over-year although it did increase sequentially for a number of reasons including the legal settlement of the lawsuit we inherited with an acquisition we completed in 2011. On a core basis the efficiency ratio was slightly higher than target this quarter at 61.1% as a result of some cost associated with the new product rollout as well as higher compensation costs. But our efficiency ratio target remained 60% and we expect to drop back below that level once we complete the integration of CommunityOne. And regarding the merger systems conversion scheduled for first quarter 2017 and you should start to see cost savings falling through the bottom line during the second quarter and we expect all cost savings to be fully phased in by the end of 2017. We are still on top for our original estimate that cost savings will amount to 39% of CommunityOne’s expense base and this is coming from the elimination of duplicate back office functions not reductions in any customer facing teammates.
Slide 12, summarizes our capital and liquidity positions which remain very strong. The consolidated tier one leverage ratio rose 12.6% to 12.9% during the quarter in part due to the fact that we were prohibited from repurchasing stock or proxy for the CommunityOne transaction is outstanding. However, you should assume that deploying access capital and improving returns on tangible common equity remain critical financial goals for Capital Bank and that the management team and board are fully committed to achieving them.
So with that I will now turn the call over to Bruce to discuss credit trends.
Thanks Chris. Let's start now reviewing performance of the new loan portfolio on slide 13. As you can see credit metric are quite strong, past year’s decline sequentially 11 basis points. Now accruals were up slightly in the quarter remain very low at 18 basis points. The addition to criticized and classified loans drop from 1.22% last quarter to 1.14%. Net charge-offs declined to 12 basis points annualized. The reserve in new loans is currently at 43 basis point which provides strong coverage of charge-offs and non-approvals. As a reminder there are separate reserves for purchase acquired impaired portfolio as well to remain in purchase accounting discount and core in the reserves plus the discount combined total 1.28% of loans.
Our strategy has been to deliver diversified portfolio, high quality credit relationship and to avoid concentration by loan type, industry or geography. We are well on this point this morning but I would refer you slide and appendix that provide details about portfolio competition.
Slide 14 provides you an update on special assets activity. For the total portfolio non-performing loans declined to 1%. We continue to resolve our special assets portfolio. As you can see [indiscernible] loans were down from approximately 1 billion at the end of 2012 to just under 250 million at quarter end. Legacy credit expenses are down from 5.5 million a year ago quarter to 1.7 million.
I will conclude by commenting on the credit quality on the CommunityOne portfolio. Unlike our past acquisitions CommunityOne in credit policies a very similar to our own and the quality of their portfolio is good. As a result we don't expect the merger to have a material impact on our overall pro forma credit policy. We don't expect material interest increases to legacy credit expenses.
I will now turn the call over to Ken for questions-and-answers.
Thanks Bruce and Gareth would you now please open the call for question.
Absolutely. [Operator Instructions] we will take our first question from Erika Najaran with Bank of America.
Good morning Erika.
Thank you so much for reiterating the expensive targets for CommunityOne and I was wondering given the pushed out time table of closing the deal if we can get an updated view on earnings accretion for 2017 and Chris if you could remind us whether or not this accretion would be on top of the core ROA goal of 1.1%?
So Erika I am not going to give guidance for next year in terms of accretion only because I think we still need to get in and finalize some of our schedules for next year. I would tell you though that our original assumptions for the transaction remain absolutely solid. The only difference is timing. So we intend to convert on Presidents Day weekend. We expect to see most of our cost savings come out in the second and third quarter. But in terms of overall accretion for the year, we will give you better guidance at the beginning of the year as we traditionally do when we’ve got all of our plans and all of our schedules finalized.
Thank you. And my follow-up question is, as your approach on the $10 billion asset number how do you philosophically view how to hurdle that growth, is it - are you going to continue to optimize organic growth to remain below 10 billion and wait for the second deal to hurdle you over or how should we think about or do you not care about that as a bright line?
I think you should assume that we are going to manage to stay under 10 billion through the end of the year and beginning next year you should expect us to continue to grow at our historical organic growth levels. Having said that you should also expect for us to continue to optimize the balance sheet de-emphasizing some of the low spread products that we put on in the past and that is inter-goal to us trying to achieve our ROA and even much more importantly our double-digit return on tangible common equity targets.
