Cadence Bank
Q2 2019 Earnings Call Transcript

Published: 22 Jul 2019

[Operator:]

Welcome to the Cadence Bancorporation Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. The comments are subject to the forward-looking statement disclaimer, which can be found in the press release and then on Page 2 of the financial results presentation. Both of those documents can be located in the Investor Relations section at www.cadencebancorporation.com. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.I would now like to turn the conference over to Paul Murphy, Chairman, and CEO. Please go ahead.

[Paul Murphy:]

So, thank you all for joining us and welcome to our second quarter 2019 earnings conference call. Joining me today are Sam Tortorici, Valerie Toalson and Hank Holmes.For the second quarter, on an adjusted basis, we earned $51.5 million of net income, that's $0.40 per share. So, right out at 13% adjusted return on tangible common and a 1.2 on assets, it's a 50% adjusted efficiency ratio.And while these results are within peer averages, they obviously are disappointing to me, and the higher credit costs in the quarter does not meet with our top-level industry performance bar that we've set for ourselves. So just, in all honesty, open, we're saying, it's not a great quarter. However, I think once you dig into the numbers and walk through with us, you're going to see, it's not an awful quarter either.First and foremost, we're not in business to make bad loans and having charge-offs of almost $19 million resulting -- related to four credits is a disappointment, for sure. The four credits, one of those credits was a restaurant, the other three were general C&I credits. One of the four was a SNC. There's no correlation on these four credits and we don't view this as systemic.If you look at our last 12 months trailing, total charge-offs were $22.5 million or 18 basis points on average loans, which is still higher than our past several years, but within the acceptable ranges for a C&I focused bank. We also reported increases in non-performers of roughly $30 million, that's three loans; one energy, one restaurant and one C&I. Of these three loans, two are SNCs.We took targeted prudent steps in these credits as we reviewed updated information during the quarter that led to these accounting impairments. C&I lending for us, of course, has historically been lumpy, but overall, our view on credit remains unchanged. We take action promptly when issues arise and we had some issues this quarter.We do not believe that the second quarter credit problems are a result of a weakening economy. They are more episodic. We remain very diligent and very focused on every credit -- every new credit at renewal or every existing credit, just looking at all of the trends and properly underwriting on an ongoing basis.And -- so, while reporting credit losses stings, we still are fundamentally confident in our team, our discipline, our credit underwriting, our policies, our credit monitoring practices that have served us well in the past and we're confident that, that will be the case going forward, but we also remain forever humble on credit.Turning to some of the more positive developments in the quarter. Tangible book value increased $0.98 linked-quarter, pretty spectacular to $14.21. Our capital ratios continue to grow. Our tangible common equity ratio at 10.83% is over 100 basis points higher than a year ago.Our well-timed interest rate color from the first quarter increased in value significantly in the quarter and does give us nice protection against lower interest rates. We reduced our wholesale funding in the quarter. We had $145 million in debt that matured. We refinanced $85 million of that, so $60 million less debt and it's a sub-debt issuance, so we get more favorable capital treatments and at a rate that's a bit less than the year previous issue. So, really a lot of positives there.We completed the exit of the Patriot Capital line of business, which came from the State Bank acquisition. That's about $130 million of equipment finance loans that were non-strategic. This moderates our loan growth a bit, moderates risk a bit, allows us to better fund with core deposits, and is a positive for capital ratios.So, we have intentionally moderated our growth and I believe improved the risk profile of the loan portfolio this quarter and are looking for a less aggressive growth in the future. And again, meaning for improved outlook for capital ratios, which increased nicely in the second quarter.So, let me ask you to turn your attention to slide four of our presentation and comment on a few of the highlights there. Net income, $48.3 million, $0.37 a share, while again, the higher credit cost are disappointing, we have not given up on our goal of top-level performance in the future.NIM was 3.97% for the quarter and it's a bit complicated. Valerie is going to walk you through, a lot going on with NIM, here in a moment. Period-end loans were $13.6 billion. Excluding the impact of the acquired loans, we've increased loan to a $0.5 billion or 16% from a year ago and our update on 2019 organic loan growth estimates of 8% to 10%.We're now currently expecting that to come in on the lower end of that range or possibly maybe just a little shy of the low end of that range as we're just moving toward a more conservative posture on overall loan growth.Period-end deposits were $14.5 billion, up $289 million, 2% linked-quarter. Sam is going to go into more of an update on those initiatives. Adjusted efficiency ratio, as I mentioned, 50% compared to 45.7% last quarter. So, the operating leverage on our model continues to be one of the key drivers of the, I think, attractive investment thesis here.And we still believe we'll see good expense discipline as we continue to manage that 44% to 46% longer term efficiency ratio target that we have previously reported. We don't see this changing math.And so as I began to mention on these quarterly calls in the past, I just again have to take a moment to brag on our team. We've got a lot of great bankers that are really the engines that are driving our growth, and they are experienced and they're motivated and they're out making a lot of calls and really good customers and prospects.And again, tip my hat to the hardworking Cadence bankers and thank them for their dedication. And we feel really good about the retention rates and top talent is so hard to get and never take them for granted. But we've done a good job of hanging on to a great team.So, as we think about quality growth around our footprint, we still feel like we've strengthened our customer service relationships and I feel like we're well-positioned for a good future growth.As a public company for the last two years, we've generated a pretty decent track record and we're still very focused on our long range goal of consistently being among the top-performing regional banks in the country.So, with that, I'll turn it over to Sam for more on deposits.

