CapStar Financial Holdings, Inc.
Q1 2018 Earnings Call Transcript

Published: 28 Apr 2018

[Operator:]

Good morning, ladies and gentlemen, and welcome to CapStar Financial Holdings’ First Quarter 2018 Earnings Conference Call. Hosting the call today from CapStar are Ms. Claire Tucker, President and Chief Executive Officer; Mr. Rob Anderson, Chief Financial Officer and Chief Administrative Officer; Mr. Dan Hogan, Chief Executive Officer, CapStar Bank; and Mr. Chris Tietz, Chief Credit Officer, CapStar Bank. Please note that today’s call is being recorded and will be made available for replay on CapStar’s website. Please note that CapStar’s earnings release, the presentation materials that will be referred to in this call and the Form 8-K that CapStar filed with the SEC are available on the SEC’s website at www.sec.gov and the Investor Relations page of CapStar’s website at www.ir.capstarbank.com. Also during this presentation, CapStar may make certain comments that constitute forward-looking statements within the meaning of the federal securities laws. Forward-looking statements reflect CapStar’s current views with respect to, among other things, future events and its financial performance. Forward-looking statements are not historical facts and are based upon CapStar’s expectations, estimates and projections as of today. Accordingly, forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties, many of which are difficult to predict and beyond CapStar’s control. Actual results may prove to be materially different from the results expressed or implied by the forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of today. Except as otherwise required by law, CapStar disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events or otherwise. In addition, this presentation may include certain non-GAAP financial measures. The risks, assumptions and uncertainties impacting forward-looking statements and the presentation of non-GAAP financial measures and a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures are included in the earnings release and the presentation materials referred to in this call. Finally, CapStar is not responsible for and does not edit nor guarantee the accuracy of its earnings teleconference transcripts provided by third-parties. The only authorized live and archived webcast and transcripts are located on CapStar’s website. With that, I am now going to turn the presentation over to Ms. Claire Tucker, CapStar’s President and Chief Executive Officer.

[Claire Tucker:]

Thank you, operator. Good morning, everyone. Thank you for joining us for our first quarter 2018 earnings call. As we reported Thursday afternoon, we earned net income of $3.2 million or $0.25 per share on a fully diluted basis for the three months ended March 31, 2018. If you have the presentation deck in front of you. I direct your attention to Page 4, so that I may share with you some of the drivers of this performance. Our vision for CapStar is to be a high-performing financial institution known for sound profitable growth. First quarter results demonstrate execution of this strategy and are highlighted on this page. In the context of soundness, non-performing assets to loans plus OREO declined 15 basis points to 13 basis points from the fourth quarter 2017, and we had net recoveries of $165,000. We believe that the allowance for loan loss – losses is adequate at 1.41%. As I noted a moment ago, first quarter profitability resulted in earnings of $3.2 million. Although, the return on average assets of 96 basis points was slightly below our target of 1%, we made the decision to invest in the future growth of the company with the lift out of an SBA team during the first quarter, which had an impact on expenses. Additionally, the normal first quarter reload of employee-related expenses such as FICA impacted our results. The net interest margin expanded to 3.37% from 3.26% in the fourth quarter of 2017. Pretax pre-provision income was up 18% over the prior year. Rob will dive into more detail in a moment, but a driver of this improvement relates to the asset-sensitivity of our balance sheet and the lift resulting from additional rate increases from the Fed as well as a shift in asset mix. In terms of growth, there are multiple achievements, I would like to highlight for you. We posted record quarterly loan growth of $84 million on an end-of-period basis comparing 12/31/17 to 3/31/2018. Average demand deposit accounts increased 29%, positively impacting both Treasury Management and Deposit Service charges, which increased 22% over the prior year. The SBA team of five people that we hired during the first quarter has been successful in converting both loan and deposit relationships to CapStar. We believe that this business has great potential to build a nice book of business, but it also provides an alternative way to structure transactions for our core C&I target market. This is consistent with the M&A strategy that we have referenced before. In this case, adding a business line that is complementary to our core C&I business model and enhances our sources of noninterest income. Let’s move to Page 5, and I’ll provide more insight into loan growth. As I mentioned loan growth in the first quarter was strong with absolute growth of $84 million on an EOP basis. There were several key drivers. Line usage increased by $20 million over the fourth quarter. The chart at the bottom depicts this visually. Line usage hit a low for CapStar in the fourth quarter at 67%, but seems to be rebounding. We have ample room for loan growth given the $464 million in unfunded commitments. Loan production increased significantly with growth in all client segments, but driven by C&I and commercial real estate. Pay-offs will always be a fundamental part of our business. Those were outsized in the third and fourth quarters of 2017 as we experienced completion of multiple commercial real estate projects that went into the permanent market. The goal is always to outrun pay-offs with our new production. We remain committed to the healthcare line of business where we experienced nice new production in the fourth quarter. This absolute growth was tempered by pay-offs, pay-downs which were largely due to contractual excess cash flow recapture, normal amortization and, in one case, the sale of the business. We expect additional pay downs in the second quarter due to known business sales that are in the works. As I noted last quarter, several CRE clients have funded their upfront equity on construction projects, and we expect they will begin drawing down on their construction facilities at CapStar as they progress on their projects. Overall, our bankers continued to experience competitive pressure from new market entrants as well as nontraditional providers of financing at terms inconsistent with our profitability and soundness profile in many cases. Our observation is that the market remains frothy, reflecting a slippage in discipline around pricing, covenants, leverage in general terms. As I’ve said before, CapStar is not in the business of growth for the sake of growth, and we intend to maintain our structural discipline. The bench of bankers that we have at CapStar is the best in the market, and we believe that the deep relationships that they have will continue to be differentiating factors. Moving to Page 6, let’s look at credit quality. In the slide at the top left – in the graph at the top left of the slide, you will note that we continue to maintain healthy levels of reserves to total loans, specifically the allowance for loan and lease losses was 1.41% for the first quarter. The ratio of nonperforming assets to loans plus OREO declined 15 basis points to 13 basis points notably at a low point over the quarters depicted in the chart. During the quarter, we reported net recoveries of $165,000. A couple of takeaways from the graph at the bottom right, criticized and classified loans are at their lowest level for all quarters on the graph. The low level of criticized loans sets a positive expectation in terms of potential migration in coming quarters. As we evaluate historical performance, the level of classified loans remains moderate. However, by their nature and by definition, these loans possess inherent loss potential. Again, our overall asset quality is solid, and we believe that we are adequately reserved with an ALLL at 1.41%. With that, I’ll turn it over to Rob, so he may review the summary financials for you.

