CapStar Financial Holdings, Inc.
Q1 2017 Earnings Call Transcript

Published: 29 Apr 2017

[Operator:]

Good morning, ladies and gentlemen, and welcome to CapStar Financial Holdings' First Quarter 2017 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, the Chief Credit Officer, CapStar Bank. [Operator Instructions] Please note that today's call is being recorded and will be available for replay on CapStar's website. At this time, all participants are placed in a listen-only mode. The floor will be open for your questions following the presentation, and instructions will be given at that time. 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 yesterday afternoon are available on the SEC's website at www.SEC.gov and the Investor Relations page at 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 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/implied by 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 statement 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 the non-GAAP financial measures and a reconciliation of the non-GAAP measures to the most direct 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/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, and good morning, everyone. Thank you for joining us for our first quarter 2017 earnings call. You have the deck in front of you that we put on the Internet. I will refer you to Page 4. The first quarter of 2017 was a disappointing one when many positive results were overshadowed by deterioration in two loans in the healthcare sector, which negatively impacted EPS by $0.18. Consequently, we reported net income of $332,000, which equates to earnings per share of $0.03. However, we remain confident that overall asset quality remains solid, growth continues at a robust pace, and we are committed to delivering the profitability that will help us achieve our goal of 1% ROAA by the end of 2018. You will note the highlights from the first quarter versus the same period in 2016. Pre-tax pre-provision income was up 11%. It was up 18% excluding the increase in non-accruals. Average loan growth was 19%. Average deposit growth was 11%. And importantly, average DDA and NOW accounts were up 38% in terms of balances. The net interest margin declined 5 basis points to 3.12%, and Rob will address some of this in his comments. We are proactively dealing with two credits. Both loans were recently placed on non-accrual, which prompted the aforementioned $207,000 reversal of interest income. One of the credits was charged off at $1.1 million, with the balance on that loan subsequently resolved. A $2 million specific reserve was placed on the second loan. We are actively working with the company to execute on a plan for full resolution of the debt. Moving to Page 5, we remain committed to our core tenets of sound profitable growth. Regarding soundness, we believe that the overall credit infrastructure and risk management systems of the company are appropriate and provide us with the ability to operate in a range of 15 to 30 basis points charge-offs over time. A fundamental component of our credit principles and practices is ongoing evaluation of our own experiences within the loan portfolio, economic trends, as well as regulatory and legislative trends. From this analysis, emerge certain modifications aimed at enhancing our asset quality. We have consistently been transparent about the lumpiness of our charge-offs, which is the way that I would characterize the situation. It is pertinent to note that, since inception of CapStar, total charge-offs are less than $10 million, including the $1 million net charge-off recently booked. Simultaneously, we have consistently maintained appropriate levels of reserves to loans, which at Q1 of 2017 is 1.39%. We previously have provided guidance in terms of balance sheet growth. Consistent with that guidance, the CapStar bankers delivered average loan growth of 19% and average deposit growth of 11%. We continue to emphasize penetration of our customers' wallets through the expansion of core DDA and NOW accounts, which today represent 48% of total deposits. The sophistication of the CapStar treasury management product array has been validated as our sales team has won various request for proposals, which pitted them against larger regional competitor. Implementation of these treasury management systems is in process. Speaking to profitability, the graphs at the top of the page depict the disappointing results in both earnings per share and ROAA for the quarter. As is the case with our ongoing assessment of credit processes, we are continually developing initiatives and plans to improve and enhance our profitability. First quarter pre-tax pre-provision income increased 11% compared to the same quarter of last year, demonstrating the impact of the increase in the ALLL on the bottom line. However, the net interest margin came in at 3.12% with a major component of the decline attributable to placement of the two loans on non-accrual. Without the non-accrual interest income reversal the margin would have been 3.19%. Again, Rob will provide more color around NIM, loan yields and cost of funds in his comments. Moving to Page 6, we continue to build full relationships. Our profitability roadmap is dependent upon expanding existing relationships and developing or cultivating new relationships. While loans typically lead the relationship, increasingly we have been able to garner the full relationship at inception. This typically consists of short and intermediate term loans, operating accounts, and treasury management systems. The 46% growth in deposit service charges reinforces the importance of this approach, further enhancing non-interest income. I will now ask Rob to provide more color around our operating results.

