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Taylor Capital Group Inc. (NASDAQ:TAYC)

Q1 2008 Earnings Call

April 30, 2008 9:00 am ET

Executives

Bruce Taylor - Chairman and CEO

Robin VanCastle - CFO

Mark Hoppe - President

Analysts

Brian Martin - Howe Barnes

Michael Salzhauer - Benjamin Partners

David Konrad - KBW

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2008, Taylor Capital Group Incorporated earnings call. (Operator Instructions).

Before we begin our presentation we would like to remind you that some of the information we will be providing today falls under the guidelines for forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, we must point out that any statements made during this presentation regarding our hopes, beliefs, expectations or predictions of the future are forward-looking statements and our actual results could differ materially from those projected. Additional information on these factors is included in these materials and from time to time in our 10-K and 10-Q filings which can be obtained in our website or the SEC's website.

With these formalities out of the way, let's proceed with our presentation. I would now like to turn the presentation over to Bruce Taylor, Chairman and CEO of Taylor Capital Group Incorporated. Please proceed sir.

Bruce Taylor

Thank you. Good morning everyone. With me today is our Chief Financial Officer, Robin VanCastle, who will review the financial highlights of the first quarter. I am also excited to introduce Mark Hoppe who joined us earlier this year as President of Taylor Capital Group and CEO of Cole Taylor Bank. Mark is here to provide his perspectives on the market and the opportunities that we have.

The first quarter's performance reflects two major factors impacting the company. The first is the consummation of the most significant external growth transaction in our core business since the last bank acquisition we made in 1984. Second is the ongoing challenge being faced by homebuilders in the market. We do not foresee any near term improvement in the housing market conditions which will continue to cause stress amongst our borrowers in that business.

It is no secret that a key component of building our company's long-term value is the growth of our business with closely-held companies. Continuing to build a force of talented, experienced and well-known commercial bankers is a prerequisite to accomplishing this. During the first quarter in addition to Mark joining us as President and CEO of Cole Taylor Bank, we hired Larry Ryan, a 27 year veteran over LaSalle Bank N.A. as our Executive Vice President of Commercial Banking and Mike Morton, formerly one of the top risk officers of LaSalle Bank as our Chief Credit Officer.

In late March and early April we hired 29 other commercial bankers and related support staff including six Group Senior Vice Presidents and our new head of asset-based lending. We made a substantial investment to recruit these people and will incur an increase in ongoing expense.

Robin will provide more details about the financial impact in her remarks.

I would like to note that some of the newly added expense is offset by our ongoing efficiency efforts. Some of the new personnel are filling vacant positions. We also eliminated some positions late last year and early this year as our ongoing planning and efficiency management which resulted in our recognizing severance expense during the quarter.

The business focus, cultural alignment and tactical execution of our growth strategy could not be more tightly aligned to our core business. This builds on our strong heritage in commercial banking and an infrastructure that's in place to support the needs of the companies we bank. Our efforts are now focused on quickly integrating our new staff and accelerating our growth in the relationships.

At the same time that we are planting these seeds for our future growth we've not lost sight of the importance of effectively working through the downturn in the residential market, improving asset quality and mitigating our exposure to potential losses. We are fortunate to have a strong capital base and substantial allowance for loan losses to help absorb losses we may face from the decline in home sales and related real estate values.

The first quarter loss provision of $11.8 million was half of what we provided in the fourth quarter. Non-performing assets now stand at 2.9% of total assets. This is a historically high amount and the result of the quick and sharp downturn in home sales.

First quarter new home sales in the Chicago area were 61% or what they were a year ago with only about 2,100 homes sold. As of March 31, residential real estate and related land exposures make up approximately 79% of our non-accrual loan totals. The majority of our non-accruals are represented by floor borrowers, including our single largest exposure that was put on non-accrual status during the first quarter.

We continue to add strength and experience to our staff charged with credit risk management. In addition to Mike Morton, Chief Credit Officer, we have added three other credit professionals to our staff since the beginning of the year. They include our head of loan reviews, Senior Vice President, a Senior Vice President in our special assets division, and also a Senior Vice President in commercial real estate administrative management. All of these individuals will add strength and experience to our credit support functions and allow us to work through the current economic environment while building the foundation needed to support our growth.

Mark will talk more about this in his comments. I will now turn the call over to Robin VanCastle who will provide more detail on our financial results for the quarter.