[Rob Anderson:]

Thank you, Claire, and good morning, everyone. On Page 7, you’ll see our summary balance sheet, P&L and key metrics. As Claire mentioned, we are in $0.25 on a fully diluted earnings per share basis. Over the past year, we have worked to reposition our balance sheet to improve our earnings profile. This improvement has been on both sides of the balance sheet. As you can see, our total assets are up 1% over prior year, but cash and securities are down 11%, and our loans have grown 5%. Equally as important is the shift occurring on the liability side of the balance sheet. Our total deposits are down 3% but we are growing our demand deposits 29% over prior year. The net result for these actions is an expanding net interest margin of 3.37%, up 25 basis points over prior year and our net interest income growing 9% over prior year. For sometime, we have spoken to you about our emphasis on expanding our fee businesses to become less capital and balance sheet dependent, especially in a low rate environment. For the first quarter in 2018, we grew our noninterest income 45% over prior year. More on this in a bit. On the provision line, we had a net recovery of $165,000, and added to the loan loss reserve with record loan growth of $84 million for the quarter. Our expenses came in a bit higher than expected, but we made some investments in the business that I’ll detail out for you in a few slides. Knowing there are differences in the provision line between quarters and with the changes in the effective tax rate this year, a good metric to analyze our core growth is the pretax pre-provision number, which is up 18% over prior year. Let’s move on to our loan yields. Our overall loan yield increased 20 basis points from the fourth quarter, with the largest driver of this coming from the repricing of the variable rate loan book. As a reminder, 65% of our loan book is variable rate in nature and predominantly tied to 1-month LIBOR. Additionally, we saw an 8 basis point increase in yields due to mix and another 2 basis point increase in our loan fees. Let’s move to our deposit book. With the last five rate increases, we have held our deposit cost to a 24% beta with an overall deposit cost of 88 basis points for the quarter. As you know, we run a branch-light model, so we don’t carry the expense of a large branch network. The growth of our deposit book has been predominantly in our demand deposits, which are growing 27% sequentially and 29% over prior year. This type of growth over a consistent period of time has helped us to improve our funding base. As you can see from the table on the lower left, 49% of our deposits are now in some form of checking account with us. Let’s see how all this impacts our margin. First, we run an asset-sensitive balance sheet and have been in this position for sometime. The chart on the lower right shows the net interest income impact with a parallel interest rate shock in year one. With 65% of our loan book variable rate and predominantly tied to one-month LIBOR, we are certainly looking forward to more interest rate increases. Our net interest margin increased 11 basis points from the prior quarter and was largely due to an improved mix, loan growth and the repricing of our variable rate loans and was offset by the increase in our deposit cost. Additionally, we saw a couple basis point increase in our loan fees and improvement in our investment and cash mix. Let’s move on to our noninterest income. We have spoken to you about expanding our fee businesses and to be less capital intensive and balance sheet dependent. For the first quarter, we booked fees in excess of $3 million, which represents 22% of our total revenue for the quarter. And last year, that amount was just over 17%. Next, all of our fee businesses grew from prior year. First, Treasury Management and Other Deposit Service charges increased 22%, as we further penetrated our C&I customer base. Loan fees were up 64% over prior year, with higher loan production levels and we booked record TriNet fees of $528,000 in the quarter. Mortgage fees were up 8% over prior year, and other income was up 67%, which is mainly driven by swap fees and wealth management fees. With the hiring of the SBA team, we have further diversified our revenue streams. Let’s move to our expenses. First, our overall expense base moved up to $9.6 million, which is a marked increase from the fourth quarter. We have added 14 FTEs since September of 2017 and 12 of those are in sales-facing roles. We got five FTE with SBA lift out, four mortgage loan officers, one in commercial real estate and two in consumer. This increase is an investment in our business, which we believe will pay us in future quarters. Additionally, we have higher FICA expense in the first quarter and are running with a higher level of incentive accruals than in previous quarters. Data processing and software expense increased with higher processing volumes and the implementation of new software in our mortgage division. We have guided you for some time that our efficiency ratio will trend down to the low 60s by the end of 2018, and we are fully committed to reaching that goal. So let’s move on to taxes. As we have mentioned in previous calls, we are coming up on our 10-year anniversary. With this milestone, we have a number of stock options and organizer warrants, which will expire this year. Assuming all these options and warrants are exercised before their expiration, we will see a benefit on the tax line, which will lower our effective tax rate. For the first quarter of 2018, we had a 13.1% effective tax rate with a $363,000 benefit related to the exercise of options and warrants. We have provided a table at the bottom of the page, so you can see the relative benefit we have remaining this year. As noted on the slide, the benefit fluctuates with changes in our stock price. Let’s move quickly on to capital. Capital levels are all above well-capitalized guidelines, and our tangible common equity to tangible assets is at 9.7%. Knowing you want to get into some questions, let me turn it back to Claire for some closing comments.