[Sam Tortorici:]

Thanks, Paul. I'll be commenting on our deposit growth, starting on slide 9 of our presentation. I'm pleased to report that combination with State Bank & Trust has enhanced our funding and deposit mix as we had projected. Core deposit growth was up $276 million, or 2% linked quarter and up $5 billion from the prior year, driven by the State Bank acquisition, client retention and deposit growth initiatives.The organic drivers of this growth continue to be the expansion of commercial, treasury management and consumer retail growth throughout our Texas and Southeastern markets. We also increased non-interest-bearing deposits by $87 million linked quarter and $1.2 billion from a year ago.Non-interest-bearing deposits represent 23% of total deposits and are trending nicely. Our improved core deposit mix is a priority for the company and has been directly tied this year to management compensation. We are confident that all these efforts will drive improved funding costs in the future.We're really pleased that Cadence Bank recently secured an investment-grade credit rating from Standard & Poor's, which in addition to our accrual investment grade rating, validates the bank's financial strength and stability. We believe the ratings will contribute to furthering long-term client relationships and attract additional commercial, corporate and institutional deposits to the bank.Our brokered deposits were $868 million, or 6% of total deposits at quarter end. $228 million of brokered deposits matured following the end of the quarter, which we don't currently anticipate replacing until the latter half of 2019. Other borrowings and debt also declined by $349 million, or 48% as a result of the quarter's deposit growth and also due to repayment of $145 million in senior debt in June. We replaced that debt with a lower amount, $85 million of subordinated debt at a lower interest rate.Now a quick update on our new Georgia franchise. Following our January 1 closing and subsequent rebranding and systems conversion of State Bank, we're quite pleased with our progress in the new Georgia market. A few highlights.First, customer and associate retention, a key priority for us, has been solid. This has been evidenced by Georgia retail deposits being steady, since conversion, and deposits in our community bank and commercial real estate group showing solid growth. Our Georgia Community Bank and commercial real estate teams also experienced one of their strongest loan production quarters in recent history.As you know, commercial middle-market has been one of Cadence's core strengths, and we added a top Atlanta middle-market sales leader during the quarter, along with two seasoned bankers. We will continue to thoughtfully build out this important team.We also recently announced the acquisition of an Atlanta-based Wealth & Pension Services Group, which has approximately $400 million in assets under management to combine with our Linscomb & Williams registered investment advisory platform, representing our initial wealth management offering in the Georgia market and adding nicely to fee income. So, we're encouraged by our prospects to grow our core businesses throughout Atlanta and the rest of the state.With that, let me turn it over to Valerie to go through a little more of our quarterly performance.

[Valerie Toalson:]

Thanks, Sam. Slide 10 summarizes our net interest margin. There were a number of moving parts this quarter, but if you step back and look at it from a high level, we did experienced some NIM compression from higher deposit costs combined with the new deposit acquisitions that was partially offset by positive originated loan interest income from loan growth at a slightly lower yields. Of course, the predict NIM was further impacted by a couple additional items.One was the timing of hedge income between the first and second quarters that we have discussed previously and that would not be recurring. Year-to-date, the total impact from the hedges on NIM is a negative $3 million, which in a similar rate environment is at a normalized level.Second, the total accretion for acquired portfolios was a little bit lower this quarter. We expect the year-to-date yields on these portfolios, excluding recovery accretion to approximate the yields for the rest of the year. Recovery accretion as you know can be bumpy and is generally not significant for us. These yields are laid out in Table 3 in earnings release.We also included a couple additional slides this quarter in the presentation appendix, slide 14 and slide 16, to help clarify the quarterly movements for you, so you can really hone in on core margin facets more easily. Based on the recent trends we're seeing, we believe our funding costs may have peaked linked quarter as wholesale funds and brokered deposits have declined. We have $60 million less debt on the balance sheet. We are seeing maturing CDs being replaced with lower rates. And we have over $2 billion of deposits that are linked to indices and would have 100% beta if rates were cut.Our originated loan yields, excluding the hedge impacts, declined about 5 basis points, largely due to loan mix shifts and an average LIBOR decline of 5 basis points during the quarter. Close to 70% of our loans are variable rate, with about 85% of those tied to LIBOR and about 85% percent of those tied to one-month LIBOR.On an overall balance sheet basis, it's important to note that at a down 100 basis point scenario, our next 12 months net interest income is modeled to be down only 1%, due to the positive impact of hedging activities on our otherwise asset-sensitive balance sheet. We're very pleased with that dynamic as we look out toward the rest of the year.Slide 11 highlights non-interest income that also had a nice increase in the quarter, 3.5% for the quarter and now up to 16.5% of our total operating revenues. Credit-related fees grew at impressive 10% linked quarter and assets under management from our investment advisory and Trust business lines grew 3%, both from asset acquisitions as well as market performance. We also had a little over $900,000 in securities gains due to some portfolio rebalancing in the second quarter.Moving on to slide 12. This highlights the GAAP and adjusted measures of net income and efficiency, with the largest differences between GAAP and adjusted coming from merger-related expenses. Now, two quarters since the State Bank merger and over a full quarter since systems integration, we believe the vast majority of these merger-related expenses are behind us.We noted last quarter that the first quarter's adjusted expenses were unsustainably low and the adjusted base this quarter essentially represents full run rate expenses for the larger combined organization. While we do anticipate some modest increase in expenses in the latter half of 2019 as we continue to invest in talent and technology, we remain confident in our ability to achieve further efficiencies based on scale, and also maintain our commitments to the longer-term mid-40s efficiency ratio target.Operator, let's go ahead and turn it over for questions now. Thank you.

