CapStar Financial Holdings, Inc.
Q4 2017 Earnings Call Transcript

Published: 26 Jan 2018

[Operator:]

Good morning, ladies and gentlemen, and welcome to CapStar Financial Holdings Fourth 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, Chief Credit Officer, CapStar Bank. [Operator Instructions] Please note that today’s call is being recorded and will be made available for replay on CapStar’s website. At this time, all participants have been placed in a listen-only mode. The floor will be opened 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 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’m 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 fourth quarter 2017 earnings call. As we reported Thursday afternoon, CapStar reported net income of $91,000, or $0.01 per share on a fully diluted basis for the three months ended December 31, 2017. As a result of the Tax Cuts and Jobs Act of 2017 that was signed into law in December, CapStar revalued its net deferred tax asset position, resulting in a one-time non-cash charge of $3.6 million, or $0.27 per share on a fully diluted basis. Reflecting this charge, adjusted net income was $3.7 million, or $0.28 per share, compared to net income of $2.9 million, or $0.23 per share for the three months ended December 31, 2016. 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. Fourth quarter results demonstrating execution of this strategy are highlighted below. In the context of soundness, nonperforming assets to loans plus OREO declined 4 basis points to 28 basis points, and we had net charge-offs of $372,000, predominantly related to a loan for which a specific reserve was in place. As I noted a moment ago, absent the DTA charge, fourth quarter profitability resulted in adjusted quarterly earnings of $3.7 million and return on average assets of 1.09%. The net interest margin was flat to the prior quarter at 3.26%, with loan yields down 1 basis point, deposit cost up 1 basis point, and a nice pickup of 13 basis points in the investment portfolio. In terms of growth, there are multiple achievements I would like to highlight for you. Average demand deposit accounts increased 30%, positively impacting both treasury management and deposit service charges. Wealth management assets under management crossed over the $100 million mark, as our registered investment advisors continued to expand our relationships. You may have noticed in our press release on Wednesday that we completed the hiring of an SBA team earlier this month. This is consistent with the M&A strategy that we have referenced before, in this case, adding a business line that is complimentary to our core C&I business model and enhances our sources of non-interest income. Additionally, we hired three new mortgage loan officers in our Farmington Financial Residential Mortgage business. They have hit the ground running and we expect them to be strong contributors to that fee income business in 2018. I will address loan growth at a high-level, and then I will provide more color as we move through the deck. Comparing the fourth quarter 2017 to the same period in 2016, average loans held for investment grew 2%. Excluding the healthcare loan book, average loans grew 8% during that period. From the third quarter of 2017 to the fourth quarter 2017, loans declined 14%, predominantly impacted by payoffs in the Commercial Real Estate segment as several construction projects were completed and paid off, we also experienced the decline in the Healthcare segment. Our bankers continue to deepen relationships with our customers as indicated by growth and average DDA balances during the quarter. Greenwich Associates completed a customer experience evaluation during the fourth quarter revealing some very positive trends and feedback. Several examples include client advocacy and willingness to recommend CapStar are well above industry norms. Our bankers are considered proactive and presenting new commercial solutions to their clients, and a majority of commercial clients consider CapStar to be their primary treasury management services provider. Moving to Page 5, let’s look at credit quality for a moment. You’ll note that we continue to maintain healthy levels of reserves to total loans, specifically the allowance for loan and lease losses with 1.45% for the fourth quarter. Due to the decline in our loan portfolio, a slight negative provision for loan losses was booked. The ratio of non-performing assets to loans plus OREO declined 4 basis points to 28 basis points, notably at a low point over the quarters depicted in the chart. Similarly, the ratio of criticized and classified loans to total gross loans remained stable at 2.7%. The final point I will make on this page relates to net charge-offs. During the quarter, we reported net charge-offs of 372,000, primarily attributable to a loan on which there was already a specific reserve. Comparing fourth quarter 2017 to fourth quarter 2016, average loan growth was 2%. Excluding the healthcare book, average loan growth was 8%. Comparing third quarter of 2017 to fourth quarter 2017, results generated a 14% decline. Our Commercial Real Estate segment was impacted by payoffs of construction loans on projects that reached completion and were refinanced through permanent loan sources. We’ve pointed out previously that our loan portfolio will not reflect straight line growth every quarter due to the nature of commercial real estate construction business. Additionally, the commercial real estate market is hot resulting in inflated property values in some areas. In several instances, our borrowers received unsolicited offers on their property and opted to sale and repaid their debt. With these two categories, we were paid off on $41 million of loans during the quarter. The commercial real estate team has closed multiple construction lines for new projects that we expect funding to begin in the first quarter after borrower equity has been injected into the project. Asset quality in this segment remains solid. The second factor impacting growth was embedded in the healthcare client segments, where we experienced roughly $20 million in payoffs