First Citizens BancShares, Inc.
Q2 2020 Earnings Call Transcript

Published: 1 Aug 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the First Citizens BancShares Q2 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. . As a reminder, today’s conference is being recorded. I would now like to introduce your host of this conference call, Mr. Tom Heath, Director of Investor Relations. You may begin.

[Tom Heath:]

Thank you, Kevin. Good morning and thank you all so much for joining us. It is my great pleasure this morning to introduce you to our Chairman and Chief Executive Officer, Frank Holding, as well as our Chief Financial Officer, Craig Nix. The two will provide an overview of the company and our second quarter results, after which we will be happy to take any questions you may have. We are also delighted to have several other members of the senior team with us and they too will be available for Q&A. Our remarks today will reference an earnings presentation that is available at firstcitizens.com/earningspresentation.

[Frank Holding:]

Thank you, Tom, and good morning, everyone. All of us have been through a challenging four-plus month now and I want to start by saying how proud I am of this organization for rising to the occasion and being the best it can be for our customers, communities and associates. We like to think of First Citizens as showing its best in trying times, and I genuinely believe we’re doing so. As we move into the presentation, we will give you some specific examples that speak to this point. Today represents the first time that we’ve conducted an earnings call and we concluded that as we’ve grown, have issued more securities into the market and are getting a lot more attention from both analysts and investors, that all of our constituencies would benefit from the calls. So thank you again for joining us, and we’re delighted to be here. Prior to diving into our second quarter results, we thought it would be helpful to quickly review a few pages on who we are and what we think about ourselves, so we will briefly do so and then move to the second quarter earnings commentary. So let me begin on Page 3. I’ll note that First Citizens has operated since 1898, and I’ve personally been or have had the good fortune to be a part of the organization since 1983. Over the past three decades, we’ve grown assets from approximately $3.5 billion to almost $48 billion today. With deposits of 41.5 billion as of June 30, we now rank as approximately the 38th largest U.S. bank. Our Chief Financial Officer, Craig Nix, will cover our second quarter financial performance later in the presentation. But despite a challenging environment, we’ve achieved a return on assets of close to 1% and a return on common equity of 11.40% in the first six months of 2020. The core of the franchise, the attractive markets of the Carolinas, represents 73% of our deposit base with many adjacent markets in the Greater Southeast from Maryland to Florida. Beginning with my predecessor, however, we have from time to time expanded out of market as we saw opportunities. We will touch on this in more detail shortly, but we are pleased with all of our geographies, and to an extent we are a national franchise.

[Craig Nix:]

Thank you, Frank, and good morning to you all. Continuing where Frank left off in the deck, I would like to briefly discuss our second quarter earnings results, which are included on Page 17, and then I will move on to more specific pages that detail the drivers behind our results. For the second quarter, we earned nearly 154 million before preferred dividends and nearly 149 million after dividends. This represented a 24.8% increase in net income available to common shareholders over the second quarter of last year. Earnings translated to $14.74 per share, an ROA of 1.36% and an ROE of 16.43%.

[Frank Holding:]

Craig, thank you. We’re pleased with the quarter and excited about our opportunities going forward. We welcome any questions you may have.

[Operator:]

. Our first question comes from Josh Wheeler with Reinhart Partners.

[Josh Wheeler:]

Hello. I just want to start by saying, we’ve been shareholders for going on seven years now and we really appreciate you taking the step to open up more communication with investors and put more information out. We think you have a unique and a compelling story. So we appreciate this step forward. Just wanted to ask about if we are in a lower rate environment for a longer period of time here and NIM is kind of structurally lower, are there significant cost takeouts that you can execute? And maybe you can touch on, is there an intention to get your efficiency ratio more in line with peers, maybe somewhere in the 50s?

[Craig Nix:]

This is Craig Nix here. I’ll take the first part of that and I’ll let Elliot Howard, our Director of Financial Strategy, amplify my comment there. I think – just as I referenced in my comments, our efficiency ratio is higher a bit by design, given our go-to-market strategy. The payoff of that is a very low cost of funds. In times like this, we are likely to operate in a range of efficiency ratio between 67% and 70%. And in better business cycles or normal business cycles, we’re comfortable in the 62% to 65% range. I will tell you that we are very diligent about lowering our expenses where we have a lot of focus also on the denominator side of that, the revenue side as well. But I will let Elliot Howard, our Director of Financial Strategy, talk about some of the costs that will be removed for both acquisitions and as we convert those and also talk about a little bit of the impact of this hiring freeze that we’ve instituted.

