Atlantic Capital Bancshares, Inc.
Q3 2018 Earnings Call Transcript

Published: 26 Oct 2018

[Operator:]

Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2018 Earnings Conference Call. [Operator Instructions] Thank you. Gray Fleming, Chief Risk Officer, you may begin your conference.

[Gary Fleming:]

Thank you, Heidi, and thank you all for joining us for our third quarter earnings call. With me today to discuss our results are Doug Williams, Chief Executive Officer; and Patrick Oakes, Chief Financial Officer. As a reminder, the Atlantic Capital earnings release is available in the Investor Relations section of our website. I wish to caution you that we will be making forward-looking statements during this call and that actual results may differ materially. We encourage you to review the disclaimer in the earnings release dealing with forward-looking information. This disclaimer applies equally to statements made in this call. In addition, some discussions may include references to non-GAAP financial measures. Information about those measures, including reconciliation to GAAP measures, may be found in our SEC filings and in our earnings release. And with that, I'll turn the call over to the CEO of Atlantic Capital, Doug Williams.

[Douglas Williams:]

Thank you, Gary, and good morning. After the close of the market yesterday, Atlantic Capital reported net income of $6.5 million or $0.25 per diluted share for the third quarter of 2018 compared to net operating income of $6.9 million or $0.26 per diluted share in the second quarter. We had record loan and deposit growth in the third quarter. You’ll recall that based on solid loan pipelines, we expected meaningful loan growth in the second half of the year. As anticipated loan sell for investments were up $104 million or 22% annualized in the third quarter and 7% year-over-year. Growth was balanced across our business units. Our corporate business banking team grew commercial and industrial and owner-occupied real estate loans 25% annualized and 14% year-over-year. Average deposits increased $118 million in the third quarter or 22% annualized for the quarter and 6% year-over-year. Average transaction account balances that is demand deposit now accounts are 48% of total deposits and were up 36% annualized in the quarter and 18% year-over-year as corporate treasury management and depository client relationship growth continue to build. Asset quality metrics remain strong during the quarter. Net and nonperforming assets to assets declined 1 basis points to 13 basis points and there were no net charge-offs. Generally credit quality improved with positive migration and a reduction in criticized and classified loan levels. Now Pat Oakes will review the financials with you. Then I'll return to comment on the outlook and the focus of our fourth quarter's strategy and capital planning and process priorities. Pat?

[Patrick Oakes:]