and pay downs, largely related to refinancing of debt by our borrowers in accordance with our request. As I have mentioned previously, with the development and implementation of the revised healthcare strategy, the team has pivoted and is rebuilding their pipelines. The sales cycle from prospect development to conversion to clients always varies and certainly will impact timing and momentum of loan growth. So with that said, they’re certainly benefiting from the inside from our Healthcare Advisory Committee, which is populated with well healed National Bank Healthcare executive. It is important to note also that the healthcare team has been very successful in developing depository and treasury management business with key clients. Overall, our bankers continue 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 very frothy, reflecting a slippage and discipline around pricing, covenants, leverage, and general terms. CapStar is not in the business of growth for the sake of growth. Conversely, we’re more focused on soundness and profitability to drive positive results for our shareholders. It is important to note the capacity for loan growth that exists in our unfunded commitments. At the end of the fourth quarter, unfunded commitments totaled $468 million. Additionally, the pipeline of loan opportunities has increased since the beginning of the fourth quarter. 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. As Claire mentioned, the CapStar team delivered an adjusted net income of $3.7 million, or $0.28 earnings per share on an adjusted fully diluted basis. Additionally, the earnings produced a 1.09% return on average assets and we saw expansion in our net interest margin for the quarter and on a year-to-date basis. As you look at the balance sheet, you’ll see our growth for the quarter was lower than our previous guidance, but on a year-to-date basis, it still came in at the low-end of our guidance. Loans grew on average 2% for the quarter and a 11% on a year-to-date basis. Deposits shrank for the quarter, but we did grow our transaction accounts 11% for the quarter and 17% on a year-to-date basis. This performance continues to demonstrate our ability to attract, retain and deepen our relationships with our clients. As we move to the income statement, we saw growth in our net interest income consistent with our loan growth. Noninterest income shrank for the quarter and on a year-to-date basis, mainly due to lower mortgage volume and loan fees. We booked a slight negative provision number this quarter as we experienced a decline in our loan book on a period-end basis. Expenses were contained relative to revenue growth and we experienced higher than normal operating leverage on a year-to-date basis. The revaluation of our deferred tax asset with tax reform was $3.6 million, adjusting this out of our numbers leaves our effective tax rate at 20% for the quarter and 16.4% on a year-to-date basis. Again, our effective tax rate benefited from the new accounting guidance on stock compensation transactions, more on this in a bit. One metric beneficial to understand our earnings power on a go-forward basis is our pre-tax pre-provision income number, which grew 16% in 2017. This metric adjust out the lumpy credit and noisy tax items we experienced this year. Let’s move on to our loan yields. Our loan yield was 4.54% for the quarter and down 1 basis point from the third quarter. Our variable rate loans repriced with the Fed rate increase in mid-December, but was offset with a slight change in mix and lower loan fees. We typically see a full repricing of our variable rate loan book 90 days post the Fed movement, as loans contractually repriced throughout the quarter. As you can see by the chart on the lower left, our loan book is 64% variable rate in nature and predominately tied to one month LIBOR. Any rate increases by the Fed should benefit the yield in our variable rate loan book. So let’s move to our deposits. Our deposit book shrank when compared to the prior quarter and prior year. However, we don’t view this as a negative as we want to grow the right type of deposits and obtain an optimal loan to deposit ratio with a solid funding base. As you can see by the table on the bottom right, we grew DDA balances 28% over prior quarter and 30% over prior year. Our track record of managing our deposit book with low-cost deposit has improved over time evidenced by the chart on the lower left. In Q4 of 2014, 28% of our deposit book was in some form of checking accounts, either a DDA or a NOW account. In Q4 of 2017, the mix of our deposit book has shifted where 52% of our deposit book is in a checking account. As it relates to our deposit cost, we expect our deposit cost to increase whenever the FOMC raises rates or when market expectations of a rate increase are high. As you can see by the graph on the upper right-hand side of the page, we held our deposit cost to a 19% beta during the past 125 basis point increase in the Fed funds rate. If we continue to grow our DDA at the pace we did this past year, then we should be able to manage our deposit beta to a reasonable level moving forward. Let’s move to our margin. Our net interest margin was 3.26% for the quarter and flat compared to prior quarter. Our variable rate loans repriced adding 1 basis point to our margin, but was offset by lower loan fees. The yields on our investment portfolio increased 13 basis points for the quarter and that helped to improve the margin by 2 basis points for the quarter. Our interest rate risk sensitivity report show that we have an asset-sensitive balance sheet. Therefore, should the Fed continue to raise rates in 2018, we would expect our net interest margin to expand quietly. The magnitude of the increase will be dependent on the number and timing of the rate hikes, the shape of the yield curve, as well as our ability to manage a number of factors that could impact our long yields and deposit costs. Again, 64% of our loan book is variable rate in nature and predominately tied to one-month LIBOR. Let’s move to our non-interest income. Our non-interest income to average assets was 82 basis points