Capital Bank Financial Corp (NASDAQ:CBF) Q1 2017 Earnings Conference Call April 21, 2017 10:00 AM ET
Kenneth Posner - Chief of Strategic Planning & IR
Eugene Taylor - Chairman, CEO & President
Christopher Marshall - CFO
Brian Reeves - Former Market President for Middle Tennessee and Middle Tennessee Commercial Banking Executive
Stephen Scouten - Sandler O'Neill
Stephen Moss - FBR Capital Markets
Blair Brantley - Brean Capital
Peyton Green - Piper Jaffray
Good morning. I'm Ken Posner, Chief of Strategic Planning and Investor Relations for Capital Bank Financial Corp. Welcome to our First Quarter 2017 Conference Call which is being recorded. During the call, we'll refer to a slide deck on the Investor 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 fact 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'm here this morning with our Chief Financial Officer, Chris Marshall; our Chief Credit Officer, Bruce Singletary; and our Chief Accounting Officer, Jamie Gow. We'll discuss the company's results and then take your questions.
Let's start with the first quarter highlights on Slide 4. Capital Bank reported EPS of $0.39 and core EPS of $0.45 which was equivalent to a core ROA of 96 basis points. This was the first quarter with the full contribution of CommunityOne and the results were wide in line with plan and a great start to 2017.
During the quarter, we successfully completed the systems conversion for CommunityOne and we're tracking precisely on the updated mid-40% cost savings we guided you to expect on our last call. With integration now complete, we're as always generating consistent, predictable, sustainable, high-quality revenue growth. New loan production was $505 million. Credit quality remains excellent with past dues and charge-offs down in the quarter, non-performers for the total portfolio falling to a record low.
Net loan growth came in at 6% on an annualized basis, as our [indiscernible] teammates are continuing to build their boats of business in line with Capital Bank pricing and underwriting standards. Regardless of market conditions, I'm confident that Capital Bank will continue to outperform the market based on the disciplined targeting calling efforts of our commercial and retail teammates.
Core owned -- core deposit growth was very strong this quarter, averaging 15% on linked quarter annualized basis with total -- and total deposit costs were flat. We were particularly pleased with $90 million growth in noninterest checking balances. The retail branch network continues to focus on executing against their standardized sales practices and commercial and treasury management teams are also contributing to the deposit growth. Another white spot in the quarter was the net interest margin which expanded by 7 basis points due to the full quarter contribution of CommunityOne, the Fed rate hike and net recoveries on legacy loans.
We were pleased to achieve a core efficiency ratio of 59% which is below our target of 60%. As Chris will explain in a moment, we [indiscernible] plans to close 18 branches this year which will generate additional cost savings towards our 1.1% ROA and double-digit ROTCE goals. Taking into account these closures, Capital Bank will operate a robust network of 178 branches in some of the best markets in the Southeast, staffs with local teammates offering high levels of personalized service.
We finished the quarter with $10.1 billion in assets, but anticipates [indiscernible]. We don't expect to incur additional costs for passing this threshold besides the Durbin impact starting in the second half of 2018.
Over the last few years, we've made significant investments in our infrastructure, including consumer compliance, BSA/AML, enterprise risk management, internal audit and Dodd Frank's stress testing. Regulatory compliance will remain a critical focus for senior management and the board and we will undoubtedly over time invest further in these areas as the bank reaches new milestones and size. But for now, all these expenses are in our run rate.
I'll now turn the call over to Chris.
Thank you, Gene and good morning, everyone. Let's turn to Slide 5 and I'll start with a high-level review of our first quarter results. As you can see, core net income is $23.9 million or $0.45 per share. GAAP net income was $3 million lower due to charges associated with the CommunityOne integration as well as the pending branch closures that Gene just mentioned.
Now starting with net interest income, you'll notice the NIM improved sequentially by 7 basis points, reflecting the full quarter contribution of CommunityOne, the impact of the Fed rate hike and some significant net recoveries on legacy loans.