[Claire Tucker:]

Thank you, Rob. To reiterate our stated strategy, we remain committed to delivering sound profitable growth. Net income of $3.2 million or $0.25 per share represents a solid quarter of profitability. With focus on all of our shareholders, we are committed to consistently delivering strong financial results throughout the company. As Rob noted in his comments, the efficiency ratio is trending to the low 60%, and we remain committed to delivering a sustainable return on average assets of 1% by the end of the fourth quarter. We are pleased with the continued market penetration our bankers are achieving, as demonstrated by the gains we posted in Demand Deposits, Treasury Management and Deposit Service charges. Our goal is to become the primary bank for our clients. A study conducted by Greenwich Associates in the fall of 2017 revealed that the majority of our commercial clients consider CapStar to be their primary Treasury Management provider. We are also excited about the opportunities to grow organically through market share takeaway and creation of new business lines. We will continue to evaluate strategically and financially sound M&A opportunities to augment our franchise and our financial performance. Likewise, we will continue to evaluate opportunities to complete lift outs of established teams of bankers and will evaluate other opportunities to expand our sources of noninterest income. The addition of the SBA team is a prime example of executing against this strategy. We view this new opportunity to broaden our client base through prospect conversion as well as having a new alternative financing solution for our current clients. We’re appreciative of the investment that many of you on the call have made in CapStar and your continued support of our company. Operator, we are now ready to open the lines for questions from participants on the call. Thank you.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Stephen Scouten of Sandler O’Neill. Your line is open.

[Stephen Scouten:]

Hey Claire, Rob, good morning, guys.

[Claire Tucker:]

Good morning, Stephen.

[Rob Anderson:]

Good morning.

[Stephen Scouten:]

So Claire, I appreciate the color you gave kind of around loan growth and the line utilization. Just curious if there was any kind of larger-than-normal loans within that $84 million? Or anything that was, I guess, kind of just chunkier in nature? Do you take non-technical term, I guess.

[Claire Tucker:]

Is chunkier your nontechnical term?

[Stephen Scouten:]

Yes, yes. I’m going to go with chunkier.

[Claire Tucker:]

Yes, we had growth across all of the segments. Stephen, certainly, some loans are going to be larger than others just in terms of how we approach the market. But I think it was pretty evenly dispersed that represented that growth.

[Stephen Scouten:]

Okay. And I know the level of participation has obviously been trending down consistently. Anything to note there, is that progress kind of continue to – is a lot of this more your internally generated stuff that you are the core bank for the clients?