[Elliot Howard:]

That’s correct. Thank you, Craig. So when we look forward, I think the thing we have on the horizon is to be at least – is the conversion of Entegra in August. We think compared to where our run rates have been on those acquisitions this year, it will save $18 million out of our cost base on an annualized basis. As we look to branch closures, we’ve been diligent about looking at our branch network. We closed over 100 branches since 2015 for an estimated annualized impact of 27 million, and we’ll continue that process with the least impact to our communities and places where it makes sense. One thing we are committed to is our technology and digital spend. We really see this as something we’ve committed fully to over the past few years and continue to do so. So as we move forward, outside of the conversion expense, the hiring freeze we think will have a $15 million positive impact on the following year compared to what the run rate would have been previously. And we’re going to also continue to assess our branch network in terms of how we staff, how we work hours and how we serve our clients because I think that’s one of the positive impacts of the COVID-19 experience is that we’ve learned a little bit more about our customer base, some of their habits and how we can serve them better with the altered brand strategy.

[Josh Wheeler:]

Okay. You touched on your acquisition strategy a fair bit. Can you talk more about the trade-off of looking at new geographies, new markets versus the higher profitability that you would get from building density around your core markets? And also, if you could touch on just how you think about return hurdles in general for acquisitions.

[Elliot Howard:]

Sure. This is Elliot again. So when we look at acquisitions in general, I think we consider a few things. First, is the market attractive and can we grow there? Can we sustain the business? Can we control the credit issues? And can we generate low-cost deposits in the market? What type of talent is going to come along with that acquisition? And is this a cultural fit? I think overall, we’re extremely focused on tangible book value growth. With that comes, from an acquisition standpoint, that most often in-market acquisitions serve that best. And so I think more generally, you see us pursue in-market acquisitions. We will pursue adjacent or out-of-market acquisitions when the financial case is compelling. From the financial metrics, we really look at a shortened tangible dilution period and payback. We look at the earnings per share accretion as well as what the internal rate of return is on the acquisition. For acquisitions that are outside of our market that might prevent a little bit higher risk, we’re obviously going to look for a higher rate of return when we look at that acquisition.

[Josh Wheeler:]

Are you likely to do a deal that’s much larger in size than what we’ve seen you do, which is a lot of smaller deals in recent years? Is that something that’s on the table?

[Elliot Howard:]

Yes. I think in this current environment where valuations are, I think there’s a lot of compelling reasons with earnings compression, with NIM compression, to consider larger deals. I think we’re constantly on the look for the value of our shareholder. And if we found an opportunity that really afforded that, created a stronger institution, created better capabilities for our customers, we’d certainly consider it.

[Josh Wheeler:]

Okay. In regards to the loan portfolio, I think medical and dental loans are roughly 18% of the total. Can you talk more about the composition of that portfolio and how you expect it to perform from a credit standpoint contrasting with '08, '09 where I think losses were minuscule, but dentist offices faced some unique challenges to operate in this time with the virus?

[Craig Nix:]

Okay. Jim Bryan, our Chief Credit Officer, will answer that question.

[Jim Bryan:]

Thank you for the question. We do have a good concentration in the dental activity. What we are seeing is that, if you recall, our dentist professionals were asked to stand down in the early stages of the pandemic. And now they are back at work and their offices are open. If you look at the detail of the deferral activity, we had seen dramatic decrease in deferral activity with a very modest 1% asking for a second deferral. They have gone back to payment. They are open. We do not anticipate material deterioration in that portfolio at all.

[Josh Wheeler:]

Is that book mostly dental or is it a mix of medical and dental?

[Jim Bryan:]

Well, we do have a strong medical book as well. The one I just referenced is the dental portfolio, but we don’t anticipate heightened risk issues in either of those portfolios. They both are back at work and accepting patients and working at or near levels prior to COVID.

[Josh Wheeler:]

And 8, 9 and 10 were the losses in that portfolio below average losses across your C&I book?