[Operator:]

And thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Steven Alexopoulos with JPMorgan. Please go ahead.

[Steven Alexopoulos:]

Hi, everybody.

[Paul Murphy:]

Hi, Steve.

[Valerie Toalson:]

Hi, Steve.

[Steven Alexopoulos:]

To start, surprise on credit, if we look at the increase in non-performers and net charge-offs, the market's clearly concerned, this is systemic. Could you give us more color on these three NPAs and the four NCOs, or maybe size the loans or reserves on there? Just give us a little bit more color that these are truly one-offs.

[Paul Murphy:]

Yeah, Steve let me try to walk you through at a high level here. The first credit that we took a charge on in the quarter is a 40-year old business. Its two well-known private equity firms, sponsored the acquisitions business several years ago. They went through a major expansion period. That was not effective and had a management team change out. Initially, the private equity firms were supportive and put some more money in, but couldn't get comfortable with the go-forward projections from the new management team and have elected to put the, basically, the business up for sale.And so, it's not a SNC by the way this first one. And so we -- and take a look at the operating performance of the company and the fact that they're going through a sales process, we thought the accounting treatment taking a charge on that was appropriate.Credit number two, different industry, a great private equity firm. We've done six deals or seven deals, with all successful, except this one. This is a SNC. The agent by the way has done a fantastic job. And this company went through some major margin contraction in their business just due to new competition and decided to sell the business. And that has been done. And the marks on this one are based on the final resolution of the sale of the business, which I think funds here just in the next two days or three days. So really, hats off to the agent on that one.Company three is a supply chain management business. They lost their major vendor there and turned their business inside out several years ago. They've gone through a restructuring, hired a new management team. And this mark is a result of the ASC-310 to see accounting process that you go through looking at their operating performance. Again, they are showing some improvement within their results, but it's very stressed company.Credit number four is a restaurant deal. And by the way the first two are Houston deals. The third deal is a Birmingham deal. And deal number four is an Atlanta deal. It's a restaurant company that is going through the sale of their business and that may or may not be in or out of bankruptcy. And marks seem appropriate there.Turning to the three new non-performers. The first one is just an orderly liquidation of an inventory of a company whose business plan changed and based on new appraisals; we believe we’re adequately secured there. They will wind down over a period of several months. It will take some time.Credit number two is an energy credit that is in bankruptcy because of the sub debt. We believe our senior secured position is in a good collateral position. And then -- and that's a SNC, by the way.And then credit number three, a restaurant SNC, is a company that management team is continuing to support the business, including putting cash on hand. But they have multiple concepts, one of which is doing really great. And they are going through a sale process. And our mark on that one seem to be prudent.So as you might expect, I'd much rather talk about the best ones we've ever made. But it is my view that these are not correlated, unique sets of facts, just a little bit of bad luck coming on the heels of the Investor Day. But my view of credit really unchanged. Our credit underwriting at Cadence is good. We've got a bad quarter here, but all-in, still pretty confident with where we are.

[Steven Alexopoulos:]

Well, I guess I'm trying to figure out, so these do appear to be one-offs, if you will. But I'm trying to connect that to the commentary that loan growth expectations are being reduced, maybe even below the low end of the range. Have you decided to exit segments, reduce exposure to segments? And not really clear to me, why we're all simultaneously lowering the loan growth outlook?

[Paul Murphy:]

The only thing we've decided to exit was the Patriot Capital business. And so that's part of it. What we're seeing is the loan pipelines look good. It's the payoffs are running a little bit higher. It's what sort of yield gets me to maybe the lower end of the range. And we debated here internally. I mean, we are -- we're open for business in all lines. There is no business line that we are actively deciding to exit. But we, of course, have an ongoing review of everything we're doing. And as we've reported previously, restaurant is not slated for growth. So, we see those numbers coming down there. So, that impacts our totals just a bit. But, overall, we're steady in the boat. It's the pay downs that lead me to think more about lower net growth in the future.

[Steven Alexopoulos:]

Okay. And maybe -- thank you. Just one final one for Valerie. There's, obviously, many moving parts to the NIM this quarter. How should we think about the starting point for NIM? And then from that level, where do you see NIM trending, assuming the Fed does cut rates in July? Thanks.