for the quarter and down from the third quarter and prior year. Mortgage was the main driver with origination volume lighter throughout 2017. Additionally, loan fees contributed to the decline as we saw less opportunity in our healthcare space. We also repositioned a small portion of the securities portfolio at year-end for a loss of $108,000. On a more positive note, we had a 38% increase in our treasury management and other deposit service charge line. This demonstrates our ability to further penetrate our existing client base and provide them with a comprehensive financial solution. Next, you’ll notice our TriNet business, which produced over $1 million in fees in 2017. As you may recall, this was a business we entered into in the fourth quarter of 2016. And at that time, we told you one of our goals as a company was to expand our fee-related business and to be less capital and balance sheet dependent. By all internal standards, we believe this initiative has helped us in this endeavor. Additionally, as Claire mentioned earlier in the call, we hired an SBA team from a local competitor. The goal of this team is to further enhance our fee-related businesses and to deepen our product offerings to small and medium-sized businesses. So let’s move to expenses. Our overall expense base was $8.7 million, and was slightly higher than Q3 and prior year. Our efficiency ratio came in at 65.6%, salaries and employee benefits increased due to the new hires, the cost to acquire those individuals and an increase in our year-end incentive accrual. Data processing and software expense increased during the periods presented due to an increase in the volume of transactions and implementation of new software in our mortgage banking line of business. Going forward, we expect an increase in our expense base with the hiring of the new SBA team and mortgage loan officers. So let’s move on to taxes. As you may recall, we are coming up on our 10-year anniversary and many of the original investors, employees have options and warrants, which will expire in 2018. In Q4, our effective tax rate benefited as some of those options were exercised. Prior to the impact of tax reform, our effective tax rate was 20%. In 2018, our effective tax rate will benefit from the newly enacted tax reform, but will also benefit from the exercise of expiring options and warrants. Assuming these securities are exercised, we should experience an effective tax rate of 13% to 16% in 2018 dependent upon when they are exercised and at what stock price. Therefore, quarterly rates may differ some, but the annual number should fall within this range. I will touch quickly on our capital ratios, which are highlighted on Page 14. With a positive earnings and stock options being exercised in Q4, all of our capital ratios increased from Q3. I know all of your are interested in our guidance for 2018, so let me spend sometime laying out our expectations for 2018. Although, we experienced low growth in the second-half of 2017, we do expect high single to low double-digit loan growth in 2018. As stated earlier, our 2017 year-to-date average loan growth was a 11% over 2016, and we would expect to be in a similar range in 2018. We expect our net charge-offs to range between 15 and 30 basis points. We have guided you to this range in the past. And if you remove the large credit we charged off in the second quarter of 2017, we would have landed at the lower-end of this range this year. As stated earlier, we expect to continue to expand our non-interest income on fee-related businesses. The hiring of the SBA teams should provide benefits that we didn’t see in 2017, and we will continue to grow in our treasury management, wealth, and Tri-Net lines of business. We have previously talked to you about our efficiency ratio and driving that towards the low 60s by the end of 2018. While we may be elevated near-term with the hiring of new revenue producers, we expect to hit this target by the fourth quarter of 2018. I already touched on our effective tax rate, so let’s touch on our profitability aspirations. For sometime, we have talked to you about a profitability profile for CapStar and consistently producing a 1% return on average assets. Absent the DTArevaluationimpact, this is the second quarter in row with an ROA exceeding 1%. CapStar is a shareholder-focused institution, and improving our profitability profile has been and always will be a top goal. With tax reform and two interest rate increases in 2017, we’re confident that reaching a 1% ROA is now more attainable on a consistent basis, especially by the fourth quarter of 2018. However, given the recent investments in new revenue producers and seasonally low mortgage revenue in Q1, we may be below this level near-term. With that, 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. Adjusted net income of $3.7 million, or $0.28 per share represents a solid quarter of profitability. With focus on all our shareholders, we’re committed to consistently delivering strong financial results throughout the company. We’re pleased with the continued market penetration our bankers are achieving as demonstrated by the gains we posted and becoming the primary bank for clients. As I referenced earlier, a study conducted by Greenwich Associates in the fall of 2017 revealed that a majority of our commercial clients consider CapStar to be their primary treasury management provider. We’re also excited about the opportunities to grow organically for market share takeaway in creation of new business lines. 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 a new alternative financing solution for our current clients. As Rob noted in his comments, we remain committed to delivering a sustainable return on average assets of 1% by the end of the fourth quarter. We will continue to evaluate strategically and financially sound M&A opportunities to augment our franchise and our financial performance. We’re appreciative of the investment that many of you on the call have made in CapStar and your continued support. Operator, we’re now ready to open the lines for questions from participants on the call. Thank you.

