TriState Capital Holdings, Inc.
Q3 2015 Earnings Call Transcript

Published: 22 Oct 2015

[Operator:]

Good morning, everyone, and welcome to TriState Capital Holdings’ Conference Call to discuss the financial results for the three months ended September 30, 2015. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. Before turning the call over to management, I would like to remind everyone that today’s call may contain forward-looking statements related to TriState Capital that may generally be identified as describing the company’s future plans, objectives, or goals. Such forward-looking statements are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those currently anticipated. These forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For further information about the factors that could affect TriState Capital’s future results, please see the company’s most recent annual and quarterly reports filed on Forms 10-K and 10-Q. You should keep in mind that any forward-looking statements made by TriState Capital speak only as of the date on which they were made. New risks and uncertainties come up from time-to-time and management cannot predict these events or how they may affect the company. TriState Capital has no duty to and does not intend to update or revise forward-looking statements after the date on which they are made. To the extent non-GAAP financial measures are discussed in this call, comparable GAAP measures and reconciliations can be found in TriState Capital’s earnings release, which is available on its website at tristatecapitalbank.com. Representing TriState Capital today is Jim Getz, Chairman, President and Chief Executive Officer. Jim will be joined by Mark Sullivan, Vice Chairman and Chief Financial Officer for the question-and-answer session. At this time, I would like to turn the conference over to Mr. Getz.

[James Getz:]

