CapStar Financial Holdings, Inc.
Q2 2018 Earnings Call Transcript

Published: 28 Jul 2018

[Operator:]

Good morning, ladies and gentlemen and welcome to CapStar Financial Holdings’ Second 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, President and Chief Operating 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 obligations 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 W. Tucker:]

Thank you operator, good morning everyone. Thank you for joining us for our second quarter 2018 earnings call. In the 8-K. released Thursday afternoon CapStar reported net income of $3.5 million or $0.27 per share on a fully diluted basis for the three months ended June 30, 2018. This compares favorably to a net loss of $3.3 million or $0.26 per share loss on a fully diluted basis for the three months ended June 30, 2017. Excluding pretax merger related charges of $335,000 net income on a fully diluted per share basis was $0.29 for the three months ended June 30, 2018. If you have the presentation deck in front of you I direct your attention to page 5 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. Second quarter results demonstrate execution of this strategy and are highlighted on this page. We are excited about our pending merger with Athens Bancshares. Throughout this presentation we will differentiate between our GAAP results including merger charges and results that reflect operating results excluding the merger charges. So let's look at GAAP results. We delivered fully diluted earnings per share of $0.27 resulting in a return on average assets of 1.01% and return on average tangible equity of 9.7%. The efficiency ratio was 69.71% and our net interest margin was 3.46%. On a non-GAAP basis adjusting for $335,000 in merger related expenses, fully diluted EPS was $.29, return on average assets was 1.08%, and return on average tangible equity was 10.38%, and the efficiency ratio was 67.38% There were multiple drivers of our financial performance in the quarter. Net interest margin expanded seven basis points and loan yields expanded 30 basis points from the prior quarter. Rob will provide more detail in a few minutes but the loan yield improvements were a result of repricing of variable rate loans and an increase in loan fees. Average held for investment loan growth was up 24% from the prior quarter growing from $983 million to 1.042 billion. This growth was fueled by growth in commercial real estate. Treasury management fees expanded nicely year-over-year and quarter-over-quarter and importantly our credit metrics remained solid as we booked net charge offs of $27,000 for the quarter while maintaining a net recovery of $138,000 year-to-date. The allowance for loan and lease losses remains adequate at 1.41%. Moving to page 6, I direct your attention to the loan growth metrics. At the top left quadrant you will note the aforementioned increase of 24% in average loans held for investment growing at a healthy clip from $983 million to 1.042 billion quarter-over-quarter. Growth occurred in all client segments except healthcare. I would point out that within the commercial real estate classification on the balance sheet our owner occupied properties that are part of the C&I client segment. 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 initiative has great potential to build out a nice book of business and 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 reference before, in this case adding a business line that is complementary to our core C&I business model and also enhances our sources of non-interest income. Unfunded commitments of $461 million represent an opportunity for future loan growth. We've experienced steady increases in usage of these lines of credit over the past two quarters. Outstandings have increased in both C&I and commercial real estate as construction projects have funded up. As we've shared with you previously our commercial construction projects are structured such that cash equity is injected prior to initial draws under construction lines. We continue to manage credit concentration for the entire loan portfolio with further segmentations done within the real estate and healthcare categories. We have established guidelines that are a function of the bank's risk based capital and review on a quarterly basis. We believe that all concentrations are being managed appropriately. Overall our bankers continued to experience competitive pressure from new market entrants as well as nontraditional providers of financing at terms sometimes inconsistent with our profitability and soundness profiles. Our observation is that the market remains very frothy reflecting a slippage in discipline around pricing, covenants, leverage in general terms. CapStar is not in the business of growth for the sake of growth and we intend to maintain structural discipline. Advancing to page 7 I will address credit quality for CapStar. In the top left quadrant you'll note that the ALLL remains at 1.41% which we believe is adequate based upon our quarterly analysis. As I noted a moment ago we had net charge off of $27,000 for the quarter and a net recovery of $138,000 for the six months ended June 30, 2018. NPAs to loans plus Oreo increased 39 basis points during the quarter moving from 13 basis points to 52 basis points. This was due to movement of one loan to non-accrual status. In the bottom right quadrant you will note our six quarter trends in asset quality broken into special mention and substandard categories. The trends in both of these categories and the relatively low levels are positive remaining at their lowest levels for the quarters shown on the graph. We believe that we remain adequately reserved with ALLL at 1.41%. With that I'll turn it over to Rob for his comments.