[Chris Tietz:]

Yes, Stephen, this is Chris Tietz. At the core, yes. The trend continues to go down. We have some that, that we’ve increased occasionally, but the bias is very strongly towards to the organic growth. We’re not out running a loan desk or something like that buying participations, we’re continuing to participate with customers that we know. Period-over-period to this time last year, we’re down about $40 million, $45 million in that bought portfolio. So and again, we would differentiate. It’s not just bought, these are also relationships where we have relationships with management and so on and so forth. We’re co-lenders in those transactions.

[Stephen Scouten:]

Yes. That’s helpful. That sounds good. And then kind of curious and maybe Rob this is more for you, I guess, on the deposit pricing front, obviously, I appreciate that detail on Slide 9, that’s really helpful. But obviously, if loan growth kind of continues in the accelerated pace, you guys are at 95% fully baked loan-to-deposit ratio now, I think with the held for sale. So would you expect the deposit pricing pressure to increase significantly with the need to grow deposits at a faster pace?

[Rob Anderson:]

Well, I wouldn’t say significantly. All I can say, Stephen, is that we have had some growth this past quarter, which was nice to see after the past two quarters. But I’d look to our trend and especially with interest rate increases, we’re running about 24% beta. But deposits will and has been somewhat of a challenge for us with our model a little bit. But certainly, we’ve demonstrated, we’ve been able to manage through that. So I think we’ll have to wait and see, but we feel good about where we are in terms of execution this past quarter.

[Stephen Scouten:]

Yes, definitely. Okay. Great. And then maybe just last one from me. We saw M&A transaction there within your market couple of days ago, I guess. I’m just curious what you guys are hearing on a deal activity front if that was a deal that you would have had interest in kind of why or not – why not from a competition standpoint, so we can get a feel for what you guys might be looking at and if that’s kind of a near-term hope, I guess, for you all?

[Claire Tucker:]

Yes. Stephen, I think in the past, I’ve showed you a chart – showed each of you a chart that we used to track opportunities in the market. It really looks at a radius around Nashville different deal sizes that we would be interested in. Certainly, the one that you’ve referenced would have been in that category. I’m not familiar with the exact terms of that deal, but what I will say is that as we approach opportunities, we’re going to be very disciplined in terms of how we structure those and make sure they’re strategically sound and financially sound. So we’ll adhere to our discipline there just like we do on the loan book.

[Stephen Scouten:]

Great. Thanks so much. Appreciate the color guys.

[Claire Tucker:]

Thank you, Stephen.

[Rob Anderson:]

Thanks.

[Operator:]

Our next question comes from Catherine Mealor of KBW. Your line is open.

[Catherine Mealor:]

Thanks. Good morning.

[Claire Tucker:]

Good morning, Catherine.

[Rob Anderson:]

Good morning.

[Catherine Mealor:]

I wanted to take a dig into the expenses just a little bit, and as a follow up to the last comment. So as we think about the efficiency ratio moving down to the low-60s through the year, is that – should we see a reduction in the expenses maybe if FICA taxes come out and I don’t know if maybe data processing will come down, or if it’s the new elevated pace, but can you kind of walk us through directionally where the expenses should go? Or is the improvement in efficiency really just revenue growth on top of this kind of new expense level? Thanks.

[Rob Anderson:]

Yes, Catherine, it’s more the latter around $9.6 million for the quarter on expenses. I think you can expect that to hang around that level. I think what we would expect as we grow. And certainly, we’ve provisioned for the $84 million of loan growth. But I would think we are expecting revenue growth to continue and then to leverage those expenses and investments, especially as we’ve made the investments in the people, that typically takes a little bit of time for them to get up and going and put the revenue on the books. So it’s more going to be a leveraging of the expenses. But you can expect that dollar amount on a quarterly basis give or take few base – few – I would say, 100,000 or so plus or minus on either side, but it’s going to hang around that level.

[Catherine Mealor:]

Okay. Great. That’s helpful. And then on...

[Claire Tucker:]

And Catherine, I’ll just add – Catherine I’ll just add to Rob’s comment. We’re really, really excited about the opportunity to have picked up strong revenue producers. I think 11 or 12 during the quarter, and that’s an opportunity to invest in the future of the company that I’m excited about. We expect revenues to push through to improve the operating leverage.

[Catherine Mealor:]

Got it. Yes, I totally understood. And then on loan yields, I think the loan yields were up 20 bps, which is great to see and clearly kind of which is – what we have been expecting on your asset-sensitive balance sheet. So as you think about for future rate hike, is this the kind of asset data that you think we you should continue to see? Or as you look at your new production, are you seeing any tightening spread just from your competition remaining competitive, that we may not get that full 20 bps in the next couple of rate hikes?