[Rob Anderson:]

Thank you, Claire, and good morning, everyone. Before going deeper into our earnings, let me provide you with a quick overview of our financial statements. On the balance sheet, we experienced 19% growth in loans, 11% growth in our deposits and 38% growth in our transaction-related deposits, which we have discussed as an indication of our ability to expand existing relationships and acquire new ones. As we move into the income statement, we experienced 11% growth in our net interest income, but our non-interest income was down from prior year. I will touch on the drivers of this in a bit. Claire mentioned the two credits, which drove our provision expense up for the quarter. And like many other institutions, we adopted the new accounting guidance for stock compensation, which helped us on tax line. Our expenses were in line with our expectations, leaving us with net income of $332,000 for the quarter. Although we are disappointed in our bottom-line earnings for the quarter, we did experience solid balance sheet growth and our core earnings denoted as pre-tax pre-provision earnings were up double-digits. So, let's take a deeper look at our loan growth. As you can see, our loan growth has been consistent and stable for some time. Year-over-year loan growth was up 19% and up 15% on a sequential quarterly basis. Driving this growth was solid client wins from our C&I team. As I have reported to you in the past, our focus is on developing full relationships with our customers that will bring in credit, fee income through a depository account and low-cost deposits. This is a desired segment by most strong commercial banks. The long-term benefit of banking these customers is beneficial to our increased profitability of the company. As discussed previously, 65% of our loan book is variable rate in nature. And I'll discuss more on this in a bit. So let's move to the next page. Last quarter, we talked to you about elevated payoffs and paydowns. This quarter, those payoffs and paydowns normalized, and our new loan production was very strong with $154 million in new loan production. This is up 26% when compared to both the prior year and prior quarter. Another important aspect to our loan book is that our unfunded commitments grew in pure dollars and our utilization is still low by historical standards, representing untapped loan growth opportunities. So let's talk about our loan yields. Our portfolio loan yield was down 8 basis points from the prior quarter to stand at 4.24%. If you adjust for the loans placed on non-accrual, our loan yields would have increased to 4.33%. A little less than 60% of our variable-rate portfolio is tied to one-month LIBOR, another 30% is tied to prime and 10% is tied to three-month LIBOR. These indices have increased 47, 50 and 32 basis points respectively over the past two quarters. While our variable-rate loans are re-pricing upwards as we expect, we haven't seen the magnitude increase in our variable rate loan yield. Factors impacting this include the timing of rate increases compared to the dates when rate on the individual loans reset, loan floors, performance-based pricing, and a competitive market that is driving spread compression. All told, our variable rate book increased 12 basis points, which resulted in an 8 basis point increase [Technical Difficulty]. In regards to new production, we continue to experience the front book coming on at lower than portfolio yields. Four of the five past quarters, that coupon on our new loan production has been lower than the yields on our existing portfolio. On top of this, loan fees have been down in each of the past two quarters. These two items are negatively impacting our loan yield. The loan pricing we were seeing in the market continues to create a challenge for us. Our goal is to be competitive when we work to win a relationship. It is important to note that just about every credit request has multiple banks looking at it, which drives the price down. We are winning business from time to time where we are not the cheapest bank, which is the desired position for us. Let's move to the deposit book. Loan growth has outpaced deposit growth over the past few quarters, as excess liquidity has been redeployed from cash into higher earning loans. Our deposit costs increased 10 basis points during the quarter, primarily due to the re-pricing of our correspondent banking balances to remain competitive with the