And if I could just please sneak one more in, where are you in the investment cycle in terms of setting up the bank to deal with the higher scrutiny and compliance, potential higher compliance cost of being above $10 billion?
You should assume that our - we have been investing in our infrastructure from beginning of the company and that there are no significant infrastructure capital requirements. Of course as the Durbin amendment and that will hit us overtime after we cross $10 billion. But in terms of building out our enterprise risk function, or BSA function, or any of those infrastructure projects have been accomplished long ago.
Thank you so much.
And moving on we will next hear from Paul Miller with FBR Company.
Yes. Thank you very much. Can you talk about your philosophy of buying back stock? I know you used to say in the past that you feel that you added value buying back stocks accretive at two times book is that still philosophy you guys have?
I am not sure what you meant about two times book. But we I think you should assume Paul that our philosophy on buybacks which is really a decision at the board meetings remains unchanged. Now we haven't been able to buy back shares just because of the proxy being outstanding. But you should assume that once we pass that point we will continue to operate as we have in the past. There is no change in our strategy.
And then on M&A I know this took a little bit longer on the M&A front this acquisition did in the past because some other things were going on. But where do you stand, are you still on a lot of conversations with some M&A targets? Is there still a lot of opportunities out there in your market in your footprint?
Yes we think there is - although the pricing expectations for some of the targets throughout there have been moved a little bit, we remain very active in conversations and you should assume that our strategy has not changed at all.
And because this has taken so long, could we expect an M&A transaction quicker than normal?
Well, I think what we drew out on the folks right now is talking about getting this one completed which we will do next, again Paul I would emphasize that our strategy hasn't changed.
Okay guys thanks for taking my questions.
[Operator Instructions] We will take our next question from Jill Shea with Credit Suisse.
Good morning guys. Just in terms of loan growth, growth is solid this quarter can you just provide some color in terms of what you are seeing in your market and just provide demand particularly in light of the general industry slowdown in C&I and some softness there. So just maybe touching on your overall outlook for growth in both the CRE and C&I dock?
Hi Jill this is Gene. I will try and address them and if Bruce also jump he can, first and foremost on CRE we have a competitive advantage as you heard me say earlier being at 161% we have a lot of room to grow that asset. Make no mistake Bruce and I want to go out and book a bunch of commercial real estate assets just to book them but if it's top quality developers with the right underwriting we have the capacity and frankly in the market we already seeing other banks unable to meet some of their borrower needs because there at 300 or over it. We will be given some opportunities but that's not the way I think Jill you actually like this. I think, I have it more about I like to do business with people who have known and operated their companies successfully for a very long time. That's our target client. And we have to work hard to get them to move from where they are. Majority of our business that we get is taking it from someone else and then growing share. So I would say it has been little tougher on the C&I side because of challenges that are out there but as we noted earlier in [indiscernible] and Nashville we do very well and so I am very confident that the remainder of this year, next year we will continue to compete effectively in those markets. But we’ve seen a slowdown and we don't have to deal with it. We have to me, myself our bankers are going to have to work harder to identify prospect that meet our criteria both for returns and credit and successfully get them in into Capital Bank. Bruce would you add?
Yes. So we did last see in our last quarter than in previous quarters. I don't really say that competition is greater I just think there are fewer opportunities and I don't really predict there is going to be less in the fourth quarter. There is just uncertainty in the market price and less opportunity but that's been tough environment for quite some time and there is no reason for us to think that we cannot generate the levels we have previously.
Okay. That's helpful. Maybe just turning to the margin, you did some good color in your opening remarks with your expectations to the margin but could you just remind us on the benefit that you would see in the margin if we get to the 25 basis points rate hike in December and does the close of CommunityOne affect your assets sensitivity at all?
The close of assets, I will take the second part first. The close of CommunityOne will have a slight impact on our asset sensitivity, but we have been getting more asset sensitive during the first three quarters of the year. So on balance, I would say we still remain more asset sensitive than the average bank pro forma for CommunityOne. And with regard to 25 basis point hike it maybe a basis point perhaps to - its 25 basis points is not going to have a significant impact on the margin.
Okay. Thank you.
And it appears we have no further questions at this time. I would now like to turn the conference back over to Mr. Gene Taylor for any additional or closing remarks.
Thank you to everyone that's participated. Thank you very much and we look forward to talking you next quarter.
And once again that does conclude today's conference. We thank you all for your participation.
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