[Rob Anderson:]

Yes. So let me make a couple of comments on that. So a good question, Catherine. So as you know, we had the rate increase in mid-December and then mid-March, so you had to write back to back. So that certainly is helping us with our variable rate loan book. I think what we could see in the marketplace and maybe Claire can add some comments on this as well. But we would expect the repricing of that variable rate loan book, but in terms of more medium term loans, which I’d call it the five-year mark, we really haven’t seen the pricing on that to move up if we’re doing fixed-rate loans. And there is a lot of competitive pressures around that point and the midpoint of the curve is not moving that much. I think if we see sequential quarterly rate increases, another one in June or July in the second quarter, we certainly have positioned the balance sheet to benefit from rising rates. I think the challenge will be for us to be holding our deposit cost more or so than our loan yield, but I would expect our loan yield to keep moving up with rate increases.

[Claire Tucker:]

Catherine, I would add to that – just to augment what Rob said. The competition is pretty stiff. And in my comments I mentioned that we are going to continue our discipline from the structural standpoint. With that said, we are seeing new deals that we have opportunities for where the spread – the margin, if you will, over LIBOR is shrinking somewhat. We will compete on that basis, particularly in the situations where we can get the full relationship. So as you look at our numbers going forward, you may not be able to fully see a relationship profitability, but if you’re just looking at the loan yields, but embedded in the financials will be pick up that we get from having full treasury, and we use our ROE model when we’re pricing relationships to make those decisions. So we may – you may see us new production at slightly lower spreads, but we will be managing those through the full relationship that we have with our clients.

[Catherine Mealor:]

Great, makes sense. Thank you for having the great quarter.

[Rob Anderson:]

Thanks so much, Catherine.

[Operator:]

Our next question comes from Tyler Stafford of Stephens Incorporated. Your line is open.

[Gordon McGuire:]

Hey, guys, this is actually Gordon McGuire on for Tyler this morning.

[Claire Tucker:]

Good morning, Gordon.

[Rob Anderson:]

Good morning, Gordon.

[Gordon McGuire:]

So I just wanted to start following up on one of Stephen’s questions. Can you remind us what your current size tolerances are at kind of a individual loan or relationship level? And then maybe an update on just the size of some of your larger credits?

[Chris Tietz:]

Yes, this is Chris Tietz, again, Gordon. I’m going to deal with it high level, if I may. The level of our loan portfolio attributable to the top 25 relationships that we have hasn’t changed materially over the last 12 months. When you go down that list, what you’ll see is you’ll see a cluster of different transactions under one relationship where, for instance, there might be multiple real estate entities with the same sponsor. If you go down our top 10 list, you’ve got everything from CRE to owner-occupied commercial real estate to healthcare entities and so on. So – but again, at the top of the house, the aggregate number of our outstanding balance is from the top 25 relationships is in a very tight range over the last 12 to 18 months.

[Claire Tucker:]

The rest of that question, Gordon, about the whole levels, you may recall that we use a risk rating system that determines what our tolerance level is, and we have certain gradations that are associated with each of those. So if you set a risk rating, one might be a cash secured deal. It’s going to have a higher whole level than something that’s not secured by cash, just to make the example. And we use those disciplines in internal whole levels or less than what our legal lending limits are.

[Gordon McGuire:]

Thanks, that’s helpful. And then, obviously, 1Q loan growth was strong. Are you still thinking around a high single to low digit level of – low double-digit level of growth for the remainder of the year?

[Claire Tucker:]

I think that’s a reasonable expectation, Gordon. As we mentioned from time-to-time, we’re going to have pay-offs on our commercial real estate projects. We know that we’ve got couple of loans that are in the queue to be paid off in the quarter just because of sales of businesses. That’s one thing that continues to happen in the Nashville market as there is a lot of out-of-market private equity money that’s coming in, wanting to deploy their capital and they are investing in our home grown companies here. We’re seeing some pay-offs as a result of that. So I think on average, that’s a good place for your modeling to be.

[Gordon McGuire:]

Thanks. And then on the deposit cost increases. So last year, you saw a pretty similar high beta in 1Q and that kind of moderated into 2Q. Is that a trend we could see continue this year? Or do you think there is more pull-forward this year?

[Rob Anderson:]

Yes. I mean, it’s going to be dependent on the timing of the Fed rating increases, certainly. But what I would say is that – and this is why I gave you the data on the historical. It can move around from quarter-to-quarter. A lot of things depending upon some of the growth and how we need the deposits. But I think a 24% beta is our history. And I think that’s what you should use for your modeling going forward, until it changes.

[Gordon McGuire:]

Okay. And then TriNet – well, just real quick, TriNet was strong this quarter. Just wondering if there is anything – any outsized sales activity and just general expectations for the year there?

[Rob Anderson:]

No. I think if I go back to the sheet with our – we still have that – on average for the quarter, we still have around $68 million on average of TriNet paper and also residential mortgages on our book. So we’re in the business of – certainly, on the residential mortgage, we have a simple originate-to-sell model, and we do the same thing on the TriNet paper. So I think you can – while this one was large in the first quarter. I think you should expect similar sales, but maybe on a smaller level going forward. Our goal is to get to more of a flow basis, but at least have one or two sales per quarter.