[Rob Anderson:]

Thank you Claire and good morning everyone. On page 8 you can see our second quarter loan yield moved up 30 basis points to 5.04%. The increase was driven by a number of factors but predominantly in two areas. First, our bearable rate loans are repricing as expected and contributed 11 basis points of the increased. Second, our loan fees increased 14 basis points which is predominantly driven by new SBA loans which typically carry a higher coupon than our traditional C&I loans and they come with these. As you may recall we highlighted the SBA team that joined us in the first quarter of this year and we are beginning to see the fruits of this investment very quickly. We are pleased with the team's calling activity, business book to date, and pipeline of future deals. As you can see by the chart on the lower left our loan book is 63% bearable rate in nature and predominately tied to one month LIBOR. We believe this mix should serve us well if the Federal Reserve continues to raise interest rates. So let's move on to deposits. With the last fixed rate increases we have held our total deposit cost to a 35% beta. This past quarter however the movement in our deposit costs was much more pronounced. This was magnified by the quarterly decline in our DDA and now balances which pushed our overall costs higher. A few notes on this topic which may help you understand all the levers at work here. First the competition for deposits in Nashville has intensified. We are seeing institutions that are new to the area pay up for business as well as locally based institutions competing more aggressively. In turn we have exception price key client relationships to retain the business. Second, we are noticing that our commercial clients are holding less cash on their balance sheets. So it is not a function of losing accounts but rather that our clients are putting their money to work. Next we typically some seasonality in our correspondent banking group during the second quarter with balances usually hitting a low for the year around tax season in mid-April before rebounding upwards throughout the remainder of the year. As you may recall our correspondent banking groups deposit book is approximately 150 million split 35%, 65% between DDA and now accounts. So this is another factor at play here. And then our loan to deposit ratio continued to tighten up at the end of the quarter coming in at 97% if you include our loans held for sale or at 91% without loans held for sale. With that let's move on to the margin. Our net interest margin increased seven basis points for the quarter to 3.46%. In short while we continue to see nice increases from the repricing of our bearable rate loan book, increases in our deposit costs negated much of that benefit during the second quarter. It was the SBA loans which [indiscernible] coupons and fees being the differentiator. Just as the competition for deposits is heating up so is the competition for loans. We continue to see spreads over LIBOR shrink and compromises on pricing and structure that we're not willing to match. With competition for deposits here in Nashville are unlikely to slow down we will need to do a much better job going forward on the liability side of the balance sheet in order to realize our inherent asset sensitivity with future rate increases. As we talked about last month this is one of the key areas we think the merger with Athens Federal Community Bank will be able to help us. So let's move on to non-interest income. Our non-interest income was $2.8 million for the quarter and 79 basis points to average assets. Overall this level is below our expectations but I would like to go through each area to provide more color. On the treasury management side we are up 25% over prior year and the previous quarter. At any given month our clients can pay us in our hard charge fees or in compensating balances. This past quarter we have more clients paying fees than in previous quarter and this links back to the activity we have seen in our deposit book with our commercial clients holding less cash in their accounts. Our loan fees came in flat to prior year but down from previous quarter. Although this performance was in line with expectations, know that the first quarter was larger than expected. As stated previously this line item can be lumpy from time to time. Our Tri-Net fees came in as expected and we held $23 million held for sale at quarter-end. So we fully expect a similar sized sale in the third quarter. Mortgage fees were lower than expected but we are a function of selling a lower number of loans for the quarter. Two things I will highlight; first, if you look at the specific origination volumes in the appendix you'll notice the origination volume was up 28% over last year and we held $43 million dollars held for sale at quarter end which is much higher than what we have typically been carrying. In short I would fully expect mortgage fees to be higher in the third quarter. So let's move onto our expenses. First we've got $335,000 of merger related expenses and we will isolate those expenses for you as we move forward with our partnership with Athens. Excluding the merger related expenses we've booked $9.7 million for the quarter and that's consistent to last quarter and where we guided you. In the near term you can expect similar levels of expenses excluding the merger related items. As it relates to our efficiency ratio we are still committed to achieving an efficiency ratio in the low 60's with similar expense levels of $9.7 million a quarter for the remainder of the year, this means we need more revenue in the second half of the year to make this score materialize. Let's move on to taxes. As we have mentioned in previous calls we celebrated our 10 year anniversary this month. With this milestone we had a number of stock options and organizer warrants that were exercised in the quarter. For the second quarter of 2018 we had a 15.9% effective tax rate with a $277,000 benefit related to the exercise of options and warrants. All of the warrants have now been exercised and we have 294,000 of stock options remaining which will expire in the fourth quarter of this year. Assuming all of these options are exercised before they expire 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. I would expect the majority of this benefit to hit in Q3 and to a smaller extent in Q4. Let's move on to capital. Capital levels are all about well capitalized guidelines and our tangible common equity to tangible assets is now at 9.89%. Additionally I will remind you that we declared a quarterly dividend to all shareholders this quarter and it will be paid in the third quarter. We're excited about this step for our shareholders and are confident about our ability to sustain this level of dividend and attain strong capital levels going forward. So with that let me turn it back to Claire for some closing comments.