[Operator:]

[Operator Instructions] Thank you. And our first question comes from the line of Nick Grant with KBW. Your line is open.

[Nicholas Grant:]

Hey, good morning, guys.

[Claire Tucker:]

Good morning, Nick.

[Nicholas Grant:]

Hey. So kind of with a little bit less loan growth than you guys had previously expected or at lower range, does that take any pressure off deposit betas and benefit the margin at the same time?

[Rob Anderson:]

Hey, Nick, it’s Rob. It would a little bit. I mean, one of our main goals is always to grow our low-cost deposits regardless of what our loan book is doing. We need some core stable funding. But certainly, if we have more growth, that’s going to put a little bit more pressure on our funding cost as well.

[Nicholas Grant:]

Okay, great. And then maybe following up on the SBA team here. So can you give a little more color on the strategy of this unit? Would all of this be just end-market customers and would it be selling entire guarantee piece, or how would you guys be looking to run this business and how fast this take to ramp up?

[Claire Tucker:]

Yes. Great question, Nick. Thanks for asking that. We’re really, really excited about the addition of this team and expect to expand it. We’ve talked with you previously about the importance of adding additional non-interest income fee sources, as well as having product line that’s complementary to our existing commercial business. So with that said, we think we’ve got some great opportunities with the team. We will sell the government guaranteed portion from which we would generate non-interest income. There’ll be a portion of each individual loan that we would hold on the balance sheet. We think that gives us some real terrific opportunities to expand into the non-credit relationships with those underlying borrowers and by that I mean expanding the – begin able to build DDA relationships, as well as again, their treasury management. It will be predominantly Middle Tennessee to answer your questions. The team has great experience that we’re excited that they’ve been here just a couple of weeks and the pipeline is already extremely strong. We also think it’s going to enable us to be introduced to some folks that we’ve not called them before, but also give us a tool to use with our existing commercial clients, where they might have a little tougher deal that you couldn’t underwrite on a traditional basis that makes more sense in one of the SBA type of products.

[Nicholas Grant:]

Okay, great. And then maybe one quick follow-up on that. As you continue with the expiration of M&A opportunities that you have on the slides and layer that on with your fee initiatives, do you kind of these deals like the SBA that add fees become more attractive relative to bank deals?

[Claire Tucker:]

I think, if you look at our history, we’ve been able to get into a couple of fee income businesses over the last several years that really enhanced our performance and reduced the reliance on the balance sheet. Example of those would be our Farmington mortgage business that we bought in 2014 and the TriNet business that we initiated in the fall of 2016. So these are not capital intensive businesses. They’re a great diversified non-interest income sources. And so I think, we’ll continue to really pursue those type of opportunities a lot.

[Nicholas Grant:]

All right. Thanks. I’ll hop back in the queue.

[Claire Tucker:]

Thank you.

[Operator:]

And our next question comes from the line of Stephen Scouten with Sandler O’Neill. Your line is open.

[Stephen Scouten:]

Hey, guys, good morning. How are you doing?

[Claire Tucker:]

Good morning, Stephen.

[Stephen Scouten:]

I was wondering if you could talk and I apologize I’ve been hopping around on different calls, if I missed some of this I can always catch it up later. But can you talk a little bit about loan pipeline maybe, and what gives you confidence around resuming kind of deposits in 2018? Any specifics that you’re seeing that gives you that confidence? And then just kind of what your plans are for that healthcare book at this point, given the last couple of quarters runoff?

[Claire Tucker:]

Let me see if I can take this in order, Stephen. The loan pipeline – I’ll start with commercial real estate, because that’s the place where we had the most significant level of pay downs in the fourth quarter. As you know, the cycle on most commercial real estate projects is anywhere from year to two-and-a-half years just depending upon the complexity of the project. And so the – in large part, the pay downs that we had in the fourth quarter in the commercial real estate arena were a result of either the project coming to completion and going to the permanent market, or as I referenced earlier, sales of some properties where people just taking money off the table. Now with that said, all the while as these projects are going on, the commercial real estate team is developing new projects. And I’m very confident in the pipeline that they’ve built over the last four, five months. As you know, we require, in most cases, the equity on these projects to go into the project first before we begin our funding. And so we will begin to benefit from commitments that we closed in the third and fourth quarter that are now beginning to fund up. So we feel good about the commercial real estate sector. I think, the healthcare team is building a very nice pipeline. We did – we had about $20 million in pay downs on several of those credits during the fourth quarter, all of which were by design in accordance with the adjusted healthcare strategy. So we believe that they are on pace to have net new growth in 2018, probably in the low double digits going into the year. And then the core C&I team, I think, sort of steady, as you go, and we feel pretty good about the pipeline that we’ve got there.

[Stephen Scouten:]

Okay. That’s really helpful. And then, I guess, if I can pivot over to the NIM kind of, how do you guys think about, maybe Rob, the upside for each additional rate hike from here? I mean, you got 3 bps from loan repricings already in 4Q. So kind of as it pertains to the December hike, maybe how much do we have left and how much do you anticipate – how much lift could you see getting from each subsequent hike from here?

[Rob Anderson:]

Yes, that’s a tricky question, Stephen. Certainly, 64% of the loan book is variable rate and tied to one month LIBOR, as we’ve stated for a long time. So we do expect our loan book to reprice in the first quarter. Obviously, the rate increase was mid-December and contractually a lot of our loans had repricing dates throughout a quarter. So it typically takes 90 days on the loan side. What I would say is that the area where we are intensely focused is around the deposit or the liability side. And what I would say through 2017, we’ve known for a long time that, our funding needs to be improved and gaining low-cost stable deposits will help us in that category. I would say, Nashville is a highly competitive market for deposits. And I think, the deposit side is where we’re going to concentrate and where we could have some slippage. Now I go back and say, hey, look at our track record on the last 125 basis points of Fed movement and with that a 19% beta, we’re modeling higher than that in our interest rate sensitivity reports, but that’s is going to be tricky. But we do expect the margin to increase with rate movement. So we’ll see where it lands in the first quarter. And I’d also point maybe to what happened in the third quarter post the second quarter this past year, you did see our margin move as an indication of what to expect.

[Stephen Scouten:]

Yes, fair point. No, that’s helpful, Rob. And then – and just, as you touched on, maybe last one for me on the deposit side. How do you think about that today now 88% loan to deposit ratio? But obviously, the loan book have been shrinking in the last couple of quarters. So I mean, are there categories of higher-cost deposits that you still feel like you can allow to runoff, or based on the growth do you anticipate for 2018? Are we actually moving in the other direction, where if you do you have to kind of step into that competition in the Nashville market to make sure you can have adequate fundings at a decent price?