[Gordon McGuire:]

Okay. And then just one more for me. Just assuming a consistent stock price, can you remind us where you think the 2019 tax rate should fall once these warrants expire?

[Rob Anderson:]

For 2018?

[Gordon McGuire:]

For 2019?

[Rob Anderson:]

For 2019. Yes, I think for 2019, you could probably move back up to more of the corporate tax rate around 21%-or-so, 19%, 21%.

[Gordon McGuire:]

Okay, thank you.

[Claire Tucker:]

Thank you, Gordon.

[Operator:]

[Operator Instructions] Our next question comes from the line of Laurie Hunsicker of Compass Point.

[Laurie Hunsicker:]

Thanks. Hi, Claire, Rob and Chris.

[Claire Tucker:]

Good morning, Laurie.

[Rob Anderson:]

Good morning, Laurie.

[Laurie Hunsicker:]

Good morning. I just wanted to follow-up on Gordon’s question on tax rate, just wanted to make sure that I understood. All of the options and warrants they all expire this year. Is that correct, like November and December?

[Claire Tucker:]

No. No, there are significant number of options and warrants that do expire this year, Laurie, that relate to those options and warrants that were granted 10 years ago when we founded the bank. But in ensuing years after the bank was founded, as we added new bankers, we certainly granted additional stock options. And so there will be a continuum just as a normal course of business that will have options expiring, but the big chunks will be in 2018.

[Laurie Hunsicker:]

Okay. Okay. And they’ll be in the back half for the most part, is that right?

[Claire Tucker:]

Not necessarily.

[Rob Anderson:]

Not necessarily, Laurie. On Page 13, we have 440,000 of options and organizer warrants that will expire this year. And we were assuming that all of those will get exercised. And if they do, that – it’s going to trend us into, I would say, a 13% to 16% effective tax rate. Now depending on when those individuals are exercised, those securities, then we capture the benefit. But I would expect them to not get real close to the deadline.

[Laurie Hunsicker:]

Got it. That makes sense. So in theory, I guess to Gordon’s question, so if the deadline is November, December expiration, really for the December quarter, we could already being at a 21% tax rate?

[Rob Anderson:]

I would think in the fourth quarter, you would see – most of these have already been exercised. So the fourth quarter could move up a tad, and we could see more exercises to gum these in the second and third quarter. I doubt people will wait to the last minute exercise of this.

[Laurie Hunsicker:]

I agree, okay. And then this is a question for you Chris. Can you help us think a little bit about loan loss provisioning? I mean, your credit looks fantastic. You had recoveries. Obviously, as we think about growth, and I’d love a little bit more color on the growth, but the 36% annualized growth rate is not going to continue, but even so if your mid-teens, if I heard you right, how should we be thinking about that loan loss provision line assuming, as you mentioned, I think several times at the beginning of the call, Claire, you had 141 reserves to loans and you want to stay here?

[Rob Anderson:]

Hi, Laurie, it’s Rob, maybe I’ll start off with this, but certainly our mantra is to have sound profitable growth. Part of our soundness is to have a healthy reserve. What I would say is that as we continue to grow and I think we said this on the fourth quarter call as well is that you should see that trend down over a period of time. So if you look back a few quarters prior, maybe last year this time, we are probably at 125-or-so. And I think what you can see as we look at our credit book, we always want to make sure we’re adequately reserved for the risk that’s inherent in the portfolio. And while the trends on asset quality are good, there is always inherent risk in that portfolio. And as we continue to grow, I think, last quarter, we’re at 145, now we’re at 141. I think you can expect that to trend down over a longer period of time.

[Laurie Hunsicker:]

Okay. And then, I mean, I guess, again, your outsized growth this quarter, but you had recoveries. If we’re modeling a loan loss provision somewhere in the neighborhood of $800,000 to $1 million per quarter, does that seem to fit what you’re thinking? Or is that a little bit too high?

[Rob Anderson:]

Welcome, I would say for new growth, if you’re provisioning around the 120, 125 for new growth, I think that is sufficient. And as that growth comes on at a lower provisioning rate, then your overall reserve will come down. So we’ve always guided provisioning around the 120, 125 for new growth.

[Laurie Hunsicker:]

Got it. Okay. And then to that point, you had $85 million of net loan growth linked quarter. Can you just take us through how much of that or just even in terms of your total growth, how much was originated versus purchased? And then how much was in market versus out of market?

[Chris Tietz:]

Yes. Well, first of all, let’s deal with the last question, first. We’ve maintained a very constant ratio of 85% of our loans being in market in nature. And that has not changed by more than basis points over the course of time recently. Relating to your first question, again, was what Laurie?