[Valerie Toalson:]

Yeah, sure. So basically, if we -- so there are a number of moving parts and I can go through those if you like. But basically, if we get a rate cut, next week, we do expect some modest margin pressure in the latter half of the year from the current level, but probably in the range of 8 to 12 basis points or so on average for that, the latter half.Said another way, for the full year of 2019, we're looking at a NIM probably near what we saw this quarter, give or take a basis point or two basis points. That being said, based on the anticipated growth for the rest of the year, we do expect net interest income in dollars to be up even with a little bit softer margin. So -- and of course LIBOR movement and betas and all of that can change a rate environment. But that's what we're expecting currently.

[Steven Alexopoulos:]

So full-year NIM 3.97%, is that what you're saying?

[Valerie Toalson:]

Within that range

[Steven Alexopoulos:]

Within that range? Okay. Thanks for taking my questions.

[Valerie Toalson:]

Absolutely.

[Operator:]

The next question comes from Brady Gailey with KBW. Please go ahead.

[Paul Murphy:]

Hi, Brady. Thanks for joining us.

[Brady Gailey:]

Yeah. Thanks, Paul. I know one other thing you all talked about is your guidance on expense growth this year. I think you've talked about at 5% to 6% level. Is that still an appropriate way to think about expense growth this year?

[Valerie Toalson:]

Hi, Brady. Yeah, we talked about that based on the first quarter run rate expenses. As we look out the latter half of the year, materially within lines meet expectations, we might see an extra $1 million or so per quarter in the third quarter and fourth quarter, but overall, fairly consistent, maybe slightly higher.

[Brady Gailey:]

All right. And then, if you look at capital levels, I mean they grew pretty nicely in the quarter. I think some of it was related to the mark-to-market of the hedge. But your TCE is now kind of approaching 11%. Your stock is now trading around 16 bucks. I know you have a buyback in place.It doesn't look like you all repurchased any stock this quarter. But with the stock trading how it's trading, with your capital going up pretty nicely this quarter, maybe just talk about your thoughts around the buyback for the back half of this year?

[Paul Murphy:]

Yeah, Brady. So the buyback that we had in place previously has been fully satisfied. So, there's not any current buyback authorized by the Board or approved by the Fed. And our position on additional buybacks in the future is really remains unchanged from the first quarter where we've got CECL coming up. Really understanding that as our first priority.I get your point on the stock price. That's kind of new information to bake into the equation here. But I think in the future, we'll be looking at it every quarter and making a decision based on facts and circumstances at the time. But -- so no additional buyback is eminent, but something we'll consider.

[Brady Gailey:]

All right, and then finally for me. Paul, when you were walking us through the problematic credits out of second quarter, you mentioned a lot of these were private equity sponsored deals. Are some of these loans considered levered lending loans?

[Paul Murphy:]

Yeah. We look at that. At origination, are they considered levered? If they had poor operating results, then they typically trip leverage covenants and they become levered by definition. And so -- oh, gosh, help me with that at origination?

[Hank Holmes:]

At origination, none of them were levered under the levered definition.

[Brady Gailey:]

All right. Great. Thanks, guys.

[Operator:]

The next question comes from Brad Milsaps with Sandler O'Neill. Please go ahead.

[Brad Milsaps:]

Hey. Good afternoon.

[Paul Murphy:]

Hi, Brad.

[Brad Milsaps:]

Paul, curious if you could add maybe some additional color on the -- also the bump in criticized loans. I think coining the release, they went from about 260 basis points at March 31, up to 3% at June 30. Is all of that driven by the NPA categories or were there other loans in there as well?

[Paul Murphy:]

It would be mostly the NPAs. I mean, there were few other downgrades. I consider it to be really pretty flat, all things considered. I wouldn't talk to call that a big increase. But -- yeah, mostly for things that were identified.

[Brad Milsaps:]

Okay. And then, Valerie, I appreciate the color on the margin and accretion. I think in the release notes that you adjusted some of your assumptions with the accretion from January 1 when the deal closed. Does the guidance still hold in terms of some of the recovery accretion as it relates to CECL heading into next year?And then, I think if I heard you correctly, you said that the yields on the acquired book would sort of approximate kind of the first half yields in the second half of the year, is that correct?

[Valerie Toalson:]

Yeah, that's correct. And that was kind of a pretty easy way to look at that. And if you look at table three in the press release, we've got those year-to-date there for you. That would be on the ANCI accretion and then the ACI accretion.But the recovery accretion as you know is kind of bumpy. So, I wouldn't expect materially higher levels than that as we go forward. On the guidance for CECL, yeah, the recovery accretion is treated differently under CECL in addition to that…

[Brad Milsaps:]

Okay. And how much do you have left in that bucket?

[Valerie Toalson:]

Well, the recovery accretion, the accretable difference is ballpark around $75 million at the end of the quarter. And most of that comes in through a scheduled accretion timeline where cash flows changes their payoffs, et-cetera, that's where you see recovery accretion come in.