Federal Reserve, and increases in our private banking deposit book. On a 25 basis point fed move, this resulted in a 40% beta on our deposits, which is less than what we assumed in our model. And we are optimistic that we will be able to hold deposit rates down and lag any future FOMC rate hikes. We have put in place plans to modify pricing on correspondent banks where we do not have their settlement account, and we have also limited increases in rates to private banking clients where we have a deposit-only relationship. We are further encouraged that our non-interest-bearing deposit growth has remained strong, up $15 million during the quarter or 30% annualized, led by our correspondent and commercial banking lines of business. Our transaction related deposit accounts now represent 48% of our entire deposit book. As we obtain primary bank status with more of our clients our intrinsic value as a company increases. Let's move to the margin. Our net interest margin was 3.12% for the quarter, down 5 basis points versus last quarter. As you can see in the NIM roll-forward, the primary reason for the decline where the two loans placed on non-accrual. Lower loan fees reduced our margin 2 basis points for the quarter. Excluding these two items, our net interest margin would have increased to 3.21%. In fact, all facets of the balance sheet improved this quarter. Our loan to deposit ratio increased. We grew our DDA balances, decreased cash levels and increased yields on our investment portfolio. Though our static balance sheet remains slightly asset sensitive, it is being impacted by the yields on runoff and new production. We have identified several initiatives to combat these concerns, some of which are already underway. We are committed to maintaining our NIM within the 3.15% to 3.25% range previously communicated to you. So let's move to the next page. Non-interest income came in as expected. Service charges, which is predominantly our treasury management business continues to grow as we expand existing relationships and acquire new ones. In fact, it's up 46% over prior year. Loan fees are up from Q4, but down from prior year. Loan fees can be lumpy based on the commercial nature of our business. Last year, in Q1, we had two arranger fees distorting our growth year-over-year. Mortgage fees are seasonally lower in Q1, but we were down versus prior year. We actually sold more loans this year, but they were sold at a slightly lower margin. Origination volume, which was up from prior year, the amount sold and the spread that we sold them for are detailed on the next page and in the appendix. Our wealth management continues to pick up steam, and we sold more of our TriNet loans. So let's talk about our expenses. Our overall expense base has trended down to $8.3 million for the quarter. As we discussed last quarter, our expense base was slightly elevated in prior quarters due to the mortgage contingent liability. Our efficiency ratio rose to 69.4%, but that is more of a function of softer revenue in the quarter, not an increase in our expenses. Of note, we did move our headquarters location in Q1 and opened up our flagship branch at the street level of the building. We are now located in the CapStar building in downtown Nashville. The building which carries our brand name at the top and the new branch location at street level provides a multitude of new benefits for our customers and associates. Related with this move was a one-time cost of $150,000. Additionally, we incurred an increase in our special asset expense associated with our two problem credits. So let's talk about our credit metrics. As Claire mentioned, we had two problem credits that impacted our numbers this quarter. The first was charged off for $1.1 million and drove our 43 basis points in net charge-offs for the quarter. That credit has been subsequently resolved in its entirety. The second credit had a $2 million specific reserve placed on it and drove our reserve to loans to 1.39%. Absent this specific reserve, our ratio would have been 1.20%. Additionally, both loans, which totaled $10 million in balances, were placed on non-accrual, pushing our NPAs to loans plus OREO to 1.36%. Absent these two loans, our ratio would have been decreased to 35 basis points. Let's move to capital. As you can see on Page 17, all our capital ratios remain strong. So let me turn it back to Claire with some closing comments, before we get into Q&A.