[Laurie Hunsicker:]

Just as we think about the incredible loan growth that you guys put on this quarter, how much of it was originated versus purchased?

[Chris Tietz:]

Yes. The vast majority of it was originated. We had some increases in existing, I think, as Claire and Rob indicated earlier, we had some increases in existing nonlead relationships, but only roughly $12 million quarter-over-quarter was relating to net new loan participations or nonlead positions that we purchased.

[Laurie Hunsicker:]

Okay, that’s helpful.

[Rob Anderson:]

Laurie, I would say it maybe a little differently. I mean, I would say a 100% of its originated. We co-lend with other borrowers and other key lenders in the marketplace where we want to diversify risk. But if we do that, we’re typically either the lead on that or we have a deposit relationship with us. So we want to get rid off the binocular of [indiscernible] because that’s not what we do.

[Chris Tietz:]

Yes, as a matter of fact, many of these, Laurie, again, we have direct loans with many of these borrowers. And we also will be involved in a club deal with the – with another lender. So again, we want to keep that as part of our strategy.

[Laurie Hunsicker:]

Okay, okay, great. And then on your healthcare at a $162 million, can just remind me how much of that is mix? Or maybe even SNC under the old definition just so that we have a benchmark comparison? A year ago, that was about $129 million, do you have a...

[Chris Tietz:]

I don’t do it to the new – to the old definition, and I apologize for that. But in aggregate, our SNC portfolio is approximately $140 million and total under the new definition. And...

[Rob Anderson:]

I’ve got it here. The $161 million in healthcare, we got about maybe $100 million is that was – in with some type of participations.

[Laurie Hunsicker:]

Okay. And so then – in the $140 million is new definition SNC, is that correct?

[Chris Tietz:]

That’s correct.

[Claire Tucker:]

For the entire portfolio.

[Chris Tietz:]

For the entire portfolio, it’s not just healthcare.

[Laurie Hunsicker:]

Perfect. Okay, great. And then just few more sort of loan specific questions. Your CRE book, the $390 million, which has really been having great growth. What percentage of that is out of footprint because I know you do have some lenders that go across the U.S.?

[Chris Tietz:]

Yes, we don’t track it that way. I’ll say, virtually – again, we may follow a local project sponsor or developer to an outer market area or we may do things in-market with those folks. But just because we go out of the Nashville and let’s say, we’re usually doing that with a direct borrowing relationship with a local-oriented sponsor.

[Claire Tucker:]

Yes, so Laurie, what you said about, we have bankers that go across the nation, that’s not accurate. It’s – as Chris said, we’ll follow a local customer that we have a long relationship with that might be doing a project some place else, but we’re largely dealing with people right here in the market.

[Chris Tietz:]

TriNet is probably the strategy that you’re talking about, which is a continental 48 strategy, but again, that’s primarily in originate-to-sell model.

[Laurie Hunsicker:]

Got it. Okay. That’s helpful. Okay. And then lastly, again, your credit is looking great. Your healthcare nonperformance, can you just update us on what that number was? And if the recoveries that we see this quarter came from that book?

[Chris Tietz:]

Well, that the nonperformers within the book is in terms of nonaccruals $1.3 million. And that has been a legacy credit that we’ve been working for some time and are nearing resolution we believe. We do have a CDR, which is now a performing TDR and – but that’s a CRE transaction. So in terms of total nonperforming assets, we’re only about, I believe, $2.4 million, $2.5 million, but only part of that is healthcare. And that’s, again, the legacy credit, that I just referred too.

[Laurie Hunsicker:]

Okay. Okay, great. And then recoveries, were any of the recoveries did those come from healthcare?

[Chris Tietz:]

Yes. I’d say 80% of the recoveries in the quarter were related to the healthcare book.

[Laurie Hunsicker:]

Okay. Okay, great. And then just last question on loans here. Your SBA team, can you remind me what you’re looking at in terms of their goals as we fast-forward a year from now? What you’re thinking in terms of dollars they could produce?

[Claire Tucker:]

I’ll put it like this, Laurie, we’re probably not going to broadcast exactly what we’ve got in terms of internal forecast just because they’re getting their legs underneath them here. But I will tell you that they’ve got a pretty significant pipeline right now of around a $100 million of transactions that they’re looking at. They’ve already closed two or three relationships to date. So I’d say stay tuned on that, but their pipeline is about $100 million.

[Laurie Hunsicker:]

Okay, great. Thank you for taking my question.

[Claire Tucker:]

Sure. Thanks for calling in.

[Rob Anderson:]

Thanks, Laurie.

[Operator:]

Our next question comes from Daniel Cardenas of Raymond James. Your line is open.

[Daniel Cardenas:]

Good morning guys.