Net expansion was positive, but I'll remind you that we don't include loan recoveries in our forecast and that we're still subject to the run-off and purchase accounting is expected to compress the NIM by 5 to 7 basis points per quarter during the rest of 2017. The provision was $3.4 million which covered charge-offs and boosted reserves by $700,000. Core fee income was up slightly on a sequential basis, as our debit card income offset the typical seasonal weakness and NSF fees and slower first quarter mortgage production.
As Gene mentioned, the core efficiency ratio came below target this quarter at 59%. And with the systems conversion completed in February, we're right on track for the mid-40% cost savings we talked about last quarter and a mid-50%s core efficiency ratio by the end of the year.
The core ROA was 96 basis points, flat quarter-over quarter which is also in line with plan. As you know, first quarter was typically the low point of the year for ROA due to payroll and tax accruals. But we're continuing to work towards the fourth quarter target of 1.1% ROA and the branch closures will help as well other cost savings plans that we have in the works.
Now turning to Slide 6, you'll see a summary of non-GAAP core adjustments and the roll-forward intangible book value which increased to $20.29.
Turning to Slide 7, you'll see we had new loan production of $505 million during the quarter which drove 6% net portfolio growth, offsetting runoff in the prime and direct portfolio, some reduction in line utilization and some transition-related runoff in the CommunityOne book. Our new North Carolina teams have been building their books of business and we're expecting portfolio growth to come in a little faster during the rest of the year.
You'll notice we had stronger commercial real estate growth this quarter and $181 million in new loans and we're clearly benefiting from a pullback in this space on the part of institutions that have reached counter-efficient limits. But there's no change to our highly selective approach. We're making loans for quality projects, with strong operators and these loans benefit from good pricing and strong equity commitments. Over the last year, CRE loans have increased from 22% of the portfolio to 24% and our regulatory CRE concentration ratios remained well below our peers.
Turning to Slide 8. First quarter was very strong for both deposit growth and cost control. Core deposits increased at an annualized 15% rate during the quarter and we were particularly pleased to see $90 million in noninterest checking balance growth. However, I'd also point out that the first quarter is seasonally our strongest quarter for deposits. And also, this quarter we experienced some short term inflows from a few large commercial customers. So we don't expect these growth rates to continue throughout 2017. But having said that, we do feel very good about funding loan growth at high quality, stable, low cost customer deposits. And in that regard, we're off to a great start for the year. You notice that core deposits cost rose a couple of basis points during the quarter and we do have some public funds and commercial accounts which are indexed to short term interest rates and that's what you're seeing there.
However, you also notice that total deposit costs are actually down by 1 basis point year-over-year on a contractual basis and down 3 basis points on a GAAP basis. And what's going on here is that we've been able to manage our funding costs by consistently growing core deposits and continuing to ship out of CDs. Now I'd anticipate the question, so far we haven't seen much reaction among customers or competitors for recent Fed rate hikes. And therefore, it's premature to talk about what kind of deposit base we'll see in the months to come. The Bank remains in an asset-sensitive position and we continue to think that our modeling assumptions are conservative relevant to peers. The more important fact, we continue to focus our retail network and commercial teams on growing relationship deposit balances which are the most stable and lowest cost funding source for the bank.
See, Slide 9 gives you an update on a net interest margin which expanded by 7 basis points during the quarter to 3.73% and it's actually up year-over-year. As you know, we've been guiding the 5 to 7 basis points in NIM per quarter. So let me explain what's going on here and what led to the expansion. First of all, we had net recoveries on legacy loans this quarter which contributed 7 basis points to the NIM at roughly the same level as last quarter. Additionally, we got 2 basis point benefit from the Fed's rate hike. Additionally, we had the full quarter impact of the CommunityOne transaction and that contributed a small amount of accretable yield which is why you didn't see the full 5 to 7 basis points in NIM compression from purchase accounting this quarter. And then finally, the timing with which we cashed out the CommunityOne investment portfolio and then redeployed the cash back into securities boosted investment portfolio yields from 2.39% last quarter to 2.51% at quarter end.