Thanks Doug. Good morning everyone. Our operating ROA for the third quarter was 92 basis points compared to 1.02% in the second quarter. This decrease was mainly a result of a decline in our net interest margin which I’ll discuss in a minute along with our higher provision expense from the third quarter strong loan growth. We anticipate the ROA to improve in the fourth quarter from further margin expansion along with the full benefit from a recent loan growth. Our net interest margin declined seven basis points to 3.47% in the third quarter. The decline was primarily the result of three items, a change in asset mix towards liquid assets from the strong growth and deposits during the quarter, the increase in our cost of interest bearing liabilities and the impact of limit increases in one month’s LIBOR in the third quarter among yields. With approximately 50% of our loan portfolio tied to one month LIBOR any changes in this index have a significant impact on our loan yield and NIM. Earlier this year, we saw one month LIBOR increase at a faster pace with an increase in Fed funds rate holding a nice benefit to our loan from yield. During the third quarter the spread between LIBOR and Fed funds returned to more normal levels resulting only a two basis point increase in loan yields in the third quarter. Now that we see a normalization and the spread between LIBOR and Fed funds along with September increase in the Fed funds rates, we expect to see higher loan yields and NIM in the fourth quarter. We're still pleased with the NIM expansion over the last few years. We have seen it increase from a 3.11% in the fourth quarter of 2016 to a 3.47% this quarter. Our deposit beta for this interest rate cycle has been approximately 43% compared to 60% for our loan portfolio. Our overall cost of deposits increased by eight basis points to 77 basis points in the third quarter which is less than the increase of 12 basis points in the second quarter, as a result of nice increases in non-interest bearing deposits. The cost of interest bearing deposits increased 15 basis points slightly above our expectations and less than the 16 basis points increase in the second quarter. The provision for loan loss was 845,000 in the third quarter compared to negative 173,000 in the second quarter. This increase was attributable to the strong loan growth in the quarter offset by improved credit quality. Non-interest income for the third quarter totaled 3.1 million compared to 5.3 million last quarter which include a gain of 1.7 million on the sale of Southeastern Trust Company and the remaining 507,000 in trust income. SBA income in the second quarter totaled 882,000, a decrease of 115,000 from the second quarter mainly due to lower SBA premiums and the bank's decision of retaining the government guaranteed portion of some loans. Year-to-date SBA production as of September 30 was 73 million, an increase of 34% compared to year-to-date 2017. Non-interest expense totaled 16.6 million in the third quarter which is a decrease of 766,000 from the second quarter. This included a decrease of personal expense of 769,000 primarily from the remaining savings associated with the sale of the trust company, lower equity incentive expense and lower payroll taxes. Bearing deposits in the third quarter increased 313 million and quarterly average deposits increased 118 million compared to the second quarter. We benefited in the quarter from solid growth in our core businesses including some large short-term deposits from nice clients that we anticipate to leave the bank over the next few quarters. Our focus on growing treasury management clients generate significant levels of transactions accounts which also carry a global level of volatility than our peers. The third quarter was a good example with average non-interest bearing deposits increasing $65 million and accounting for 31% of average deposits, an increase from 29.6% of average deposits in the second quarter. Now I’ll turn it back over to Doug.

[Douglas Williams:]

Thank you, Pat. With record loan and deposit growth in the third quarter and a strong economic outlook over the next several quarters, Atlantic Capital is well positioned to build above average revenue growth, further improvement and profitability and superior through the cycle credit quality. Based on a three year track record of solid double-digit percentage compound average growth rates of loans and deposits in our commercial banking and corporate specialty finance businesses, a continued healthy economic outlook in all of our markets and merger induced market turmoil in Atlanta, we anticipate an exceptional opportunity to sustain and build strong revenue growth in these higher performance businesses next quarter and over the next couple of years. While higher levels of balance sheet, liquidity, increase deposit cost and later increases in one month LIBOR during the third quarter interrupted our transit net interest margin expansion, we expect a positive trends to resume with these future rate increase beginning in the fourth quarter. Net interest margin expansion, disciplined expense management and a shift in business mix to our growing and more profitable businesses should result in improved levels of profitability going forward. Through the global financial crisis of 2008 and 2009, the ensuing recession, subsequent recovery and current expansion Atlantic Capital’s maintained credit quality among the best in banking. Strong credit underwriting and management or our clear confidence in our company and provide confidence that we will sustain superior through the cycle credit quality. Accordingly our priorities as we look to 2019 and beyond are one, to invest to build on our solid record of growth in our commercial banking and corporate specialty businesses. Number two, to improve profitability and efficiency metrics to those approaching business model peer levels or better, and three, to maintain a fortress balance sheet with superior credit quality, reliable core client deposit funding and capital levels, calibrated for expected growth through the cycle risk and shareholder return objectives. As we complete our planning work this quarter, we’ll have more specific objectives and initiatives to share with you. Now we'll be pleased to attempt to answer your questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Brady Gailey with KBW. Please go ahead.

[Brady Gailey:]

So your Atlantic Capital clearly has excess capital here. And if you look at the stock, it's trading at around 1.3x tangible. I thought we might see a buyback announcement from you-all this quarter but we didn't get that. So just maybe an update on how you're thinking about potentially buying the stock back here?

[Patrick Oakes:]

Yes. We do have healthy capital ratio to-date and we expect improvements in profitability. So we anticipate generating excess capital levels over the next several quarters. Our capital plan for 2019 and beyond were balanced expected growth through the cycle risk and shareholder return objectives. We're calibrating those parameters now and we'll communicate them and our capital management plan later this quarter or early next quarter.