[Brad Milsaps:]

Okay. Great. Thank you.

[Valerie Toalson:]

Sure.

[Operator:]

Our next question is from Brett Rabatin with Piper Jaffray. Please go ahead.

[Brett Rabatin:]

Hey, good afternoon, everyone.

[Paul Murphy:]

Hey, Brett.

[Valerie Toalson:]

Hi, Brett.

[Brett Rabatin:]

Wanted to just go back to growth for a second. If you look at the quarter, restaurant and healthcare were a little lower. Can you talk maybe a little bit about where the growth comes from in the back half of the year, and will there be efforts to reduce any of the portfolios that you have, that might somewhat stymie that growth?

[Hank Holmes:]

Sure. I'll take that and show that one. This is Hank. So, we're seeing, as Paul mentioned, the pipelines are pretty good at this point and we are seeing some nice growth throughout the footprint.Specifically, we do see, real estate has had some good movement or should have some good movement. The C&I teams are really seeing nice portfolios and pipelines in place.And so it's hard to specifically give one area. Our midstream group continues to have a pretty strong robust pipeline. And it's -- when you look at our Atlanta group that Sam has put together, nice pipeline there. And then, obviously, we have a new group in Dallas that is seeing some growth as well. So pretty balanced in the pipelines.

[Brett Rabatin:]

Okay. Does the restaurant and healthcare book shrink from here? Or can you give us any thoughts on those portfolios?

[Sam Tortorici:]

Hey, Brett. This is -- I'm sorry, Hank. Go ahead.

[Hank Holmes:]

No, no. Go ahead, Sam. I'm sorry. Go ahead.

[Sam Tortorici:]

Yeah. Hey, Brett. Sam here. So yeah, as Paul noted earlier, we noted in the first quarter call and in Investor Day, we're intentionally kind of slowing growth in the restaurant space just due to the handful of pressures of facing that industry. So, we would expect that to be kind of flat to slightly down.On the healthcare side, we have had a really solid production year and a great pipeline that's been partially offset by some unexpected payoffs. That's the good news. Our customers are doing really well and their owners are monetizing. Good for them and not so great for us. So, we do expect to see possibly a little bit of growth in healthcare, but definitely not in the restaurant space.

[Brett Rabatin:]

Okay. And then last one on -- back on credit. Just thinking about the linked quarter increase in criticized loans and these lumpy credits that you're having there that are not related, can you give us some color on how you're thinking about provisioning in the back half of the year?And then just what -- basically, if you've taken the provision, you'd need it for all the stuff that happened in terms of 2Q? I know there is one credit that's in a liquidation-type status.

[Paul Murphy:]

Yeah, Brett. So, this is Paul. I mean, I think the accounting methodology works the way it works. You go through and do the ASC-310s and if additional provision is required then it gets -- it gets made at that time.So, predicting that with certainty is a little bit of a challenge. But I mean, I think that based on what we know today, all of the appropriate provisions that should have been taken have been taken. And hopefully, we'll get more good news, bad news from here. But if we see additional deterioration, then we'll rack it up.But I think -- I think, it's unusual that we have sort of this much in one quarter, and I would not expect that to be ongoing.

[Brett Rabatin:]

Okay. Great. Thanks for all the color.

[Operator:]

Our next question comes from Ken Zerbe with Morgan Stanley. Please go ahead.

[Ken Zerbe:]

Great. Thanks. I guess just staying with credit. You had a comment in your press release. It basically said you increased your provision expense due to general credit migration in your C&I portfolio. Now, Paul, you are very clear that these credits were very unique and not systematic. But I guess, I'm just -- love some clarity around the quote, "general credit migration" comment that you had. Thanks.

[Paul Murphy:]

Yeah. Ken, I think it just goes back to -- we did see some additional downgrades in the quarter and that is taken into consideration when we do our reserve allocation.

[Ken Zerbe:]

And these additional downgrades, were they in addition to the three non-performers and the four charge-offs? This is extra or additional stuff?

[Valerie Toalson:]

Hi, Ken. This is Valerie. Yeah. Basically, the majority of the reserves that we took relates to that specific analysis, the ASC 310s, that would include the loans that are categorized as non-performing. That's -- probably $20 million of it right there. The rest is really just related to a combination of loan growth, loan payoffs, migration. With the majority of that difference really over two-thirds of that being migration within the past category versus downgrades significantly.

[Ken Zerbe:]

Okay.

[Paul Murphy:]

So if a credit goes from a five to a six, it's going to take a little more provision …

[Valerie Toalson:]

Right.

[Paul Murphy:]

... every quarter, so that there will be ...

[Ken Zerbe:]

Got it. Understood. Yeah. I just want to clarify, because as far as I recall, I think you're the only bank that's actually mentioned general credit migration in their portfolio. So, I just want to make sure we understood what that was about.I guess just small question. Just some background in terms of the loan growth. You mentioned that payoffs were running higher than expected. What kind of assumptions are you making about future payoffs, and how does that tie into your lower end to 8% to 10% loan growth?