Slide 10 provides more detail on noninterest income. Core fee revenues were up $700,000 sequentially. And as already mentioned, the main drivers were strong debit card income, offsetting typical seasonal weakness in NSF fees and slower first quarter mortgage production. Last quarter, we rolled out new credit card and merchant services products and sales were steady quarter-over quarter. And over time, these and other initiatives should help our -- help drive improvements in our fee ratio.
Slide 11 shows you the trend in noninterest expense. As already mentioned, the core efficiency ratio remained below 59% this quarter despite seasonally higher accruals to payrolls and taxes. And despite having just completed the systems conversion in February which allows us to take our redundant back-office operations, you should expect to see the impact of these actions during the second quarter. The branch closure charge we took this quarter is associated with plans to close 18 branches during 2017 which will provide some additional cost savings on top of the cost savings coming from the CommunityOne Integration. We plan to take another charge in the second quarter, bringing the total associated with branch closures to $4 million and the earnback period from this project is expected to be under 2 years. The closures will leave us with a well situated and efficient branch network totaling 178 branches providing customers with high levels of personalized service. We're also serving our customers from state-of-the-art online and mobile banking products.
Now if you look at slide 12, it summarizes our capital and liquidity positions which remained very strong. The CommunityOne transaction deployed some of our excess capital which you can see in the improvement of the Tier 1 leverage ratio from 12.9% in the third quarter last year to 11.6%. Thanks to strong deposit growth in the first quarter, our loan to deposit ratio strengthened to 92.8% and is down year-over-year. As we discussed last quarter, our board is continuing to evaluate the benefits of stock repurchase following the postelection rally and bank stocks. Accordingly, we did not repurchase any shares during the first quarter. There's been no material changes in the compositional liquidity portfolio which remains highly liquid for the moderate duration.
And with that, I'll now turn the call over to Bruce to discuss credit trends.
Thanks, Chris. Let's talk the performance in new loan portfolio on Slide 13. Past dues imply to a very low 9 basis points on a flat year-over-year. Nonaccruals were up slightly quarter-over quarter; however, at 21 basis points, they also remained at a very low level. Criticized and classified loans did increase from 1.11% last quarter to 1.32%. And charge-offs declined 20 basis points from 24 basis points last quarter. Reserve ratio for new loans declined 1 basis point to 40 basis points. Now as you look through reserves and loans marks their current portfolio, the total reserve ratio is 1.06%.
In summary, our loan portfolio remained very diversified by industry, geography and loan time. And our credit metrics were in ranges that we regarded indicative of strong asset quality.
Going to Slide 14, we provide you an update on special assets activity. For the total portfolio, nonperforming loans declined below 1% for the first time, ending the quarter at 95 basis points. And you can see on the charts on right, special assets of $281 billion remained at very reasonable levels. I'll now turn the call over to Ken for questions and answers.
Thanks, Bruce. This completes our prepared remarks. And Allen, if you'd now open the queue for questions, please.
[Operator Instructions]. We'll take our first question from Stephen Scouten.
So really was impressed with the end of period loan growth that you were able to you deliver here this quarter on a net business. And it sounds like you guys are a little bit more positive for the rest of the year. So can you talk about maybe a couple of things, one, if that's largely going to coming from the North Carolina franchise or what you're seeing in Florida as well; and then if you feel like kind of [indiscernible] rolodex opening up for that B team is kind of a big opportunity set for that team and those lenders?
I agree totally with what you just said. That should help us immensely in the Carolina. But for my teammates listening intend to see in Florida we're not letting you all to hook. North Carolina, South Carolina will do well, but -- so I'm -- we're -- as we've always said, Steve, we don't know what the markets are going to do. We can't predict how businesses will invest for the future and what their time frame is and all the external factors. All I know is we make a lot of calls. And as a result of that, that are very targeted specific on the clients that we want to do business with. And we've been fortunate in the past and I believe we'll be able to continue in the future to getting that to grow share. So whatever the market is growing, we should do slightly better and that's our intent. And so that's the message I give to our teammate and to myself every time.