Robin VanCastle

Thank you, Bruce and good morning everyone. Continued weakness in the residential real estate market resulted in $11.8 million provision for loan losses in the first quarter. This provision represented a three-fold increase from the first quarter of last year, but was half the level we have provided last quarter.

Net charge-offs for the first quarter were $2.2 million or 36 basis points of average loans on an annualized basis compared with $2.8 million in the first quarter last year and $8.7 million in the fourth quarter. Non-performing loans increased $23.8 million or 31.5% primarily based on our assessment of a single borrower involved in residential real estate development with loans from us totaling $26.7 million.

These loans were current on interest and principle however the developer's obligations to other banks and the performance of the projects financed by those other banks was sufficient in our judgment to stop accruing interest and recognize the entire relationship as non-performing. Our accounting treatment for this loan is an example of how we are proactively recognizing and aggressively addressing weakness in the residential construction part of our portfolio.

While average non-accrual loan balances increased during the first quarter that impact was offset by interest we collected on a loan that we have placed on non-accrual last year. The interest we received when the non-accrual loan paid off during the first quarter more than offset the amount of interest reversals we recognized. As a result, the net effect of the non-accruals to our total loan yield was unchanged between the first and fourth quarters another example of how our proactive approach to recognizing potential credit weakness.

Our net interest margin in the first quarter declined 13 basis points on a linked quarter basis. We moved quickly during the quarter to reduce our funding costs and step with the declining prime rate and that supported our net interest spread which remained flat from the last quarter. One of the actions we took to reduce funding costs in the first quarter was to call above market rate brokered CD. We called approximately $70 million in CDs with average remaining terms of over three years and coupons between 4.85% and 6% and recognized early debt extinguishment expenses of $810,000. That early debt extinguishment expense is separately reported in non-interest expense. We funded the calls with additional brokered CDs.

Our net interest margin declined in spite of our flat net interest spread because the calculation for net interest margin factors in the effects of interest earning assets that are being supported by non-interest bearing funding, our so called free-funding. The lower average interest bearing liability cost reduces the value attributed to the free funding in the margin calculation.

CNI lending continues to increase as a percentage of our portfolio. While our real estate construction loan portfolio continues to decline on both the real and proportional basis. CNI loans increased $29 million or 3.4% in the first quarter, 14% on an annualized basis to comprise 35% of our total portfolio at March 31. Our real estate construction loans decreased $61.5 million or 9%, declining to 24% of our portfolio. In total our loan portfolio decreased $21 million or about 1% during the first quarter.

Non-interest expense was higher in the first quarter on both a linked quarter and year-over-year basis. The provision for losses and other real estate FDIC insurance and early debt extinguishment expenses and easily identified in our earnings release. The impact of our significant recruiting however is less apparent. So let me break that down for you.

Since mid March, we have recruited 22 commercial banking officers dedicated to business development and 7 new credit professionals, including our new Chief Credit Officer. Including our new President, Mark Hoppe and our Executive Vice President of Commercial Lending, Larry Ryan, incremental compensation expense for the first quarter totaled $1.1 million. Because approximately half of our new hires started with us after March 31, the estimated impact in future quarters is expected to be higher. Based on our recruiting to date, we estimate that the incremental recurring compensation expense will approximate $2 million per quarter.

Both the holding company and Cole Taylor Bank remain well-capitalized with total capital to risk weighted rated assets of 12.67% and 11.92% respectively at quarter end. Given the current economy and our strategic growth initiative we believe it is prudent to preserve capital and liquidity. Therefore, in spite of our stock trading at a significant discount to book value, we did not repurchase any shares during the quarter.

I look forward to your questions and now, I will hand off our conference call to Mark.

Mark Hoppe

Thank you, Robin. Good morning, everyone. First, I would like to express that I am really excited about joining Cole Taylor. What drew me to the company is its unwavering commitment to middle market commercial banking strategy and commitment to closely held business orders. I have been here for about 90 days now, which is long enough to confirm what I have always thought about Cole Taylor. This is a strong company with talented people and it is as competitive as any bank in our existing markets.

The commercial banking market in Chicago is very dynamic right now. Relationships are shifting and clients and commercial bankers as well are considering their options. My first priority is to position the bank to move quickly and to capture as many opportunities as possible during this period of market disruption.

We have the advantage of working from a position of strength. Cole Taylor has the strategic focus, a full suite of competitive products, an engaged and accessible management team and talented bankers. As a further description of that as Bruce mentioned, last month, we hired Larry Ryan, who is a well-known middle market commercial banker in the Chicago area. Larry had a 27 year career at LaSalle Bank dealing primarily with closely-held businesses.