[Brady Gailey:]

So, sounds like it's something you-all will consider at some point later on this quarter?

[Patrick Oakes:]

Certainly.

[Brady Gailey:]

And then Doug, maybe just an update on Tennessee, I know you've had issues there that hasn't really been that profitable and hadn't be growing very much but maybe just an update on kind of how you're thinking about the Tennessee franchise right now?

[Douglas Williams:]

Yes. We think Dalton, Chattanooga and the whole Knoxville region are attractive markets. Our people there are working hard and making progress. We have good loan and deposit pipelines so they continue to strengthen. We're making slow progress there.

[Brady Gailey:]

And then Pat, you guided to under $17 million of expenses this quarter which you did plus some. Your efficiency ratio is now down to the 65% mark, which I think is hurdle you all dug out there as far as one to be under that 65% mark. Maybe just an update on if you think expenses will continue to decline here that we'll continue to see an improvement in that efficiency ratio?

[Patrick Oakes:]

We'll, you're not going to see probably expenses decline from here. We're starting to do some of the hiring we've talked about before with traditional bankers here and some of our specialty businesses Atlanta. So that's going to help expenses kind of tick up from here. But I hope you can see that offset by hopefully a lot faster revenue growth and that expense growth. So, now you're right, we hit that 65% efficiency ratio, we're going to drive it down from there definitely.

[Douglas Williams:]

And just as I talked about capital planning in terms of performance objectives, we'll be recalibrating those and we do expect improved profitability and efficiency metrics going forward.

[Operator:]

Your next question comes from the line of Stephen Scouten with Sandler O'Neill. Please go ahead.

[Stephen Scouten:]

I wanted to think about your comments about the credit quality of your portfolio. Obviously I don't personally think we're really anywhere near credit cycle but there seems to be a lot of fear out there today. Do you - is there anything specific about the way you guys do underwriting or about your loan portfolio that makes - that you have that confidence and how you'd perform through the cycle? I mean, obviously everybody's metrics look good today but everybody's deposit metrics looked good two years ago. So, like where's the real differentiation within your book versus maybe someone else?

[Douglas Williams:]

Yes, I'll let Gary Fleming, our Chief Risk Officer to take that one. Gary?

[Gary Fleming:]

Stephen, I think that is a good question because like you say a lot of metrics look good and we feel we have very good underwriting on the front and then all of our business lines and everybody does say that. I would say one of our real differentiators is our portfolio management approach. We pride ourselves in identifying potential problems early and identifying credits that we think are a better fit for example in an ABL shop. And a lot of our reduction in the last couple of quarters in our criticized loan balances have been by a refinance. And so it hasn't been by way of charge-off or move to OREO, but by refinance in full by another lender. And that's really throughout our history been our primary method for working through problem of credits. And I think identifying those problems early and being able to work through that is really how we think we can continue to manage our credit book very well and in a timely manner.

[Stephen Scouten:]

And then Doug, you mentioned kind of profitability goals in line with peers in like business models. In your mind what is something that would be a more acceptable level of profitability or how are you guys thinking about what those targets would be for the franchise?

[Douglas Williams:]

Yes, our objective was to get in the neighborhood of 1% return on assets. And with the tax rate reduction that sort of number becomes the 1.15% 1.20% range number. And I would anticipate we'll move in that direction. We understand the math, what's required to get there and we're making plans accordingly.

[Stephen Scouten:]

And then maybe lastly just on the funding side, can you give any color in terms of what you think the dollar amount that will flow out in that late 4Q early 1Q? And then as you look to fill - continue to fund the balance sheet, I presume that will come more from CD's over time and can you talk about what sort of CD rates you're having to offer today on new money? Thanks.