[Rob Anderson:]

Yes, a couple of things that I would say on the deposit fees. First, on our loan to deposit ratio, if you included our held for sale would be closer to the 95% range and those are assets, obviously, that we have to fund with our deposit. So we’re probably running when – if you include the held for sale right around the 95% ratio, which we feel is a strong loan to deposit ratio and where we probably feel comfortable. Can it move plus or minus 5 percentage points from that point? Yes. But the cost – if we have high single-digit to low double-digit and maintaining at 95% means that we have to grow our deposits high single or low double-digit. So I would say, 2018 certainly on the deposit side, we’re going to have to grow in total. And certainly, mix change could be a portion of that, but we have our bankers surely selling on relationship and that means getting our operating account and becoming our clients primary bank. So that’s how we focus on relationship with our clients. We feel that’s the way we sell and that’s the way we optimize the relationship for the client as well. So 2018 will certainly see a positive deposit growth our loan book.

[Claire Tucker:]

Let me add one thing to that just to reinforce, we touched on in a moment ago, but we’re particularly excited about the results of the most recent customer experience study that Greenwich Associates did. And specifically, I want to point you back to the fact that, the majority of our commercial clients consider CapStar to be their primary treasury management bank. If you know that, that translates to sticky deposits, as well as nice fee income. So I think, that really shows the momentum that we’re able to capitalize on as we continued to expand the non-interest-bearing accounts in the full relationship.

[Stephen Scouten:]

Gotcha. And just as a footnote, what’s the balance of the correspondent deposits today?

[Rob Anderson:]

The balance on a correspondent book was around $165 million.

[Stephen Scouten:]

Okay, great. Thanks so much for the color, guys. I appreciate the time.

[Claire Tucker:]

Thank you.

[Rob Anderson:]

Thanks, Steve.

[Operator:]

Thank you. Our next question comes from the line of Daniel Cardenas with Raymond James. Your line is open.

[Daniel Cardenas:]

Good morning, guys.

[Claire Tucker:]

Good morning, Daniel.

[Rob Anderson:]

Good morning.

[Daniel Cardenas:]

A couple of questions for you. And as you look at your margin outlook, can you maybe give us a little bit of color as to how many rate hikes you guys have modeled in for 2018?

[Rob Anderson:]

Yes. The Fed is calling for three, I’ve heard people talk about four, I’ve heard people talk about two. We’re certainly looking at a minimum of two, Daniel, I mean, I think in 2017 we had two. So, we typically budget and talk about a flat rate environment and then we do scenario analysis with rate movements on multiple types of hikes and timings to see where we would shake out. But right now, we’re expecting two hikes for next year.

[Daniel Cardenas:]

Okay, good, good. And then maybe a little bit of color, I think, you guys mentioned that the market looks a little bit frothy, maybe a little color in terms of competitive pressures on both loan and deposits and where they’re coming from? And whether or not specifically on the deposit side, have you seen a pickup and intensity on competition for deposits?

[Claire Tucker:]

Daniel, I made a comment about it being frothy and it’s in the context of the lending market. So let me take that and then Rob will address the deposits frothiness or pressure on product pricing. I think, we’re seeing some new entrants into the market, as well as some nontraditional lenders that are more comfortable, for example, with a three-year interest-only period on a construction deal, or really pricing off of LIBOR at very, very thin margins, some of that’s coming from existing banks that are protecting local relationships. But really, the frothiness, I think, is more from some of the new inputs into the market that are looking for place to deploy their deposit or – excuse me, their funds or cash and they’re doing so by lending it into whether it’s a C&I, particularly the commercial real estate market. And what we’ve said and I think you can see a bit is that, we’re going to maintain our discipline. Healthcare is a prime example of that, where we want to make sure that we’re focused on the soundness and the profitability and not doing things that we think we’ll regret just given where we are in the business and economic cycle.

[Daniel Cardenas:]

And I guess, with that, I mean, is the competitive pressure is mostly on the pricing side, or are you beginning to see structural weakness from competitors?

[Claire Tucker:]

I think some of it’s structural. Case in point is like the three-year interest-only type of project that we believe is stretching the far end of the risk curve.

[Daniel Cardenas:]

Okay. And then, Rob, how about on the funding side?

[Rob Anderson:]

Yes. On the deposits, I mean, no. I would say, we’ve had success in 2017 across the Board, specifically in commercial and healthcare had a great year on the deposit side. So we’re able to certainly penetrate some of our core existing clients there offer treasury management and bring in some low-cost funding. Business banking has moved up in terms of the deposit gatherings on the consumer side and on the private banking. I would say, where we are being careful is a little bit on the correspondent side. I mean, previously, that book was probably $200 million. It’s around $160 million today. As you may know, that has a 100% beta on it, because we’re acting as the Fed for our correspondent banks. We typically have shied away with some public funds that are maybe not core to our market here in Middle Tennessee. Other than that, we’re seeing good growth from all aspects of our businesses and would expect that in 2018 as well.

[Daniel Cardenas:]

Okay. And you’re pretty confident that you can grow the deposit base and like step with the loan growth without significantly impacting your margin?