In the 30 days that Larry has been here, he has done a great job of ramping up our commercial banking team with experienced relationship driven producers who have middle market banking skills and strong deep client relationships.

Our commercial banking business unit has doubled in size over the past few months and today there are a total of 41 relationship managers in commercial banking. Larry may hire a few more people going forward but for now, his senior commercial banking team is in place and they are focused on market development. The strong, strategic, and cultural fit of the new hires makes it possible for us to become quickly and efficiently as a unified team working toward a common goal, winning in the marketplace.

In addition I've been assessing our infrastructure. We have to make sure that our bankers have the support and products they need to maximize our new business opportunities. I am pleased to say that with some modest enhancements to our existing products we can improve our delivery capability in treasury management, foreign exchange, international services, as well as interest rate risk management products.

We are committed to provide these products to our clients in an efficient and cost effective manner which will increase our fee income. I have also taken this opportunity to enhance our credit operations in ways that will support our commercial banking growth strategy. Commercial lending, particularly in the relationship banking model, must balance underwriting with an appreciation for getting deals done along with credit administration processes that protect against the risk of loss.

Mike Morton, who joined Cole Taylor from LaSalle where he was a Senior Vice President and one of the Senior Credit Officers, was a commercial banking lender before becoming a credit officer a number of years ago. He has the benefit of hands on experience working with clients and has seen a wide range of scenarios. Also, Mike has worked with most of the new RMs who have joined Cole Taylor and this familiarity should increase underwriting and credit administration efficiency and effectiveness.

In credit monitoring as Bruce alluded to before, we've added senior staff in loan review special assets and commercial real estate administration. When I arrived at Cole Taylor, I found sound underwriting and practices that are common in banking. That said, we are building a credit management infrastructure that will support the accelerated growth we expect to experience over the next several quarters.

The individuals we have recruited are experienced and successful credit professionals who are familiar working in a larger environment. Their skills will not only enhance our current practices, but also put in place those processes required to manage a larger, more diverse and complex portfolio.

I look forward to your questions and will hand the mic back to Bruce.

Bruce Taylor

Thank you very much, Mark. During the first quarter, we took advantage of a unique, maybe once in a lifetime opportunity in the market. Net-net, we made an $8 million annual investment in our company's core business and future growth. We are not the only bank in the market seeking this opportunity and yet our success in attracting this talent to our company exceeded our expectations. I expect the successful execution of this phase of our growth plan will lead into successfully executing the next phase, building our market share.

In turn, this will improve our competitive position, diversify our portfolio, improve financial performance and build long-term value.

I will ask the operator to open up the line for your questions. Thank you.

Questions-and-Answers Session

Operator

(Operator Instructions). Your first question comes from the line of Brian Martin with Howe Barnes. Please proceed.

Brian Martin - Howe Barnes

Good morning.

Bruce Taylor

Good morning, Brian.

Robin VanCastle

Good morning, Brian.

Brian Martin - Howe Barnes

Could you guys give a little of the non-performing, the one that came on this quarter, can you just give a little color as far as what that one is in the collateral and then maybe just a little bit of status on some of the other larger credits that were also in last quarter as far as where you're at and as far as resolution there?

Bruce Taylor

Okay. That is a residential development project loan principally and it is in the Chicago area, it is a suburban project loan, single family residences. And we continue to work through the situations that we have on our non-performing list that will relate to residential construction and positioning ourselves to effectively work through those situations as quickly and as appropriately as we can. When the actual resolution of the particular credit will be made is very difficult to forecast, but we would expect that we will have made some progress over the next couple of quarters.

Brian Martin - Howe Barnes

Okay, and Bruce, you said that there was it must I heard wrong there was one credit that was resolved or something that occurred this quarter, can you give a little color on that? Was that just a smaller type of credit or was there some resolution from the larger ones?

Bruce Taylor

Yes, that was a loan that was secured by a piece of commercial property that had been on non-accrual. That was approximately $5 million in total outstanding. A substantial portion of that loan was repaid by one of the components of the collateral package that we had and the remainder of the loan was put back on non-accrual.

Brian Martin - Howe Barnes

Okay, and the credit that came on this quarter there were no -- I guess no charge-offs related to that? Is there a specific allocation attached to that one?

Bruce Taylor

To the loan that we just put back on accrual?

Brian Martin - Howe Barnes

No, to the one that came on board this quarter, the $26 million relationship.