[Claire W. Tucker:]

Thank you Rob. I'll take you to page 15 of the presentation deck where I would like to give you an update on our progress on the announced partnership with Athens Federal Community Bank in Athens [ph], Tennessee. We are progressing at a pace consistent with our original plans and anticipate closing on the transaction in the fourth quarter of 2018. CapStar and Athens share a common vision of creating a high performing financial institution across the State of Tennessee with a focus on providing exceptional customer service and creative solutions. This combination adds diversity in terms of industry, business mix, and geography. Athens is an established and highly profitable community bank with dominant deposit market share in its primary market. A key consideration for CapStar was the attractiveness of this deposit base and how it may enhance the funding profile. We believe the second quarter earnings reported by Athens earlier this week further support our confidence in the merits of the combination and the potential value creation for our combined shareholder base. This combination is financially compelling, expected to produce double-digit earnings accretion, manageable tangible book value dilution, and an enhanced pro-forma capital position. We remain confident in our ability to execute on the deal economics including 6% EPS accretion in 2019 and 10% EPS accretion in 2020. Cost saves will be phased in at 60% in 2019 and 100% thereafter. We believe that the combination will create a strong financial institution with an expanded product offering, attractive funding profile, and enhanced scale to draw profitability. You will recall that these are some of the items that we've highlighted previously as core to our M&A strategy. So to wrap up our presentation I would like to highlight the key takeaways, CapStar's strategy and vision remain focused on delivering sound, profitable growth. I've mentioned before that we are not in the business of growing for the sake of growth, rather we will maintain our discipline and pursue those opportunities that provide opportunities for development of relationships. This translate to becoming the primary bank for our clients with deep share wallet. Our second quarter performance is illustrative of our focus on soundness. We're keenly focused on delivering a successful integration with our Athens partners and capturing the requisite synergies. Our annual strategic planning offsite with our Board of Directors will be held in August. At this meeting we will reconfirm our stated goals of delivering solid organic growth through market share takeaway and enhancing this growth through the pursuit of M&A opportunities that are strategically and financially sound. Likewise we will continue to evaluate opportunities to complete lift outs of established teams of bankers and evaluate opportunities to expand our sources of non-interest income. The addition of the SBA team is a prime example of executing against this strategy. We view this as an opportunity to broaden our client base through prospect conversion as well as having new alternative financing solutions for our current clients. We are 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 this call. Thank you.

[Operator:]

Thank you. [Operator Instructions]. Our first question comes from Catherine Mealor of KBW. Your line is open.

[Catherine Mealor:]

Thanks, good morning.

[Claire W. Tucker:]

Good morning Catherine.

[Catherine Mealor:]

Firstly I want to ask on the deposit side, I appreciate all your commentary around about some of the moving parts in there, it feels like given that some of it has out of DDA, it feels like where most of your growth is going is in the money market and savings line. With that can you talk a little about the pricing dynamic in the national market for that product type right now and what the current rate of new deposits going into that account look like right now and your expectations for that moving forward?

[Rob Anderson:]

Sure Catherine, you know this past quarter I would say that has intensified. As I said on the prepared remarks we have new entrants that are coming into Nashville and they are aggressively what I would call trying to attract business which means that they have to differentiate their pricing. So they are typically above wholesale rates right now at around 2% money. And then we have local institutions that are very aggressive that we have typically not seen be as aggressive and that has heightened. So, I would say money market right now is hanging around fed funds right around 2% and a little bit higher.