[Rob Anderson:]

But that’s going to be the challenge, for sure. I mean, what I would say is, our track record has been good over the – and why we put the chart in the book from Q4 of 2017 to Q4 of 2017, we’ve been able to move our checking accounts, whether it’s a NOW or a DDA and we need to continue that path. And as we grow our loan book this year, we need to make sure we hold our deposit betas and we’re working with our clients to demonstrate our value as a relationship bank.

[Daniel Cardenas:]

Okay, fair enough. All right. And then last question for me on the operating expense side. With the addition of the SBA lenders, how does that impact your operating expense number on a go-forward basis?

[Rob Anderson:]

Yes. So we’re about $8.7 million for the quarter. I think, you can see that inch up. We did have a number of hires actually in the fourth quarter. We had it around seven FTE and few of those were certainly identified in Claire’s comments on the mortgage loan officers who backfilled few positions. But with the SBA team being recently hired, that’s going to increase the run rate in 2018. I would expect that to move up. Again, we’re trying to manage with our operating leverage. But what you can expect near-term, certainly, like the efficiency ratio, I would say, was more of a function of revenue this quarter with a little bit lighter mortgage. And that’s certainly going to be the case in the first quarter that’s usually a seasonally lighter revenue quarter for us. But you can see the expense base move up from $8.7 million for those hires.

[Daniel Cardenas:]

Okay. And with the SBA lenders, they’re not operating under any non-compete agreements, are they?

[Rob Anderson:]

No, they’re not.

[Daniel Cardenas:]

Okay, great. All right, guys. Thank you, I’ll step back then.

[Claire Tucker:]

Thank you, Daniel.

[Operator:]

Thank you. Our next question comes from the line of Laurie Hunsicker with Compass Point. Your line is open.

[Laurie Hunsicker:]

Yes. Hi, thanks. Good morning.

[Claire Tucker:]

Good morning, Laurie.

[Rob Anderson:]

Good morning.

[Laurie Hunsicker:]

I just wanted to follow-up where Daniel was going with expenses, as I want to make sure that that I have a handle on it. In 2018, you’ve got a jump from the stock-based incentive comp that returns, is that correct?

[Rob Anderson:]

What do you mean, I’m sorry, maybe not following what you’re saying, Laurie.

[Laurie Hunsicker:]

So you had a – well, round numbers, I’d say, at least, I thought. I thought, you had $1 million that came out, because you didn’t hit certain hurdles that was removed back in 2Q 2017 when you had that large impair charge-offs? And so…

[Rob Anderson:]

Yes, I mean, is one of our accrual is down, if that’s what you’re asking?

[Laurie Hunsicker:]

And so does that come back up into 2018?

[Rob Anderson:]

Yes, it would come back up and we would expect that to come back up, as well as the performance is there and we expect the performance to be there.

[Laurie Hunsicker:]

Okay.

[Claire Tucker:]

Yes, Laurie, there’s great correlation to the performance of the company and how the incentive payments are made.

[Laurie Hunsicker:]

Okay. And so from a tax windfall reinvestment standpoint, if you were to quantify the dollar amount that you could see your non-interest expense line expand, what is that dollar?

[Rob Anderson:]

Noninterest expense for the tax fees, reinvestments?

[Laurie Hunsicker:]

Exactly. Right, exactly. So a lot of banks out there are saying, look, with this tax windfall what we’re doing is, we’re doing a reinvestment back into the business, salary raises, et cetera, sometimes the half a percent of expenses, sometimes it’s 1%, 2%, do you all have a number on that? Have you quantified that?

[Rob Anderson:]

No, we have not. But I would say that we’re always in the market for good talented people like the SBA team that came available. We would have done that regardless of the tax fees, that’s just the way we’re looking at growing our business. So I would not attribute any expense increase associated with tax reform.

[Laurie Hunsicker:]

Okay, okay. And so then just to sort of fine-tune, again, where I think Daniel was going. If we look at the seven FTEs that you just added plus the stock-based incentive comp. I mean, is it possible that we see that quarterly run rate? I realize there’s a seasonality to this as well, obviously, depending on where mortgage banking is falling. But if that line is closer to somewhere between $9 million to $9.2 million a quarter, is that a good run rate? Am I thinking…

[Rob Anderson:]

Yes. I think, we could easily have a nine handle on our quarterly expense base going forward, and $9 million, $9.2 million could easily be there.

[Laurie Hunsicker:]

Perfect, okay. And then secondly, I wanted to go over just to loans, the healthcare. Where – I know, you’ve given average balance in your slide deck. But do you have a period-end for that?

[Rob Anderson:]

Yes, we do. Let me grab that.

[Laurie Hunsicker:]

Okay.

[Rob Anderson:]

Yes, it’s $157 million, Laurie.

[Laurie Hunsicker:]

$157 million, okay, and that was down from $172 million. Where do we expect that to go? So that’s a pretty big drop. Where do you think that goes this year? Does that hold flat, or can you grow it?

[Claire Tucker:]

Yes. So, Laurie, great question. And I think, the way I would answer that is the $20 million drop that we experienced in the fourth quarter, again, was attributable back to several of the clients that we opted to move away from. We also had some entrants into the market from some non-bank lenders. Now with that said, what our healthcare team is positioned to do is in the low double-digit growth on a net basis. So the pipeline is good. We could still have one or two non-strategic loans payoff that might mute that in the short run. But our plan is to certainly regain our momentum there. And as I said, the pipeline is good for the business we’re working on there. So the intention, we remain very committed in the healthcare sector. As I said oftentimes, when you adjust your strategy, you have to pivot a bit and the sales cycle in terms of prospecting and conversion of a prospect to a client can take a little bit of time. I think, I’ve said last quarter that – I said both in the third and second and third quarter, we would expect that it will take a couple of quarters for them to replenish that pipeline and see those go to closing some fundings. But Mark Mattson, who is our healthcare executive is committed to the low double-digit growth in that book.