[Claire Tucker:]

Thank you, Rob. Obviously, we are disappointed in our first quarter results. However, CapStar's strategy remains one of sound profitable growth. As I mentioned earlier, our credit processes and risk management systems include the ongoing evaluation of our policies and practices to reflect our actual experience, the current and forecasted economic environment, as well as legislative and regulatory changes. In that context, we have been proactively reevaluating and refining our healthcare strategy. We are focused on driving performance throughout the company and remain committed to achieving a 1% ROAA by the end of 2018. CapStar's core strategy remains one of achieving growth organically. Consideration of strategic M&A opportunity is intended to complement our organic growth. With that, we'll pause and certainly be happy to entertain any questions that anyone might have and turn it back over to the operator.

[Operator:]

[Operator Instructions] Our first question comes from Catherine Mealor with KBW.

[Catherine Mealor:]

Thanks, good morning.

[Claire Tucker:]

Good morning, Catherine.

[Rob Anderson:]

Good morning.

[Catherine Mealor:]

I want to first just dig into these two credits. I think, first, can you give us just a little bit more color on the two? You said that they were healthcare credits. Can you talk about whether these were originated led by CapStar or were these shared national credits or participations with other banks? Were they in Nashville or were they out of market? And was there anything tied to the deterioration of these credits that is kind of special or one-off or are there the things within the healthcare book that you are monitoring now more closely because of what you saw from these two credits? Thanks.

[Christopher Tietz:]

Catherine, it's Chris Tietz. How are you this morning?

[Catherine Mealor:]

Hey, good morning, Chris. Good.

[Christopher Tietz:]

I'll take a deeper dive into that - into that question. One of the credits was a national specialty healthcare provider that is headquartered in Nashville. The loan was originated in 2011 and it is a SNIC [ph]. And the original balance or commitment we had was $4.4 million. On our book, it was criticized in Q2 of 2014 and we classified it in Q4 of 2015. We were able to reduce our exposure to $2.2 million during the course of 2016. The company remained contractually current right up until the time that we took it to non-accrual and subjected it to the impairment analysis. The balance at 3/31 was charged down to $1.1 million. We were uncertain of what the precise amount of the resolution would be. We did put a roughly $112,000 specific reserve on it at 3/31. And it has subsequently paid out for the amount that we had it as a net impairment in the month of April. The second credit was not located in Nashville. Our exposure was slightly under $9 million. It was originated in 2015. Also in the healthcare space, not a shared national credit, we were the exclusive lender. It was originated on a line basis secured by all business assets and a borrowing base tied to Accounts Receivable. Issues emerged with profitability during the course of 2016, and we classified as substandard in Quarter 3. We are working with management and the owners, and potential buyers on a structured sale of the business. At this writing, we anticipate a good probability of an outcome with no loss, but our practice - as is our practice in the past, we apply specific reserves to the bottom end of a range. And based on our analysis of contingencies we sized our impairment accordingly. Therefore, we anticipate an outcome in a loss range of 0 to $2 million, but we sized our specific reserve at the lower-end of that range.

[Catherine Mealor:]

Got it. Okay. And can you give us any more color into your current classifieds in that book and what else is in there that gives you any worry? And then did you see - have you seen any movement in your classifieds over the past couple of quarters?

[Christopher Tietz:]

Yes, that's a good question. And in very specific terms, our classifieds have been flat for the last three quarters and the deterioration to NPL came out of that book. So, if you take our aggregate performing and non-performing substandard loans, they've been right at about $21 million for the last three quarters. And it's as you can imagine a relatively small number of credits that are represented in that book. What I would say is that, in general, we have two other non-performing loans, both of which are performing favorably. And in terms of the performing book, we completed a series of deep dives into various components of our portfolio, including healthcare. Specific to our healthcare, it was very clear from our review that our determination was found, that our risk ratings correctly reflect the trends of the underlying borrowers and the inherent risk and probabilities of default. And, again, that's just part of our normal oversight administrative process. We will always be looking at classified loans robustly. But we will react accordingly if any issues emerge. But we feel that the underlying loans are trending stably or favorably as we continue to watch them.

[Claire Tucker:]

Catharine, I'll go back - this is Claire. I'll go back to part of your original question in terms of any themes that emerged as we considered these two credits. You may recall that we have a practice on an ongoing basis of looking at the industry sub segments, whether it's healthcare or commercial real estate, to establish some guidelines in terms of the percent of regulatory capital that we want to allocate to a specific sub segment. We - that is an ongoing practice that we employ and in fact have just recently updated our analysis, particularly as it pertains to healthcare, given the questions that are coming out of the current administration in terms of what will happen with healthcare coverage, reimbursement, and other legislative issues. I think the other thing is that, if you think about Nashville, there's over 500 healthcare companies headquartered here, and part of the refinement is an increased focus on working with the local companies here in our predominant trade area, and really focusing on both the non-credit and the credit needs of our target market there. So I would say a very big focus on staying close to home and really doing direct or small club deals.