[Catherine Mealor:]

And in your alco [ph] modeling what kind of beta do you assume that you need to have to still view yourself as asset sensitive?

[Rob Anderson:]

Sure, so in our modeling we use a 60% beta on our entire deposit book and there's pieces of that that's a little higher and pieces of that that's a little lower. But certainly we have beaten our model through this cycle. Now this past quarter we did not. But we use a 60% beta and that's in our modeling.

[Catherine Mealor:]

Okay, and then I one last…

[Claire W. Tucker:]

Catherine I'll add something to that too, if you think about the movement in our deposit pricing since December of 2015 when the first debt increase happened we've benefited in that and the deposits have reprised at a rate slower than the actual movement obviously, so we've been able to maintain that lower beta. What we found I guess in the last quarter or two is that with the competition some of our customers are becoming more rate sensitive and that's driving some of the pricing. So, let's say that we were delayed in following the Fed increases which benefited us and we had a good catch up that occurred during the quarter.

[Catherine Mealor:]

Got it and if you did the catch up do you feel like the betas will moderate next quarter?

[Claire W. Tucker:]

I think what Rob said about our beta we're modeling at 60% is probably where we've been guided to.

[Catherine Mealor:]

Okay, that is helpful. Thank you. And then one other one is just on the NPS increase can you just give us a little bit of color on that one non-accrual that moved this quarter? Thanks.

[Claire W. Tucker:]

Sure, I'd be happy to. This is a credit that's been on the books for several years, I think four years. We have been watching it over time as you can imagine. If you look at our Q1 numbers and our Q2 what you can see is that we had some shift from the substandard into the total impaired loans. This is a credit that lead we do have a specific reserve on, that we've assed based on the fact that as we now know it I would point out to you that even with the specific reserve we were able to maintain our allowance at 1.41.

[Catherine Mealor:]

Okay and what industry was the credit in?

[Claire W. Tucker:]

It was healthcare deal, it is a healthcare deal that was originated four years ago.

[Catherine Mealor:]

Okay, great. I think I will hop out, thanks.

[Claire W. Tucker:]

Thank you Catherine.

[Operator:]

Our next question comes from Laurie Hunsicker of Compass Point. Your line is open.

[Laurie Hunsicker:]

Yeah hi, thanks, good morning.

[Claire W. Tucker:]

Good morning Laurie.

[Laurie Hunsicker:]

I just wanted to circle back to where Catherine was asking on the deposits, I just wondered if you could clarify a couple things, the correspondent deposits of 150 million do you have a cost on those for the quarter?

[Rob Anderson:]

Yes, we do have that on the -- grab that real quick.

[Laurie Hunsicker:]

And maybe while you're looking for that if you had a comparison data point in the prior quarter for correspondent as well that would be helpful, and then maybe Rob as you are looking for that I don’t know Catherine -- I mean Claire could you give us some color specifically around money markets, was there a campaign that happened in the quarter. I mean obviously it jumped but the costs and I'm just talking linked quarter of the money markets went up from 1.07 to 1.32, can you talk a little bit more about that.

[Claire W. Tucker:]

Sure I would say there is not a specific campaign that's any different from our normal focus on developing full relationships with our clients and our bankers have been able to continue to do that. I think that's shown obviously with the $49 million pick up there. So, they could still see a good hard calling as opposed to any specific campaign where we send out a flier for certain rate.

[Laurie Hunsicker:]

Okay, any idea directionally on how we should be thinking about that as we head into the back half of the year just the cost on this money markets?

[Rob Anderson:]

Boy, that's certainly going to move up with rate increases and as you saw today the GDP number was up fairly strong. We do expect rates to increase but what I would say is that you're going to see that movement on the money markets. We still model a 60% beta overall, that's a big piece of our book. So it could hover around that. Just going back to your correspondent banking question, the overall blended cost on our 150 million of correspondent banking was around 122 basis points and that was up 15 basis points over prior quarter. So again in the correspondent banking book it's more of a mix of the DDA and the now accounts. So, that can move around but the bid on that was 15 of 25 [ph] for the last quarter.

[Laurie Hunsicker:]

Okay, that's helpful. Okay, and then just going over to your income statement, I wonder can you just talk a little bit about the China fees, I know they were down linked quarter and you said you expected that, can you just remind us what happened in first quarter, why that was elevated, and how we should expect to be seeing that line item run?