[Jim Bryan:]

Yes, they were.

[Josh Wheeler:]

Okay. And you’d expect similar performance this time?

[Jim Bryan:]

We do.

[Josh Wheeler:]

Your organic loan growth this quarter was good, I think 2.8% sequentially driven by CRE. Most banks are seeing flat or declines organically outside of PPP. Are you taking share in your markets or are your markets just outperforming the overall economy? And what do you expect to hear for the next few quarters?

[Frank Holding:]

We had a good start in the first quarter of this year. And I think what has happened is that this has been a continuation of that activity. There is disruption in the market with the merger of BB&T and also with the issues the Wells Fargo has been dealing with in North Carolina, the old Wachovia client, it’s an opportunity for us. So I think that disruption in the market has helped us with our growth strategy. And the other side of it too is that even though we were actively engaged in PPP, our bankers continued to try to attempt to develop business in those sectors that we thought would come through this well, and one of those is medical and dental which is a big part of our focus.

[Josh Wheeler:]

Okay. You bought back a fair amount of stock in the last few years, particularly in the last few quarters. I think that’s relatively new for your organization. Can you talk about your strategy there and if that’s something that we should expect to continue?

[Craig Nix:]

Okay. I will ask Tom Eklund, our Treasurer, to touch on that.

[Tom Eklund:]

Yes. So we look at our share repurchases as a way to return excess capital to shareholders, increase future earnings per share and return on equity. And we’ve been fortunate enough to have earnings growth outpacing asset growth, which has led to excess capital. And when we can’t fill that void with mergers and acquisitions, we look to share repurchases as a viable option. They’re obviously looked at in combination with internal asset growth and M&A opportunities. So essentially, it is a way for us to efficiently manage our capital.

[Josh Wheeler:]

Okay. So something we can expect to continue here for the next – for the medium term?

[Craig Nix:]

I will say that we made a decision in the current quarter to suspend repurchases of shares just to be consistent with the rest of the market. I would tell you that we will reassess that at the end of the third quarter, not trying to send the message we have capital concerns because our capital ratios are certainly on the upper end of the ranges that we target. But we are just to be prudent and consistent with the industry, we are suspending for the third quarter. Look for us to reassess that in the fourth quarter.

[Josh Wheeler:]

Okay. And then lastly – I’m sorry?

[Craig Nix:]

It was Craig Nix, by the way. I’ve transitioned from Tom, just wanted to let you know.

[Josh Wheeler:]

Okay, I appreciate that. And lastly for me, did I hear you right in your discussion on noninterest income, you have an actively managed portfolio of publicly traded bank stocks and that’s what contributed to the big gains?

[Craig Nix:]

Tom Eklund, Treasurer, will address that question.

[Tom Eklund:]

Yes. So we have had – Craig mentioned earlier, since 2015 we have added positions in bank stocks where we look for quality bank holding companies or banks. We consider those purchases to be intermediate to long term in nature and recognize that many of them, not all of them necessarily are candidates for acquisitions by us or another financial institution at a premium. We had activity during the quarter. As you saw in the financials, we had at the high point that equity portfolio which is out in the first quarter, it hit a percentage of CET1 of 9.64%. And as a percentage of total assets, it was 76 basis points and 3.6% of our total investment securities. During the first quarter or during the second quarter, we sold out of it, realizing gains of 37 million and additional fair market value adjustments of approximately 27 million on top of that.

[Josh Wheeler:]

So is this portfolio mostly larger banks, banks you find in the S&P 500, that type of thing or is it private placements, OTC, stock, small banks? What’s the composition like?

[Tom Eklund:]

It’s a little bit of both, but it’s not really larger banks. It’s mostly, I would say, smaller to community bank size.

[Josh Wheeler:]

Okay, interesting. Well, that’s good for me. Thanks, again, and I appreciate you doing the call.

[Craig Nix:]

Thanks for your questions.

[Operator:]

And I’m not showing any further questions at this time. I’d like to turn the call back over to our host for any closing remarks.

[Tom Heath:]

Thank you very much for joining us. And if you have any questions or as you think about it further, by all means give us a call. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today’s presentation. You may now disconnect and have a wonderful day.