[Catherine Mealor:]

And would you say that's a change in strategy that you are starting now, just in light of these two credits, or is that something that you've been shifting - you kind of shifting towards over a kind of longer period of time?

[Claire Tucker:]

Yes, great question. Thanks for asking for the refinement. Now, that's something that we have been doing on an ongoing basis. I think it's certainly not a reaction to these two credits. I think you try to learn, have lessons learned every time you have a situation, and there are certainly things that we have evaluated there but I would not say that this is a drastic shift. It's an ongoing metamorphosis that we would have, whether it's the healthcare book or commercial real estate or any other segment that might be impacted legislatively or regulatory-wise.

[Catherine Mealor:]

Okay, great. Thanks for the questions. I'll hop out and let others jump in. Thank you.

[Claire Tucker:]

Thank you, Catherine.

[Operator:]

Our next question comes from Stephen Scouten with Sandler O'Neill.

[Stephen Scouten:]

Hey, guys, good morning.

[Claire Tucker:]

Good morning, Stephen.

[Rob Anderson:]

Good morning.

[Stephen Scouten:]

Maybe, Claire, just to follow-up on the conversation you were having there with Catherine about the strategy changes, and I hear what you are saying. This isn't necessarily just a reaction to these credits. But can you talk more specifically about what that might entail? I mean, you mentioned doing smaller club deals. Is that - again, is that working your average exposure down on each credit, your loan limits? What are some of the tangible things you are thinking about changing?

[Claire Tucker:]

Yes, Steve, that's a great question. I would say that you could see some smaller bites, although, with the preponderance of companies headquartered in Nashville, there's certainly plenty of growth to be had in this market, so you could have more of smaller bites. But I think we would continue to expect the portfolio to grow. I think, in terms of the sub segments, we'll see some tweaking again just in terms of - let me say it this way. We really like outpatient services, behavioral that type of thing would be our primary targets in terms of where we feel like they have the ability to achieve the reimbursement that a company would need and also be an efficient method of delivering a healthcare product. So, you'll see some shifts there I think.

[Stephen Scouten:]

Okay. So you will continue to grow in here, even though, in the near-term, you won't necessarily be on the sidelines as it pertains to healthcare growth in particular?

[Claire Tucker:]

We like the healthcare segment, Stephen. We - Mark Mattson, who runs that group for us, and I have done healthcare in this market for over 20 years, and we really believe that there is plenty of opportunity for us here.

[Stephen Scouten:]

Super, super. And I noticed in the quarter, obviously you did some more CRE lending maybe than you have in the past as a percentage of loans, and that took your CRE to risk based capital up a bit, but still plenty of room there. But I mean, could we see that continue? Do you think you'll take advantage of that kind of wiggle room you have there as it pertains to concentration? And also, as you think about your asset sensitivity, are you trying to take a little bit more fixed rate exposure and get more yield? Or just talk about what that move was a little bit more towards CRE.

[Christopher Tietz:]

Yes, Stephen, this is Chris. I would say, first of all, CRE numbers change primarily driven by two things. It would be funding on construction loans for commitments that were already in place, and then some accumulation of TriNet loans that we haven't - that so we haven't yet. So, and that would be primarily in the investment grade single tenant space. So we think that we have ample real estate capacity. We manage that book in terms of expected pay downs as things go to the permanent market and so on. And so we believe we have capacity and actually feel that we are actually at a pretty prudent level relative to our peers.

[Stephen Scouten:]

Okay. So that was more just of a movement amongst the portfolio but not really a change in strategy or planning towards CRE?

[Christopher Tietz:]

That's correct. And you will also see that we had a reduction in our overall C&D component as things were completing and going into mini-perm.

[Rob Anderson:]

Yes, Stephen, it's Rob. One thing I would say is, some of the commercial real estate you are seeing, one of the strategies that we took on last year is with the TriNet, which is commercial real estate type paper. We typically hold that paper for a small bit of time until we can pool it and then sell it and put that for a fee. And we did have some loans at the end of the quarter that we would anticipate selling in the second quarter. So that's part of the growth in commercial real estate as well. And that - those loans are typically fixed rate in nature, but again, we have predominantly the intent to sell those. It's just they do sit on our balance sheet for a little bit of time after we close them.