[Douglas Williams:]

So, based on our deposit base there's a lot of volatility with our deposits. So it's kind of hard to predict what deposits are going to do. So what I would tell you is kind of how we're thinking about the fourth quarter is we've already seen the significant amount of run-off in deposits from that quarter end balance, but as we get closer to year end, we expect that to pick back up. My best guess at this point is, if you look at average deposits third quarter versus fourth quarter, I think they'd be relatively flat at this point. And then as we had in the first quarter we'll see another run-off mostly if we're going to replace that. And then your second question; I mean, our core focus here is to grow operating accounts. That involves transaction accounts, DDA and NOW, right. And that's our core business. You ramp to offset that with growing money market in CD's, the CD is not a major part of our business, they're pretty small percentage for our deposits. So it's pretty competitive out there now for the CD market. So, we have offers and promotions there but we haven't for our business as aggressive as some other banks.

[Patrick Oakes:]

We don't think CDs are going to become a prominent part of our funding profile.

[Stephen Scouten:]

But I guess, looks like they went up from 104 to 141 on the cost, so I mean is it fair to assume those are out there were 1.85%, 2% something like that?

[Patrick Oakes:]

Yes, low-two is probably a good estimate.

[Operator:]

Your next question comes from the line of Jennifer Demba with SunTrust. Please go ahead.

[Jennifer Demba:]

You mentioned your loan growth this quarter was pretty broad-based. Just wondering if you could give us more color and how many SBA loans you ended up portfolio - held on the balance sheet and kind of what's the loan growth outlook over the next few quarters for you?

[Douglas Williams:]

Pat, I’ll take the last part of that the question sort of outlook, and you can provide the detail on the disposition of loan growth across the Company. I think we'll have solid loan growth in the fourth quarter and based on the pipelines that we have now and even the first part of the year looks pretty good too at this point. Month end to the quarter, we've had very solid loan growth and sort of the pace that we saw in the third quarters continued. We still do have some prospect of some significant repayments in the quarter but also very nice funding profile. So our calendar - so I think we have solid loan growth in the quarter and I think we'll probably end 2018 in the high single digits range in terms of annual loan growth. In terms of next year, we would expect that a little bit better. So we think the opportunities are very good, we think we're really hitting stride particularly in the Atlanta market and in our specialty businesses, and we have a track record now of solid mid-teens percentage loan growth in those businesses over three years and we see that sustainable over the next several quarters. Pat, you want to talk about the quarter in particular?

[Patrick Oakes:]

Yes, it was pretty spread out between most of our commercial businesses into the specialty businesses. U.S. specifically better SBA. SBA portfolio grew about $15 million, that's probably higher than $8 million to $10 million-ish when we don't hold any. So, we really know the significant amount as you can see, but that did help boost that number a little bit but it wasn't a significant portion of the loan growth.

[Operator:]

Your next question comes from the line of Nancy Bush with NAB Research. Please go ahead.

[Nancy Bush:]

Yes, would you just talk about this issue significant repayments in the fourth quarter, are these as you're looking at it right now are these desired repayments not desired repayments - I'm sorry if I missed it, what was the repayment activity in the third quarter because this seems to be a problem industry-wide that everybody expected to go away at some point and it hasn’t gone away?

[Douglas Williams:]

Yes, I think what's underline all this Nancy is lot of liquidity out there and higher grade credit our commercial real estate business has a lot of refinancing churn. So there is a deep - from a capital markets - deep through from a capital available we see assets being sold, we see assets being refinanced by permanent lenders. The large corporate business, there is a lot of capital market’s liquidity and refinancing there, and our customers tend to have a lot of liquidity. So there's - we’ve average around $100 million of repayments per quarter. Ultimately all of that is desirable, we make loans to be repaid some of its unanticipated, some of its scheduled. It was a little bit lighter in the third quarter than it’s been in prior quarters, I think fourth quarter is probably going to be sort of around the average but we’ve had very strong production in the last couple quarters behind that so.

[Nancy Bush:]

Can you just give us your impressions, I mean we gotten into really extreme market volatility here and everybody's talking about the slowdown in 2020 and all that stuff, but as we know Atlanta marches to its own drummer. So what are you, are you hearing anything different from your clients in light of what's going on in the capital markets than you were hearing let's say two months ago?