[Laurie Hunsicker:]

That’s perfect. Okay, thanks for the color. Chris, question for you. The charge-off in the quarter related to one large loan, what loan was that?

[Christopher Tietz:]

Well, I can’t be very specific on that, but that’s the one that we’ve been – we haven’t worked out over a few years. And it was one that we have previously provided detail on, it had a specific reserve put against it 12 to 18 months ago.

[Laurie Hunsicker:]

So is this a healthcare loan?

[Rob Anderson:]

It was, yes.

[Laurie Hunsicker:]

The healthcare, okay. Can you just remind us since you provided detail before, what was the balance originally and what was the reserve?

[Rob Anderson:]

Yes, the balance roughly was north of $4 million over the history of the credit. We impaired it. I’m going to say, it would have been in Q3 or Q4 of 2016. I can’t – I’m sorry, I can’t be more precise on that. But we’ve reduced it over the last year by about $700,000 and we believe that it will be close to resolution soon.

[Laurie Hunsicker:]

Oh, okay. I’m just looking, so this is the $4.4 million the prison healthcare loan or that’s different?

[Rob Anderson:]

No, no [Multiple Speakers]

[Claire Tucker:]

That one was gone way last year.

[Rob Anderson:]

Yes, that was last year, that was gone in Q1.

[Laurie Hunsicker:]

Got it. Okay, thanks. That’s helpful. Okay. And then just last question going back over to margin, what is your impact on margin from tax reform? Can you just quantify that?

[Rob Anderson:]

I wouldn’t say – I’m not sure I’m following on from a tax reform piece negligible impact on our margin.

[Laurie Hunsicker:]

Negligible, okay. And actually, sorry, just jumping back over to healthcare for one moment. I have just one follow-up. With – within $157 million, how much of that was participation?

[Rob Anderson:]

Yes, let me get that.

[Laurie Hunsicker:]

Okay. And then maybe where you’re looking for that. Claire and Chris and Rob, can you just help us think about how we should see loan loss provision shaping up for this year assuming there are no outside healthcare credits?

[Rob Anderson:]

Yes, it’s $130 million on the healthcare piece on participation.

[Laurie Hunsicker:]

A $130 million.

[Christopher Tietz:]

Let me say, it’s exactly $93 million. [Multiple Speakers]

[Rob Anderson:]

Yes, $93 million, I’m sorry.

[Laurie Hunsicker:]

$93 million out of $157 million, okay. It’s participation, okay.

[Rob Anderson:]

Yes.

[Claire Tucker:]

Yes. And Laurie, you used the participation term. But I’d remind you that in most cases, these are either club deals or deals that we’ve done with banks in our market that we can see out this window. There’s some of those that have bankers outside, but these are – we look that as a way to share credit risk in many cases. So I just want to point that out.

[Laurie Hunsicker:]

Perfect, thanks. Okay. And then, I mean, on your credit, certainly axing out the healthcare charge credit is pristine. Your reserves to loan is high at $145 million. How should we think about that in terms of provision modeling?

[Rob Anderson:]

Yes, I’ll take that one, Laurie. Certainly, we – I think $120 million, $125 million for new growth, I think, it would be a safe modeling assumption.

[Laurie Hunsicker:]

Okay, perfect. Great. Thank you very much.

[Claire Tucker:]

Thank you, Laurie.

[Operator:]

Thank you. And our next question comes from the line of Tyler Stafford with Stephens Inc. Your line is open.

[Tyler Stafford:]

Good morning, Claire and Rob.

[Claire Tucker:]

Good morning, Tyler.

[Rob Anderson:]

Good morning, Tyler.

[Tyler Stafford:]

Hey, so you gave us the expense add from SBA team. I’m just wondering, how much once these guys are fully up and running, we could see from a fee income pickup perspective?

[Claire Tucker:]

Tyler, it’s tough to say. We certainly built a business model around what our expectation is for that line of business. I don’t want to get into too much detail on that just yet since I just now hit the ground running. But you can be assured that anytime we go into a business – a new business line that we’ve flushed it out to make sure, it’s going to be very strong in terms of profitability. So I would say, stay tuned and let’s get a quarter under our belt before we get too precise on that.

[Tyler Stafford:]

Okay, that’s fair. Hey, Rob, I appreciate the 2018 tax rate outlook. I’m just wondering what the stock options and the warrants expiring this year? Where that tax rate could increase or normalize to in 2019?

[Rob Anderson:]

I think, you could see that kind of – go back up to the corp – the revised corporate tax rate, it’s 21% to slightly under…

[Tyler Stafford:]

Okay.

[Rob Anderson:]

Because we’ve had some other activities as well, but…

[Tyler Stafford:]

Okay. So borrowing changes it goes from 13% to 16% this year back to 21% and 19%?