[Stephen Scouten:]

Okay. That makes sense. And maybe one last topic for me. Just on the deposit front, I know, I kind of missed what you were saying there at the beginning, so maybe potential changes to your correspondent relationships and how you might manage some of the sensitivity to higher rates there. Can you talk a little bit more about what caused that 10 bps hike in the cost of deposits? And is this something where the actual asset sensitivity is maybe a little bit less than you would have thought because of that deposit base, or can you tell me - maybe get a little more clear on how to think about the deposit base and the asset sensitivity?

[Rob Anderson:]

Sure. Stephen, it's Rob. Yes, we did have a 10 basis point increase in our cost of funds. One of the things that we've seen, I guess post-election and then certainly with the increase in rates, we've seen a lot of competition for higher rates in the marketplace with the anticipation of rates moving up. And that can be either on money market savings, but certainly in the correspondent book, we said we have a little over $200 million in our correspondent book, where we really are kind of the replacement for the Fed. So, one of the things, if we are the settlement bank, certainly we are moving in tandem, and that book has 100% beta on that. One of the things that we're doing, we have banks that where we have both settlement and non-settlement business, but then we do have banks that we have just non-settlement and we are working on them to either convert. The overall tenant that we work on is having a full relationship with our client. So if we feel that there's not a possibility of converting that, we are going to try to convert that, we're going to have to lag that. So we have put in place a number of initiatives on the deposit front to help flow the cost of funding or the cost of our funding going up with rate increases. And part of that would be in the correspondent space.

[Stephen Scouten:]

Okay. Thanks for all the color, guys. I appreciate it.

[Claire Tucker:]

Thank you, Stephen.

[Operator:]

[Operator Instructions] Our next question comes from Daniel Cardenas with Raymond James.

[Daniel Cardenas:]

Good morning, everybody.

[Claire Tucker:]

Good morning, Dan.

[Rob Anderson:]

Hi, Daniel.

[Daniel Cardenas:]

Jumping back to the healthcare portfolio, if you could, what was your period-end balance at the end of Q1 on the healthcare portfolio?

[Christopher Tietz:]

Yes, it was right at $200 million.

[Daniel Cardenas:]

Okay. And of that $200 million, how much in SNICs do you have?

[Christopher Tietz:]

I don't have it specifically for the healthcare book. I will tell you that in our - that in terms of our participations, approximately 60% of our participations are syndicated transactions and the other 40% are club deals. So I'm not answering your question. There is a substantial portion of the healthcare portfolio, which is a participation, either in SNIC or in a club transaction.

[Daniel Cardenas:]

Okay. All right. And then of the two loans that popped up this quarter, were they in the same subsector or were they in different subsectors?

[Christopher Tietz:]

No. In fact, there's really no dominant subsector within our healthcare book. The highest concentration is in ambulatory surgery centers at about 20%. And each of those transactions that went into the book as NPLs were in different segments than that and each other.

[Daniel Cardenas:]

All right. And then maybe the reserves on the portfolio, or is that - how much in reserves do you have against that $200 million?

[Christopher Tietz:]

Our general allocation on C&I would be about 132 bps.

[Daniel Cardenas:]

Okay. And then just kind of given your general review, I know you are looking for growth, but has your growth assumption maybe been truncated here going forward, or is that pretty much unchanged from where you were, say, six months or so ago?

[Rob Anderson:]

Yes, Daniel, it's Rob. I would say our growth in terms of what we've guided in the mid-teens is still solid. We expect our healthcare portfolio to grow, and we're going to be choosy in the subsections that we feel where we can win and make money and have the low credit exposure. But overall, we are not changing our guidance on an overall asset or loan basis. We are guiding in the mid-teens. And you'll see from time to time, like last quarter, it was a little lower than that. This quarter it was a little higher, but overall, we are guiding in the mid-teens.