[Rob Anderson:]

Yeah, so we typically do that on a sale basis it's not on a flow basis. And in the first quarter we just had a larger sale on an extra sale in the first quarter. I think when we talked to you in April we noted that that was probably on the high side but the December or fourth quarter was probably on the low. So you know I tried to tell you that it was going to come in somewhere in between those and we did. So, it certainly was within our expectations and just going forward Laurie I would say we'd probably see something similar to what we've booked this quarter versus the first quarter was I would say elevated for a quarterly sale.

[Laurie Hunsicker:]

Okay, that's perfect. Okay and then onto loans, your loan growth was 6% annualized and I think you had guided to mid-teens if my notes are correct, can you help us think about loan growth for the rest of the year and how we should be thinking about that?

[Rob Anderson:]

Yeah, so we have been guiding since at the end of last year we said on a point to point basis for 2018. We thought we would end up growing loans from the high single-digits to low double-digits. Now just for this year I would say because of the growth in the first quarter we are probably above that guidance but what we would do is from a 12 to 8 month period we're still guiding high single-digits, so about double digits. Now from quarter-to-quarter we could see either like the first quarter very strong growth but in this past quarter maybe a little bit muted and depending on payoffs and pay downs. But again for 2018 point to point from December to December we guided high single to low double digits.

[Claire W. Tucker:]

Laurie one thing I would point out too, I know you're working on your model, but just talk about the business fundamentals for a second and that is if you look at the loan growth without healthcare you'll notice that we were up 18% if you're looking at the bottom of page 6. I think that while what's important is the growth of the entire book obviously, we also think it's important that we adhere to the strategy, the pivoting that we shared with you probably in the third quarter of 2017 that we're doing within healthcare. We've obviously had some significant pay downs there. Some of that has come from companies that have been sold, some have come from refinancing with more aggressive lenders in the market. So we are really sticking to our discipline in terms of what we said we would do with the healthcare book. Now with that said, I think that we probably hit a low point there. We are very confident with the new team that's been in place for about a year now. That their traction and their calling efforts are paying off and so I would expect on a net basis that we will see some good solid pick up from them that will contribute to the overall loan growth for the second part of the year.

[Laurie Hunsicker:]

Okay, that is helpful. And then just quick question on taxes, as we think about how the benefit plays through the 15.9 this quarter is going to be probably closer to 14%? Is that the right way for 3Q?

[Rob Anderson:]

Yes, I think that's reasonable Laurie.

[Laurie Hunsicker:]

And then in the fourth quarter we go back up 20-21 something like that?

[Rob Anderson:]

We could see a little -- I think the fourth quarter will be a little higher but I would say it would be somewhere between maybe 166 and 22 at the very high end because we don't control the timing in which these individuals will exercise our stock options. But I think the third quarter will see the majority of the benefit that we've highlighted on the page.

[Laurie Hunsicker:]

Okay, great. Alright and then Claire just last question, just around your comments of how you're thinking going forward and maybe just a retail and that you've got this current acquisition pending but you're still potentially considering another acquisition or would you wait until this was closed and digested. Just want to make sure I heard you right?

[Claire W. Tucker:]

Yeah, I think Laurie we're always going to be having conversations with banks or other companies that we believe would be financially and strategically sound for CapStar. Many times the period of time that it takes to get one of these done can have a long tail. So we're not going to stop having those conversations while we're working on Athens because we think that they can end up being very complimentary if they are strategically and financially sound. But with that said my primary focus is obviously assimilating the Athens Bank from a from an employee standpoint, a customer standpoint, and certainly achieving the synergies that's priority one and we'll continue to be.

[Laurie Hunsicker:]

Okay, thank you for taking my questions.

[Claire W. Tucker:]

Sure, thanks for participating.

[Operator:]

[Operator Instructions]. And with no further questions in queue I would like to turn the call back to Claire Tucker for closing remarks.

[Claire W. Tucker:]

Thank you operator and thanks to each of you who were participating in the call today. We are very appreciative of your interest in CapStar and your investment in CapStar. I know for the Research Analysts this is a busy time with a lot of earnings calls and so if you have some subsequent questions that you would like to tee up with Rob or me please feel free to give us a shout we will be happy to work with you on any question you may have. So with that operator we will end the call and have a good day everyone.

[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.