Bruce Taylor

Yeah, so we have placed a special allocation against that credit.

Brian Martin - Howe Barnes

Okay, but no charge-offs at this point?

Bruce Taylor

Not at this point.

Brian Martin - Howe Barnes

Okay. How about just maybe a little color if you can on the delinquency trends at this point as far as where they stand versus maybe the 12/31 numbers?

Bruce Taylor

Okay. And I don't have those numbers right in front of me. I think they were fairly stable from quarter-to-quarter. We continue to monitor the portfolio very closely so I would say that there is not necessarily anything indicative in terms of the trend from quarter-to-quarter. That doesn't mean that there won't be other residential projects that could go on non-accrual in future quarters, but that remains to be determined and it is going to be a result of both the market and how the market fares as well as the borrowers' particular situation.

Brian Martin - Howe Barnes

Okay. All right. And can you give any color as far as -- Robin gave a little color as far as the expenses associated with the new hires, as far as maybe a macro perspective on your -- Mark alluded to a little bit as far as the growth over the next couple of quarters or the next four quarters as far as kind of expectations of the new talent, can you get any sense for what your expectations are there or what we can expect there?

Bruce Taylor

Brian, we don't provide specific projections mentioned in prior calls. We have talked about historical growth rates in commercial lending in the low teens. We would expect to see something somewhat higher than that going forward, but I don't want to try and forecast a specific number on a quarter-to-quarter basis.

Brian Martin - Howe Barnes

Okay. Well, I'll hop off and maybe I'll come back if I need something else. Thanks.

Bruce Taylor

Thank you.

Operator

Your next question comes from the line of Michael Salzhauer with Benjamin Partners. Please proceed.

Michael Salzhauer - Benjamin Partners

Good morning.

Bruce Taylor

Good morning, Michael.

Michael Salzhauer - Benjamin Partners

With the increase in the CNI lending, where did that come from? Was that new relationships or existing customers?

Bruce Taylor

That would probably and I don't again, have the list exactly in front of me, but it's going to be a combination of both existing and new customer relationships that were developed during the first quarter. We are seeing good opportunities notwithstanding or separate and apart from this growth strategy and the new relationship managers that have joined us. We are seeing some very good opportunities in the market place to gain new relationships. And our existing staff has been very proactive in taking advantage of those opportunities that are presented to us.

Michael Salzhauer - Benjamin Partners

With the new RMs, how long does it usually take them to bring enough business to break even?

Bruce Taylor

Again, that's going to get into us giving somewhat of a specific projection which I am a little bit lulled to do, but it's going to take some quarters into the future, whether it's three quarters, four quarters, and it's also going to depend based on a particular RM and their success in attracting the business. But it is going to be somewhat of a drag on earnings we expect through the balance of this year.

Michael Salzhauer - Benjamin Partners

Okay. I agree with you, you have a once in a lifetime opportunity. I hope you can execute. Good luck.

Bruce Taylor

We will; thank you.

Operator

Your next question comes from the line of David Konrad with KBW. Please proceed.

David Konrad - KBW

Good morning.

Bruce Taylor

Good morning.

Robin VanCastle

Good morning.

David Konrad - KBW

Robin a couple of questions. I just wanted to make sure I got the expenses right when you talk about $2 million run rate per quarter from the new hires that includes the $1 million this quarter, right? So it is a $1 million addition we should look for the next quarter?

Robin VanCastle

Yes.

David Konrad - KBW

Okay. And then in terms of margin, it seems like there is a few moving parts here going forward. It sound like you will probably get a lift from refinancing, if you will, the CDs, but assuming that the Fed cuts another 25 basis points, what's kind of your near term outlook on where that margin goes?

Robin VanCastle

Because of our asset sensitivity almost 60% of our loans are tied to prime and LIBOR. Right after the Fed cuts rates that puts compression on our margin because it takes us time to refinance the term deposits that are behind it. So, if the Fed was to not move today, then what we would see as we see still a little more decline in the margin in the second quarter and then it would start to recover as you really, your assets have all re-priced and now you are just re-pricing your term liability. If the fed moves today, that pushes that out. And that very similar to what you see with other assets sensitive bank it takes about 6 months to really start to turn the corner on that re-pricing and its impact.

David Konrad - KBW

Okay. Great, thank you.

Operator

(Operator Instructions).

Bruce Taylor

Okay. We appreciate very much your time today and your interest in our company. Thank you.

Operator

Ladies and gentlemen thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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