Okay. Yes, that sounds great. And then maybe just going to the costs saves related to COB and the branch closures, how much of the things have already been represented in your current expense run rate? How much of the COB expense saves remain? And how much leverage do you think you could see from the branch closures in the next couple of quarters?
It's a good question, Steve. This is Chris. I think we had 35% cost savings through the end of the year. And we said we'd be at mid-40s. All of that has been done. So you should expect us to have virtually everything completed at quarter end and you should see the benefits flow through in the second quarter. Not being exact, maybe a small amount, but that still has to come out in the second quarter, but it'd be a very, very small amount. With regard to the branch closures, that will be back-end-loaded. We'll start closing those branches in the second quarter, but they'll be spread across the back end of the year. I think you'll start seeing net cost saves in the fourth quarter.
Okay. So just to make sure I'm clear like this, I guess, it was maybe $57.8 million kind of core expense number. That's a pretty good run rate for right now apart from the incremental savings that will occur on the branch closures. Does that seem fair?
Okay, great. And then maybe just one last one from me on the NIM. I know you said you didn't want to talk about what deposit could be. But can you talk a little bit about what deposit base have been to date? And would you expect another 2 to 3 bps from the March hike similar to what you saw from the December hike in terms of benefit?
I think the hike is probably going to produce another 2 basis points and we should see that in the second quarter. With regard to deposit base, I think it's -- I don't really think it's possible to say you can measure the fluctuation that we've seen in our deposit cost with actions taken by the Fed. So I wouldn't go there. I think, again, I just emphasize that the deposit betas we use in our forecasting, I think, are conservative. And I think we're pretty well positioned no matter what certain rate scenario you would want to try to project.
[Operator Instructions]. We'll take a next question from Stephen Moss from FBR.
I was wondering if you talk a little bit -- just a little clarity around the expense run rate going forward. What do you think for the second quarter? Should we decline from the first quarter levels?
We should see modest decline in the second quarter because, first of all, we got higher expense levels because of the accruals I mentioned. But then secondly, we will have some additional incremental cost saves because of the actions we took after the integration was completed in February. So you should see some incremental reduction because of that. With regard to the branch closures, you will also see incremental cost reductions, but that will be back-end-loaded. And I don't think you really see anything material until the fourth quarter.
Okay. And then with regard to loan pricing in your market, so I was wondering if you've seen any changes in the market at all?
This is Gene. Yes, I think that about half of my teammates, there isn't a day goes by that we don't see that there has been a challenge to get the returns that we target in each of our transactions and surprisingly, it's tough. But my answer to them always is and I've been doing this a long time, it's always going to be tough. So you just have to go find the clients that will pay you for what you do for them and that's what we try to do.
Okay. And I guess, the third question here, I was just wondering if you have any comments or updated thoughts around the news article last month about being approached by a potential suitor.
No, we don't have any comment on that Steve. That will be inappropriate.
We'll take our next question from Mr. Blair Brantley.
A question on kind of the loan growth and that composition with CRE becoming a little bit more prominent. Is that -- I mean, I know you mentioned that it's in part because of some of the composition buddying up against their -- kind of their guidelines. But are you seeing any opportunity from the M&A dislocation? Is that a part of it as well?
No, I don't think so. I think it'd be too early. And if you're specifically talking about the larger deals that occurred in North Carolina, it'd be too early to see some of that, still very early in that process.
Okay. And then if we kept going back to that, are you seeing any opportunities to get some good talent from those deals or are you guys still looking to add talent?
We always have inbound calls. And we don't do lift-outs, as we said before. But on a selective basis, we would be willing to add. But back to the real estate question, one of the things that I know you're aware of, CommunityOne had an outstanding real estate team for North Carolina. And the addition to that team has been the driver to what we're doing. We're growing in Florida and we're growing in Tennessee. But the real opportunity to move forward has come from a group of some of the most talented commercial real estate bankers I've ever been [indiscernible].