[Claire Tucker:]

Good morning, Daniel.

[Rob Anderson:]

Good morning.

[Daniel Cardenas:]

Quick question on the deposit side. How should we be thinking about growth for the remainder of 2018 just kind of given your loan expectations? And then what’s your appetite for the use of broker deposits?

[Rob Anderson:]

Sure. I’ll take that one. Right now, I think our loan-to-deposit ratio is probably around 95%, 97% with the held for sale. If you excluded that, we’re around 91%. So we’re going to have to grow in tandem with our loan growth. So if we have double-digit loan growth, you can expect double-digit deposit growth. Our goal is to build relationships with our clients. As Claire mentioned, when discussing about loan yields, we’ll bank the full relationship, which is an operating account, typically a credit product and treasury management. So our preference is to go after low cost, stable deposits, meaning, DDA and NOW, and while we have a little brokered, that is not something that we fundamentally will go after.

[Claire Tucker:]

And Daniel, I’d add to that. Keep in mind if you look at the categorization of SEDARs, which are the deposits that we do through promontory for additional insurance coverage, those are technically considered brokered deposits. But as far as we’re considered and our discussions with the regulators, those are really core deposit relationships where we’re just spreading out some FTSE insurance coverage. I think there is some talk about changing the classification – the call classification on SEDAR, so that they don’t show as brokered going forward. But right now, that would constitute a portion of that. And that’s the strategy we’ll continue to deploy for our clients as they request.

[Daniel Cardenas:]

Okay. Good. So then if deposit growth becomes allusive, then would we expect – would it be fair to assume that we see a slowdown then in growth – in loan growth?

[Rob Anderson:]

No, we are not going to slow down on loan growth. I mean, we’ll figure out a way to get the deposit growth. We have backfilled with FHLB fundings. We have wholesale fundings right now, which is still fairly reasonable compared to some pricing on higher price deposits in the area. But we’ll grow our loan book and then we’ll figure out the funding. And again, our goal is to maintain relationships with our clients, so those clients should come with deposits as well. And what I would point too, is historically, what we’ve done as an indication of future performance.

[Daniel Cardenas:]

Okay. And you feel pretty confident that you could – you can continue to see the growth in deposits without significant erosion in the margin?

[Rob Anderson:]

Well, that’s going to be the challenge. I mean, that is, certainly, the challenge, Daniel. I think and I’ve said for some time that I sometime see more a rationale pricing on the liability side or the deposit side in town versus the asset or loan side. So the pipe for core stable low-cost funding is the challenge in a market such as Nashville. And certainly, that’s one of the key things that we look at into in terms of M&A opportunities is institutions with some really good funding.

[Daniel Cardenas:]

Good. And then if you could just remind us how many treasury management folks you have on board right now?

[Claire Tucker:]

We have two or three people that are on those, the sales and implementation side. And they’re backed up with part of our deposit team that covers customer service calls that we’re getting from clients. So there’s probably three dedicated to Treasury and the they are complemented by some of our other staff.

[Daniel Cardenas:]

Okay. And do you think that’s adequate to kind of get the job done for what you’re looking for on the...

[Claire Tucker:]

I think – yes, I would say that we would always be looking to enhance that team just to make sure we’re taking advantage of all the market, the opportunities in the market.

[Daniel Cardenas:]

Okay. Fair enough. And then just a quick question on the operating expenses that we saw in the quarter. Was that – with the five people that you added on the SBA side, was that for a full quarter? Are they – is that fully reflected in this quarter’s number? Or did they come in part way through the quarter?

[Rob Anderson:]

Yes, we hired two initially right at the start of the year. And then we – or three right at the start of the year, then we added another two probably midway. So we still have a – you’ll see next quarter more of a full year run rate on that team. But again, our overall expense base, I would guide you to around the level we’re at today is a good data point for modeling future quarters.

[Daniel Cardenas:]

It’s kind of that 9 5 to 9 8 type of range somewhere around there?

[Rob Anderson:]

Yes. I think that would be good, 9 8 maybe a little strong, but it’s going to be around 9 5, 9 6, 9 7.

[Daniel Cardenas:]

Okay, good. I think all my other questions have been asked and answered. So, thanks guys.

[Claire Tucker:]

Thank you, Daniel.

[Rob Anderson:]

Thanks, Daniel.

[Operator:]

And I’m showing no further questions in queue at this time. I’d like to turn the call back to management for any closing remarks.

[Claire Tucker:]

Thank you, operator. And thanks to all of you who participated in the call today. We appreciate your interest in CapStar. Appreciate your questions. Certainly, if you have further follow-up questions, you may just give Rob or me a call, we’ll be happy to entertain those. But for now, we’ll end the call and wish everyone a good Friday.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. And you may all disconnect. Everyone, have a great day.