[Paul Murphy:]

We certainly watch the payoffs. And just kind of anecdotally, we are seeing a few of the non-banks come in and look at some higher leverage points than we're willing to look at this point. So, we are seeing a few payoffs. It's been fairly consistent. It's a little lumpy as well, and so we recognized kind of a consistent level of payoffs. And as we've got to reposition the balance sheet and look to continue to grow, we just feel like the lower end of the range is more in line with our expectations.

[Hank Holmes:]

It's really hard to budget for it.

[Paul Murphy:]

It really is.

[Hank Holmes:]

Yes. We know there will be some unexpected payoffs, but we have had numbers in that and then sometimes we're close and sometimes it fluctuates more dramatically quarter-to-quarter.

[Paul Murphy:]

It was a little higher this quarter than it has been.

[Ken Zerbe:]

Understood. Okay. Thank you.

[Hank Holmes:]

And one of the points …

[Ken Zerbe:]

Yeah.

[Hank Holmes:]

Ken, I'm sorry. I'm going to repeat myself from earlier in the call. I'm sorry. We did have one of the loans that Paul discussed earlier that is -- that was leveraged at origination.

[Paul Murphy:]

One of the four charge-offs this quarter was leveraged on we had origination. So just to clarify that.

[Ken Zerbe:]

Got it. Okay. Thank you.

[Paul Murphy:]

Ken, maybe just to -- kind of -- I'm sorry, Ken, coming back to your -- going from 2.6% to 3%, criticized or classified, does that concern me as an indication of a beginning of a trend that would be noteworthy? I would say I consider that to be a normal ordinary fluctuation in the loan grading of a portfolio and from a pretty low level.

[Ken Zerbe:]

No, understood. I guess, we're just -- you can imagine from our side of the table, we're just trying to take into consideration the increase in criticized, plus the charge-offs, plus the NPAs, plus the reserve build. I mean, it's all kind of tied together. We're just trying to make sure we understand where to go from here.

[Paul Murphy:]

Yeah. That's fair. Absolutely.

[Ken Zerbe:]

Yeah. Thank you.

[Operator:]

And our next question comes from Michael Rose with Raymond James. Please go ahead.

[Michael Rose:]

Hey, just going back to the margin, Valerie. I think you said 8 basis points to 12 basis points, but I think that was just for one rate cut. If we were to get a second one sometime later in the year, I guess can you just layout the expectations and then if you can remind us when the hedge really or the interest rate collar really kicks in?And is it possible that with deposit costs essentially having to peak from what you said we could actually start to see the margin stabilized, perhaps increase as we move into 2020? Thanks. On a core basis.

[Valerie Toalson:]

Sure. Yeah. So, basically the guidance I gave on the margin incorporates the forward rate curve from June and I believe that incorporates a couple of rate cuts during the year. So, it already includes a couple of those. So, that's factored in there. It was less -- it would be less.On the collar, basically if you look at it on a full year-to-date basis, there's zero income coming from that collar specifically. And that's because rates LIBOR hasn't materially changed since we put it on in the first quarter. And so basically if nothing else changed, then that is what we would be expecting going forward. But obviously since we put the collar on, the forward rate curve and the expectations for a rate cut are lower. And so assuming we have a rate cut next week that would, of course, impact our LIBOR based low yields negatively and it would impact our collar positively.And based on that forward rate curve, we would actually expect the collar income to go from zero to approximately $4.3 million in the next quarter. And I think it's just important. On an overall basis, our modeling indicates that in a down 100 basis point scenario, our net interest income would be impacted by only 1% on the downside.

[Michael Rose:]

Okay. That's very helpful. And then if I can just go back to the comment around the efficiency ratio and the target there, the 44% to 46%. I guess just given a more challenging rate backdrop here and maybe a little bit higher expense build, I guess over what timeframe you think you can get back there and is it possible that you could be back there by the end of next year? Thanks.

[Paul Murphy:]

You're right. I mean, it's going to take a lot of several quarters for us to see the movement. I mean, what I'm encouraged about is our three-year trend line or really anyway you'll look at it, we've seen the operating leverage in the model almost every quarter practically. So this is a setback for that just from operating leverage standpoint.Interest rate pressure, margin pressure would also further challenge our ability to get there quickly. So -- I don't know, give me some time. I mean overall, I think that still is a trend that we'll see resume. But it's going to definitely be a setback.

[Valerie Toalson:]

Yeah. In a period of declining rate, that'll be a headwind to it. But when you look at our overall business model, that's where, over the long term, we're confident that lower efficiency. And in the meantime, if we're at 50%, where we are this quarter, that's a pretty good efficiency.

[Michael Rose:]

Okay. Thanks for taking my questions.

[Operator:]

The next question comes from Matt Olney with Stephens. Please go ahead.

[Matt Olney:]

Yeah. Thanks for taking my question. Just want to go back to the sale of the equipment finance loans. Can you tell me, at what point of the quarter did that sale take place and what's the average yield of those loans?

[Paul Murphy:]

Yeah, Matt. This is Paul. It closed very late in the quarter. And does anybody have the --

[Valerie Toalson:]

Yeah. It's just a little over 7% average yield on those loans.