[Claire Tucker:]

We haven't talked much about just the core C&I portfolio, but we're continuing to see some great growth opportunities there where our bankers, as we mentioned, are winning full relationships. We've really got some nice traction going there that I'm excited about. So we've talked a lot about healthcare, we've talked a little bit about CRE, but I think the core business of this company is around the small to medium sized businesses, the C&I sector, and we're seeing some strong pipeline activity in that sector as well.

[Daniel Cardenas:]

And are those pipelines stronger or as strong as they were at the beginning of the year?

[Rob Anderson:]

Yes, I would say, overall, Daniel that we are seeing some good growth. And again, I think that's going to translate to mid-teen growth here or certainly in the near-term. And as Claire mentioned, we are seeing strong wins from regional type players that give us full relationships. And you looked at our loan yields a little bit. They were a little compressed, but we are certainly gaining other parts of the business that make the relationship profitable and add to our long-term intrinsic value.

[Daniel Cardenas:]

Good. And then…

[Christopher Tietz:]

Daniel, it's Chris. If I could back up just a second, because I do have the data. It is two-thirds of the SNIC portfolio is healthcare. And with - and of that portfolio, it stratifies between syndicated and club deals at a 60-40 split.

[Daniel Cardenas:]

Okay, good, good. And then, as we look at the operating expenses in the quarter, is that a good run rate going forward, or do you kind of expect that number perhaps to build up a little bit throughout the course of the year?

[Rob Anderson:]

Yes, I think it will build up slightly and not material. But again, we strive for a two to one operating leverage, so we are always in the market for good bankers. We'll continue to hire, and continue to grow, and continue to fund our growth, but I think it's not going to move up material from this level.

[Daniel Cardenas:]

Okay. And how should we be thinking about your tax rate going forward?

[Rob Anderson:]

Two things I would say on the tax rate. Certainly, we adopted, like many other institutions, in the first quarter for stock compensation. I think that will give us some benefits on a go-forward basis, and then I would say anywhere from 32% to about 33.5% would be good for modeling purposes near-term.

[Daniel Cardenas:]

All right. And then my last question is, as you work towards getting your ROA goal of 1% by the end of 2018, is that going to - that sounds to me like that's going to be more revenue generated than it is going to be through further expense cuts. Is that kind of correct?

[Rob Anderson:]

Yes, absolutely. We think we're going to continue to grow the balance sheet organically. We're going to continue to expand on our non-interest income in the fee areas. And then certainly, we've guided in the past that we believe we can drive our efficiency ratio down to the low-60s by the end of 2018. So we are fully committed to the 1% ROA. And absent the credit piece, we've talked about it, that being lumpy and it has been this quarter, so a little disappointing there. But overall, it's not systemic and we believe that we have a good model going forward to deliver the 1%.

[Daniel Cardenas:]

Great. All right, that's it for me right now. I'll step back. Thanks, guys.

[Claire Tucker:]

Thanks, Dan.

[Operator:]

Our next question comes from Tyler Stafford with Stephens.

[Tyler Stafford:]

Hi, good morning, everyone.

[Rob Anderson:]

Hi, Tyler.

[Claire Tucker:]

Good morning, Tyler.

[Tyler Stafford:]

I apologize if I missed this, but just back on the credit issues this quarter, I'm trying to figure out what went wrong or what changed from last quarter when these credits were in substandard but there wasn't a big provision last quarter or a large reserve against these credits. What triggered the charge-offs and the increased provisioning this quarter?

[Christopher Tietz:]

Yes. It's a fair question, Tyler. I mean, at the core, the underlying performance of the borrowers deteriorated and we reacted accordingly. So I don't know how to say it any differently than that. We have them properly rated as substandard. That was validated at a number of points along the way and we reacted accordingly, even absent any contractual defaults or delinquencies.

[Tyler Stafford:]

Okay. And I appreciate the reserve, specific reserve, or I guess general reserve, on the C&I book. But do you have what the reserve is on the actual healthcare portfolio?

[Christopher Tietz:]

Again, there is a general allocation to C&I credit that's 131 bps plus the specific reserves we have to the non-performing or the impaired book, and that is approximately $2.5 million or $2.6 million at 3/31.