[Rob Anderson:]

I think, slightly under 21%, but…

[Tyler Stafford:]

Okay.

[Rob Anderson:]

It would go up, for sure.

[Tyler Stafford:]

Yes, okay. So on the ROA goal, I just wanted to be clear. Does that include the two rate hikes that you mentioned earlier as you’re going look out to 2018?

[Rob Anderson:]

What I’m saying on that and we’ve said this for sometime, the 1% has been a goal of ours. And in the past two quarters, we’ve hit 1%. Our goal is to consistently be at that. I think, we said in the comments that, the first quarter is going to be pressurized due to seasonally low revenue plus the adds on the expenses for the new team. And so they hit their stride. But our expectation is that, we’re going to be above that. And if we get to rate hikes, or if we don’t get that, we’re still going to have to get above that, because I think we’ve guided there and we’ve got our plans. So we modeled both ways in terms of the rate sensitivity. If we get rate increase, I’d say, we’re above the 1%. Without it, I still think, we’re shooting for the goal of being at 1% in the fourth quarter.

[Tyler Stafford:]

Okay. And I guess, just on the ROA goal, I was a little bit surprised that you didn’t increase that 1% goal by the end of 2018, despite that, the benefits of tax rates this year taking the tax rate down to the 13% to 16%. Is the major touch point on that just the hiring you guys have done in the expense side of the equation?

[Rob Anderson:]

I think, that’s a part of it. But I want to make sure that we get above the 1%. In the third quarter, I think, we’re well above the 1%. We’re like 1.09% this quarter. So, the fact that we’re above 1% and consistently above 1% then we’ll start talking about a new target what that target will be. But let’s make sure we have a track record of getting above the 1% before we start talking about how much above 1% and we set a new target. So that could come in the coming quarters, as we feel more confident about it. But our goal is to be consistently above 1%, whether that’s 1.10%, 1.15%, we’re not going to state at this point, it’s above 1%.

[Tyler Stafford:]

Understood, okay. And then just the last one for me just to clarify, you mentioned the 11% average loan growth in 2017 versus 2016, is the high single digits to low double-digit loan growth for this year, the guidance? Is that on an end of period basis, or an average for the year?

[Rob Anderson:]

That would be on an average.

[Tyler Stafford:]

So I guess, with 2017 loans much higher to start the year and then declining throughout the year….

[Rob Anderson:]

Yes.

[Tyler Stafford:]

…that would imply end of period growth in 2018 well above that high single to low double, is that right?

[Rob Anderson:]

Yes, it would be above that. I mean, what our goal is that, at the end of the day, the year-to-date average is really driving our net interest income. So, on a spot basis, that can move up and down daily. And I don’t get hung up on spot balances too much. The fact is that our point-to-point growth in 2017 wasn’t double-digit, but our year-to-date average was. So that drives our net interest income, that’s where we’re focused on. Certainly, we’d like to see our point-to-point be above that as well. But we focus on the year-to-date average and a quarterly average and monthly average.

[Tyler Stafford:]

Okay. I’m sorry to leave it at this point. But the – to get to a 10%, call it, at the midpoint of your guidance, average loan growth 2018 versus 2017, that implies for me on an end of period basis over 30% end of period growth. Does that – I just want to make sure, I’m thinking about this, because it is a big delta just given that the low-point ending 2017 versus the high-point starting 2017?

[Rob Anderson:]

Yes. No, got a good point there. And our point is to grow our end of period balances. It will be at double digits on our end of period balance.

[Tyler Stafford:]

Okay. Okay, all right. Thanks, guys. That’s it.

[Claire Tucker:]

Thanks, Tyler.

[Operator:]

Thank you. [Operator Instructions] And our next question is a follow-up from Daniel Cardenas with Raymond James. Your line is open.

[Daniel Cardenas:]

Hi, guys. Just a couple of quick questions here. On the SBA businesses, is that a business model that can hit break-even in year one, or does that going to take a little bit longer to get there than that?

[Claire Tucker:]

Our expectation, Daniel, was that, that it would hit break-even in 2018. The variables that you have there certainly around the incremental number of new revenue producers that we add to that team, new business development officers. So, if you think about, again, the sales cycle, if we add someone midyear, that could be a bit of a drag on a team. But we would hire those people, because we believe that’s the right thing to do in terms of expanding that line of business. But if you say, all things – all other things equal, we expect to be break-even this year.

[Daniel Cardenas:]

Okay, great. And then just going back to the ROA target, does the management compensation tied to you guys hitting that target in anyway?

[Claire Tucker:]

Absolutely.

[Daniel Cardenas:]

Okay. All right. That’s it. Thanks, guys.

[Claire Tucker:]

Thank you.

[Operator:]

Thank you. I’m showing no further questions at this time. I would now like to turn the call back to Ms. Claire Tucker, President and CEO of CapStar Financial Holdings for any closing remarks.

[Claire Tucker:]

Thank you, operator, and thanks to all of you who joined the call, investors and analysts alike. We’re as always very appreciative of all of our investors, all of our shareholders. We certainly have as a daily goal making sure that we’re delivering financial results that will in order to everyone’s benefit. So we’re appreciative of that investment. We’re appreciative of your time this morning. And certainly, if you have any follow-up questions, feel free to give Rob or me a call. With that, we’ll close the call.

[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.