[Matt Olney:]

Got it.

[Paul Murphy:]

We did recognize some modest gain on it.

[Valerie Toalson:]

Yeah.

[Matt Olney:]

And then, Valerie, any impact of interest reversals on the NII from some of the credit deterioration in 2Q?

[Valerie Toalson:]

Yeah. There was -- there was a couple $100,000 or so, but it was actually pretty consistent with what it was in the first quarter. So, not too much variation between that.

[Matt Olney:]

Okay. And then, I guess, lastly, going back to credit. And Paul, you gave us some good details around the problem loans. But as far as the timing, it seems unusual to see all seven of these credit issues experienced deterioration over the last 50 days or so since the Investor Day. Is this what you were saying that all happened in the last 50 days? Or was there any kind of regulatory exam that could have also resulted in some of these downgrades?

[Paul Murphy:]

The downgrades are -- have no result as of regulatory exams. And, I guess, if at Investor Day, if I have left you with the impression there would not be ever any downgrades, then I've created the wrong impression. I mean, these are, for the most part, credits that have been on non-performing, or on the watch list, or have been things that we've been watching for some time. And so, they were on my mind at Investor Day. And I still believe what I believed at Investor Day, that our credit story is a good one. But, albeit, we have had some migration in some reserves as a result of the credits that we walk through.

[Valerie Toalson:]

I would just follow up, that there wasn't any specific portfolio focus analysis, et cetera. It's really our normal course of business that where we, every quarter, do a diligent assessment of our credit and the reserving process.

[Matt Olney:]

Okay.

[Paul Murphy:]

It's episodic, just kind of like payoffs. It's episodic. You just never know when you'll have more that in one quarter or not. Though, I wish the timing were different, however, but it is what it is.

[Matt Olney:]

Thank you.

[Operator:]

Our next question is from Jennifer Demba with SunTrust. Please go ahead.

[Jennifer Demba:]

Thank you. I have two questions. First, can you give us a little bit more color on the technology investments you're making right now? And my second question is back to credit. Paul, given that you think these credit trends this quarter were episodic, what kind of net charge-off range do you think makes sense for Cadence at this point in the cycle? Thanks.

[Paul Murphy:]

Yeah. So, Jennifer, first on technology, we are, on an ongoing basis, looking at routine upgrades to applications. So it's a little bit of delay in some of that, as a result of the conversion. But like our transfer systems set for upgrade later this year, new ACH system, things like that, cost of which are very manageable, I think, for our transfer systems, $800,000, and should get a lot of efficiencies from that. So, routine ongoing investment in IT, in line with prior years would be, I think, the way to think about it.And we do continue to look out down the road at the future, what are platforms and other models and we're comparing notes with peer banks and our work through the MBCA. Just always thinking about technology and where should we go and where do we have. But we are short of steady in the boat, I guess, for technology.So from -- back to credit, I would say our long-term goal would be for charge-offs to be under 25 basis points on the C&I portfolio through a down cycle year-in, year-out. And so, we're at 18 basis points based on the last four quarters, that still seems like a reasonable goal to me.

[Jennifer Demba:]

Thanks so much.

[Operator:]

The next question will be from Jon Arfstrom with RBC Capital Markets.

[Jon Arfstrom:]

All right. Thanks. Hello, everyone.

[Hank Holmes:]

Hi, Jon.

[Valerie Toalson:]

Hey, Jon.

[Jon Arfstrom:]

Just back to Matt Olney's question. When these issues started to come up, did it cause you to do anything different, any kind of a deep dive or look deeper at some of your other credits?

[Hank Holmes:]

Well, I mean, Jon, we're always looking at the portfolio and thinking about how to -- what's the optimum level. I mean, I will say this, we -- at Investor Day, we said, hey, Paul's view is the most concentrated, the area of risk in the bank that everyone should be aware of would be the leverage lending portfolio.And so, since Investor Day, we are running really, really thin on new capacity for new leverage lending loans. We've got adequate sized book. It's performing much in line with what we thought. But with the potential recession on the horizon, increasing that is something that we've decided we don't want to do.So, we're not close to new business, but we've kind of raised the bar, if you will, on anything that would be considered leverage without moderators and a very high bar you must clear to be open there. But for many of these long-term relationships, we're still entertaining requests. But we've moved to a more conservative place on the risk spectrum with respect to leverage lending.

[Jon Arfstrom:]

Okay. You said -- you made the comment about potential recession on the horizon. I just want to be clear that you're not saying you're seeing signs of that, you still feel like the general health of the economy and that the sectors, year one and year two is strong?

[Hank Holmes:]

Main Street looks fantastic. Our loan committee, our customers are successful. They're profitable. They're growing their businesses. Finding people is oftentimes the biggest problem they say. And so -- yeah, you summed it up nicely. Yeah, we -- I'm not calling for a recession.But I know that the longer we are in a cycle, the possibility of recession is something that we have to look at. And so what we know is that companies that have low leverage can manage recessions well. And if you have high leverage, a recession can be a bigger problem, not necessarily 100%. But -- so, yeah, just moving toward a more conservative place on the portfolio risk level with leverage is the direction we've chosen to go.