[Tyler Stafford:]

Okay. Last one for me on this. Do these two credits change your look back review on the healthcare portfolio? Any change or increase to the general reserve methodology for the healthcare portfolio as a reflection of these two credits?

[Christopher Tietz:]

I think, in general, we are always evaluating this in a dynamic world and reacting to what we see around us. At the core, the - at the end of the day, we are looking to an expectation that we are going to maintain about 120 bps in the ALLL, and we have a very strong look back period of 28 quarters built into our ALLL methodology. So part of our issue, Tyler, is that the bulk of our qualitative factors are based on industry metrics, because our losses, history of bank, are still under $10 million.

[Rob Anderson:]

The other thing, Tyler, I would add, certainly with the one credit that was a charge-off that drove the 43 basis points, if you looked on maybe a rolling four quarters, we are at 17 basis points. So we would still guide to our strategic framework of 15 to 30 basis points in charge-offs on a rolling four quarters on a go-forward type basis. Certainly, with the credit that we put on specific reserve, we do have a game plan to work out in a more favorable position, but, conservatively, we've made the impairment analysis and put the reserve on there, and took the charge this quarter. So we'll see how that pans out in the coming quarters, but still would say our credit quality is solid and we are refining it as we move along.

[Tyler Stafford:]

Okay. And maybe just going back to a comment that Claire I believe made earlier, you guys have always been pretty, pretty clear, and I guess upfront about just the chunkiness - the chunkiness dynamic of your portfolio. Can you just talk about that I guess maybe specifically within the healthcare book? And how granular or what's the kind of average size here within the healthcare portfolio, and just speak to the chunkiness of that healthcare book specifically?

[Christopher Tietz:]

Well, yes, Tyler, if I might, I might come at this from a different direction. The criticized and classified loan book we have is skewed towards healthcare. I would also point out, though, that as we track our work out strategies over time, we have maintained very consistent resolution rates of criticized and classified loans over a two to three year period with a relatively stable level of loss. So it's not just about healthcare. It's really about how we manage criticized and classified loans in general with a continued strategy towards early intervention when we can still impact our position and minimize any exposure we have to loss.

[Claire Tucker:]

And Tyler, let me add one thing to that. If you - the chart that we have on Page 16 that shows the net charge-offs to loans for each quarter in 2015 and 2016, you'll see the 1.64% in the second quarter of 2015, that was a local company operating in the C&I space, not healthcare, a local company here in Nashville. The 38 bps that you see in the first quarter of 2016 was a real estate transaction. The transaction in the third quarter was a local healthcare company. And then the one we just experienced was a local healthcare company. So, I wouldn't say - we talk about - you are asking about the chunkiness as it pertains to healthcare. If you look at our history, I would suggest to you that it's been pretty evenly split across each of the primary sub segments we have in terms of lines of business.

[Tyler Stafford:]

Okay. I appreciate that, Claire. And maybe just last one from me, how does credit quality impact the lenders' and the management team's incentive compensation? I could look in the proxy but just curious how credit quality impacts that, if there's any kind of clawback that's embedded into that.

[Claire Tucker:]

Good question. Certainly, we have particular credit metrics that we look at that include the criticized loans to risk based capital, for example, past dues, charge-offs that would be correlated back to the sales team. So there is accountability there. Certainly, at the corporate level, there is not a clawback per say, but there is certainly the impact that flows through by virtue of the impact that it has on the bottom line.

[Tyler Stafford:]

Got it. Okay. Thank you, Claire, for clearing that up. I appreciate it.

[Claire Tucker:]

Sure.

[Operator:]

And I'm not showing any further questions at this time. I would like to turn the call back over to our host.

[Claire Tucker:]

Thank you very much. We really appreciate everyone's participation. Should you have any follow-up calls, just give Rob or me a shout and we'll be happy to chat with you. But we appreciate the interest from everyone that's on the call, certainly the investment community that's out there and look forward to ongoing quarters of good performance. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect. And have a wonderful day.