[Douglas Williams:]

No, we’re not and in fact there is quite a disparity between what we see in the capital markets, the equity markets in particular and what we hear from our clients. I think we’ve got several quarters of expansion certainly in the local - economies that we’re involved and are ahead of us and we’re quite optimistic. There has been this concept or this feeling of banks we're reporting peak earnings I don't think that's true in our case. I think peak earnings are in front of us and we see strong revenue growth opportunities. We see the opportunities improve our profitability and we think our credit quality would continue to be quite strong. So we are very optimistic view of our business over the next several quarters compared to what the markets generally seem to be anticipating.

[Operator:]

[Operator Instructions] And your next question comes from the line of Steve Comery with G. Research. Please go ahead.

[Steve Comery:]

Most of my questions have been asked and answered. I just wanted to ask about the multi family portfolio you guys grew that this quarter. First time in a little while it seem kind of any material growth there is anything kind of change with that portfolio or there lower paydowns in the quarter?

[Gary Fleming:]

Steve, this is Gary. Nothing has really changed I think that's largely a function of paydowns in prior quarters and the timing of refinance. We had some good growth but nothing has changed fundamentally in terms of the paydown or the origination side, it’s still a market that we’re watching closely particularly in certain markets. And so we’re being selective and focusing on top-quality developers and largely niche products, but not a change to that strategy.

[Douglas Williams:]

Yes Steve what I think you’ll see not necessarily quarter-to-quarter but year-to-year as you’ll see low to mid-single-digit growth in the commercial real estate business generally at Atlantic Capital and that would include the multifamily property type. You may see a quarter here a quarter there where we’re either down or up more than that, but generally I think year-to-year you'll see low to mid single-digit growth that’s what we plan for in that business and certainly at this point the cycle thus what we like to see.

[Steve Comery:]

And then on the margin as you guys mentioned you had some headwinds to the margin but you expect them to extend in the fourth quarter. I just kind of wondered if you get any feel for the magnitude of that, like, should we expect Q4 NIM to be above Q2 or should it go back toward that level? Just kind of wanted to get a feel there.

[Gary Fleming:]

Yes, I don't know if we can get back to that level but I'm hoping we can make significant ground back to the second quarter level. So we'll have to see if it shakes out but...

[Steve Comery:]

And our fourth quarter rate hike wouldn't affect that all, right? Because we've come too late in the quarter, is that right?

[Gary Fleming:]

Yes, any time help from LIBOR but it wouldn't be significant.

[Douglas Williams:]

Yes, half of our loan portfolio is indexed to one month LIBOR. Those rates are generally reset on the first and the 15th of the month. So a rate increase after that is likely to have minimal effect, although we will see the benefit of that in the first quarter.

[Steve Comery:]

And then just finally on the funding side, I mean, you guys had really good growth in noninterest deposits. You mentioned that some of the could be seasonally go away, I mean, how is kind of the growth in the C&I business affecting your noninterest deposit gathering capabilities? Just kind of wanted some general commentary there.

[Douglas Williams:]

Yes, it's very good and we have a high level of demand deposit funding associated with our C&I loan growth. Our penetration of C&I borrowers with Treasury Management Depository Services is in excess of 90%. We have very competitive corporate treasury management capabilities and we have a number of commercial clients who are not borrowers. So, we think - you sort of work through all the volatility that we talk about, which is customer deposits got away, these are not wholesale purchase deposits or anything. That operating business continues to grow at a nice pace and we think that that will continue. We think we have competitive advantages, we think we're vigorous in our business development activity and we think we'll continue to win new business and those existing relationships will continue to expand.

[Operator:]

And there are no further questions in the queue. I turn it back over to the presenters.

[Douglas Williams:]

All right. Well, we thank everyone for dialing-in this morning. We appreciate the questions. If there are any more questions, feel free to call us today or next week. Thank you very much.

[Operator:]

This concludes today's conference call. You may now disconnect.