Okay. And then just one question on capital. Were you blacked out during the quarter from doing buybacks or are you just -- I mean, are buybacks still an opportunity with the stock price where it is today?
We weren't blacked out for the entire quarter. But as I said, the run-up in the stock has caused our board to take some time to reflect exactly what they would like to do. And so I would just point out that we didn't buy anything in the quarter. And as the board makes the decision on how they want to deploy capital, especially around buybacks, we'll share that with you when that happens.
[Operator Instructions]. We'll now continue our session with Mr. Peyton Green with Piper Jaffray.
Gene, I was wondering, last quarter, you characterized the organic growth opportunities having improved relative to the quarter priority really sometime for most of '16. How do you view on going into 2Q? And what -- does that build more optimism for the balance of the year?
Peyton, thanks for the question. And I still feel that way. Mainly around other commercial real estate that we were just talking about, we'll continue to grow our C&I portfolio and our mortgage booking and other pieces. But clearly, we're capitalizing on -- and that's why we did the CommunityOne transaction. We knew it. And that's why we continuously look at all opportunities out there that we can avail ourselves of to help us create that sustainable organic loan growth that we'd like. And so I think you'll see us do well.
It is tougher. There is pricing pressure. There's people going outside the banking system as they refinance. And my teammates and I talk about those transactions every single day. But on balance, to answer the question, I still feel good about the second and third quarter. And it's all -- and you'll see a disproportionate percentage of that being in commercial real estate. And as Chris has alluded to, we're well below the regulatory guidelines than our peers. And frankly, the way I think about it is we've kept our powder dry and then we can use it on much better transactions.
Absolutely. And so what is your marginal loan yield that the production -- of the production in the first quarter? And how does that compare to quarter ago before rates had gone up?
Our yield on new loans in the first quarter, I want to say it was 406. And some of that was driven a little bit higher, because we had a pilot that we ran where we were buying some high-yield medical receivables from a fintech, very, very small number. But it did then push that up. So absent that, it's probably somewhere between 400 and 406.
Would that be higher?
Would that be higher relative to linked quarter a couple of quarters ago?
I don't have the exact number, but I would say it's probably 5 basis points there.
But the real driver, as everyone on the call knows, is the fee income those opportunities generate and it's making a difference.
Okay. And then, Chris, I think, you alluded to deposit cost pressure was due to indexed public funds balances. Do those public funds balances decline going into 2Q? And then secondly, in general, are you starting to see any rate pressure from specials that other banks are offering that you're having to match?
Yes, I'd say yes to all of that, except -- no, I don't expect the balances -- the index balances to drop. And I don't actually feel that pressure. It's just you're right, it's actually deposits you can get and some of them are indexed and some of them aren't. So it's a small amount of our portfolio. But you did -- we did see an impact from that. And in terms of the specials we see, they tend to be market-by-market. I have seen that in South Florida, a little bit, maybe more than a little bit in past quarters, but not necessarily across the whole franchise.
Okay. All right, great. And then, Gene, maybe from an M&A perspective, the other way, you had indicated that you're more optimistic about M&A prospects for you all buying franchises like you bought in the past. What's the outlook on that side?
I don't think it's changed. And Chris and I remain always willing to look into those that are having a hard time and are looking for appropriate pricing.
The postelection [indiscernible] combined with our integration might have slowed down that activity a little bit, but we still have a lot of conversation. I'm quite sure there is not a bank that is actionable in our footprint that we don't have discussions with.
Okay. I mean, do you get the sense that -- I mean, it's the -- do you get the sense that people are willing to come off to sidelines from that perspective or it's still a little too early for that?
I think it's too early for us to comment on that. We're observing some changes just like you are.
That does conclude today's question-and-answer session. I would now like to turn the call back over to Mr. Taylor for any additional or closing remarks.
I'd like to thank everyone for their participation and we look forward to speaking to you next quarter. If you have questions, obviously, Ken Posner is always available to answer. Thanks, everyone.
Thank you all for your participation. This does conclude today's conference and you may now disconnect.
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