[Jon Arfstrom:]

Yeah. Okay. And then maybe, Valerie, back on the provision outlook, can you help us a little more on that? Do you feel other than just for growth, do you feel like you need to continue building reserves? Or do you feel like, the next quarter's provision will come back down at the range it's been in the past?

[Valerie Toalson:]

Yeah. So, again, just kind of reiterating what Paul noted earlier. It -- it's very much a quarter-to-quarter assessment process and a careful evaluation of the individual credits for impairments. And when you do, the valuations of those, looking at the grading movements within the quarter, positive, negative with volumes, I mean, it's -- we're very consistent, I would say in the application of our allowance. And so it'll be treated on a consistent basis. But I guess that's not what you're looking for, but that's...

[Jon Arfstrom:]

Not at all, really. We're just trying -- you understand what's going on here.

[Valerie Toalson:]

I understand.

[Jon Arfstrom:]

And stock isn't doing well on the call either. So, we're just trying to figure out of seven credits went sideways in one quarter and it's going to clear up in the next quarter is what we are trying to figure out.

[Valerie Toalson:]

Well, I think Paul mentioned that we wouldn't expect to have this level of charge-offs in a near future by any means.

[Jon Arfstrom:]

Right. Okay. Okay. And then just last thing, message to your bankers. You used the term selectively growing in the release. But it sounds like it's more of a payoff issue, so the message isn't any different.

[Paul Murphy:]

Yeah. I mean, we're open for business. We're out looking for good -- good loans to good borrowers and cross-selling for deposit opportunities and doing what we always do.

[Jon Arfstrom:]

Okay. Okay. Thank you.

[Operator:]

The next question is a follow up from Brett Rabatin with Piper Jaffray. Please go ahead.

[Brett Rabatin:]

Hey. I just had one follow-up. Wanted to see if you guys might have the total amount of loan portfolio that's tied to P/E?

[Valerie Toalson:]

No, I don't think that's....

[Paul Murphy:]

That's not a number that we've given guidance on a regular basis.

[Brett Rabatin:]

Okay. And then I'm just curious. There was discussion earlier just about some of these credits. They weren't leveraged when they were made. But they could have become levered by the time they became an issue. Would you guys not have any covenants that would restrict junior debt? Or can you just talk about how these -- how these loans sort of act once they've been made are not levered? But what these P/E firms -- like what happens to them as they sort of mature?

[Paul Murphy:]

Yeah. Sure. So when -- if EBITDA drops, we do have covenants in place and typically, they would violate the covenant. If at that point, the bank has the ability to not find any additional moneys under the line of credit, it can -- has actions that we can take, foreclosure, et cetera. And so -- but if a company -- EBITDA goes from $15 million to $5 million, I mean they're going to bust the covenant, but then you're just sort of in a workout mode. And if you have good sponsors, we've seen them come to the table, put in additional equity and cure the defaults and upsized of the company, you get the business going the right direction again or in some cases, it doesn't always work that way.

[Brett Rabatin:]

Okay. I appreciate the additional color.

[Operator:]

Our next question is also a follow-up from Steven Alexopoulos with JPMorgan. Please go ahead. Go ahead, Steven. Perhaps your line is muted.

[Steven Alexopoulos:]

Hi, everyone. Thanks for taking the follow-up. So just to follow up on it. All of the questions you've had around provision and charge-offs, I hear you that credit can be choppy, right? Who knows what the future is going to have. You could see volatility quarter-over-quarter. But I guess, Valerie, what we're trying to understand, so if you look at your internal budget for net charge-offs and provision for the second half, did that change because of what we're seeing this quarter?

[Valerie Toalson:]

No material changes, no. No material changes at all.

[Steven Alexopoulos:]

So, you didn't see any changes?

[Valerie Toalson:]

We think this was a bump. We think this quarter was a bump.

[Steven Alexopoulos:]

Right. But internally, this was not an inflection point for you, where you guys are now expecting a higher level of charge-offs and provision versus your assumptions before the quarter, correct?

[Paul Murphy:]

That's a statement. I mean, I'll say it this way. I think our provision will return to a normalized level. Just being on the record, could it ever -- could we ever have another credit that requires an ASC-310 mark? Of course, we could. So, I'm not -- I'm not trying to give a carte blanche, but I think that this quarter was unusual that it -- this spike is not likely to be repeated and that we will return to more normal levels over time.

[Steven Alexopoulos:]

Okay. Thanks for taking the follow-up.

[Operator:]

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn it back to management for any closing remarks.

[Paul Murphy:]

Well, thank you, Chad, and thank all of you. And first-off, my apologies for disappointment and the results on credit. We are continuing to work that very hard and look closely at every credit. And to summarize the point that Steve just made is that I don't think this is likely to recur. And I feel like we've got a great team of professionals that are doing a good job managing risk and avoiding risk and we're going to do much better for you in the future. So with that, we stand adjourned.

[Operator:]

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.