Good morning and thank you for joining us today. As you saw in our earnings announcement released last night, the third quarter was very strong in terms of earnings and loan growth. We also saw meaningful improvement in our asset quality metrics, reflecting a 23% reduction in non-performing loans and continued private banking channel loan growth which further shifted the mix of our balance sheet toward lower risk profile assets. We are extremely pleased with the results we’ve posted and more importantly with the underlying trends that produced superior performance once again for TriState Capital. Our strategy is being executed on all fronts. First and foremost, our loan portfolio continues to expand at a robust clip with balances growing by $106.8 million, or 16.6% annualized for the quarter. In fact, even during a volatile quarter in the stock market, we grew private banking channel loans by $85.5 million or 13.5% annualized. This marks the sixth time we’ve exceeded 30% quarterly growth in private banking channel loans since going public. During August when the S&P 500 Dow Jones Industrial and NASDAQ Composite Index declined about 11% in a little more than a one week, our risk management processes and procedures for non-purpose margin loans worked exactly on plan. Out of approximately 2000 private banking channel loan accounts collateralized by market securities, only 13 required [cures] all of which were satisfied. The small number illustrates the quality and diversification of the liquid securities in the accounts secured in these loans. Overall, these non-purpose margin loans that are over collateralized and they are backed by well diversified liquid securities that are monitored daily by our proprietary systems. To date, TriState Capital has not experienced a single loss on a private banking channel loan backed by marketable securities. Obviously, we are very proud of this and it clearly supports our growth strategy for this product and our conference in the quality of our risk management. Now, another highlight I’d like to point out is the outstanding performance of our Chartwell boutique investment management business. Market depreciation of $560 million for assets under management to $7.6 billion at September 30, which is reflected in the lower investment management fees earned during the third quarter. The lower fees associated with recent equity market volatility were offset by lower incentive compensation expense, so Chartwell segment earnings still increased more than 4% in the second quarter and nearly 16% from the third quarter of last year. Our weighted average fee rate also remained constant at 37 basis points for the quarter. More importantly, during the third quarter stock market volatility, Chartwell added $61 million in net inflows from new and existing accounts. This is a testament for the strength of our investment management products and team and the reason we continue to seek opportunities to add to this business in line strength with additional investment management acquisitions under Chartwell. Again, the strategy we’ve outlined for growth continued to be executed exceedingly well. Most importantly, we are firmly pleased that Chartwell strategies continue to perform very well against their benchmarks. As of September 30, five of Chartwell’s investment disciplines beat their benchmarks one year performance, seven beat the benchmarks on three year performance and nine matched or beat their benchmarks on five year performance. Now, before I turn to the financials, I want to spend a moment on asset quality. You saw that we posted a large credit to provision this quarter attributable to a $1.1 million reserve reversal on two substandard credits that we successfully migrated out of the portfolio at par, as well as $433,000 recovery on a credit we previously charged off. This is a good opportunity for me to explain how we view credit as a significant driver of our profitability model. As we’ve said for many quarters now, we are actively executing a strategy to shift our loan mix toward a lower overall risk profile through emphasis on private banking channel lending and relationship-focused middle market commercial lending. There are several components to this strategy and there were in full display this quarter. First, we said that we aimed to eliminate private equity shared national credit from our commercial and industrial portfolio over time. As of September 30, we were down to $54 million in private equity related shared national credits, just 2% of total loans. One of the reserve releases this quarter was related to a substandard performing private equity-related shared national credit loan that we actively worked out at par. This was by design. Second, we take a conservative approach to underwriting coupled with a very active approach to loan workouts. Together this strategy allowed us to successfully exit a second substandard yet performing loan for which we were the sole bank at par in the third quarter. We also saw non-performing loans decline by $5.9 million or more than 23% due to sale pay downs and a charge-off during the quarter. Finally, our emphasis on private banking channel loan growth means that over time our overall level of general provisioning should continue to decline. So as we continuously monitor and actively manage our adverse-rated portfolio, while shifting the mix of our portfolio to a lower mix risk profile assets, we expect to see lower overall levels of provisioning. Our true profitability is a function of our credit profile, so we view earnings per share growth as a critical benchmark of our success. Pretax income was $9.1 million, up 7% from a linked quarter and over 10% from last year’s third quarter. Earnings per share reached $0.22 for the quarter, up 10% from both the linked and year ago quarters. On a year-to-date basis, pretax income and earnings per share were up 59% and 62%, respectively, demonstrating tremendous value of the Chartwell acquisition completed last March and compounded benefit of consistently strong quality loan and deposit growth. Net interest income increased to $17 million in the third quarter, up 2% and 4% from the linked and a year ago periods. Robust private banking channel loan growth more than offset the expected and general decline in earning asset yields, while our interest expense grew only modestly even as we’ve extended the maturity of our fixed rate deposit book. We continue to grow net interest income while maintaining high levels of floating rate loans at 84% in what we believe to be one of the more highly asset sensitive balance sheets in banking. Robust loan growth is producing net interest income that is outpacing margin compression. Together, our banking and investment management business has generated $8.1 million in the third quarter non-interest income. As discussed, market depreciation drove down investment management fees, while customer slop activity brought in lower revenue than in the linked and prior year quarters. [Bears] repeating at nearly 50% of our total revenue comes from non-capital intensive sources. So our internal capital generation can self fund significantly greater balance sheet and earnings growth than a traditional commercial bank model. This is something that net interest margin and other profitability metrics don’t reflect and is an important aspect of our unique business model. Moving on to the balance sheet, I’ve already highlighted the exceptional growth of our overall loan book. Importantly, this quarter we saw core growth across each of our middle market banking channels. Commercial real estate balances grew 3% or nearly 11% annualized during the quarter. Commercial and industrial outstandings reflected $18 million and private equity-related shared national credits that we eliminated during the quarter all at par. Over the past 12 months, we’ve reduced private equity related shared national credits by $75 million. During this run-off, our core strategic commercial and industrial portfolio grew by $17 million or 2.7% during the quarter. Our middle market channels remains a very important source of growth to us; so we’re pleased with these results. All in, private banking and commercial lending again drove total loan expansion in the quarter that readily supports our goal of achieving long-term compound annual growth rate of 15%. Here is the detailed background on loan growth over the last year. We entered the quarter with some $2.3 billion of loan outstandings on 9/30/2014 year ago. We originated this year some $758 million of loans. We had loan payouts of $382 million; we had loan pay downs of $11 million for a net loan balance growth of some $365 million. In the past 12 months, our commercial and industrial loan outstandings were down some 9%, commercial real estate was up 21% and private banking channel was up 31%; a good quarter. Our private banking channel loans continue to be sourced primarily through our growing network of financial intermediaries which now numbers some 113 firms nationwide. These firms give us access to more than 50,000 individual financial advisors. Today, we are doing $1.2 billion in private banking channel lending with fewer than 2% of those financial advisors. We continue to believe we are just scratching the surface of the growth potential within our existing referral network. Now, in terms of asset quality, I’ve already highlighted our excellent performance. Here’s how our metrics improved even further during the third quarter of 2015. Following a 23% decline during the quarter, non-performing loans of $19.1 million measured just 0.72% of loans at September 30 compared to 0.98% at June 30 and 1.17% of loans one year prior. In addition, non-performing loans declined 29% from $27 million one year prior. Adverse-rated credits declined by more than 22% from a year ago and represented just 2.1% of total loans at the end of the third quarter compared to 3.1% one year prior. Moving onto funding, TriState Capital Bank increased deposit balances by nearly 16% to $2.6 billion at September 30, 2015 compared to one year prior. As I mentioned earlier, over 2015, we continue to extend the maturities of time deposits in anticipation of a rising rate environment, moving average maturities to their highest levels since 2012. To date, time deposits represent 36% of total deposits. The weighted average maturity for all fixed rate time deposits was 299 days at the end of the third quarter compared to 186 at the end of last year and 213 days on September 30, 2014. Time deposits with maturities of 12 months or more increased to 29% of total deposits at September 30 from just 14% at the end of 2014. At 0.51% our average cost of deposits increased just two basis points from the third quarter of 2014. Our deposit gathering strategy and experienced banking team continue to be keys for securing stable low all-in cost deposits to fund loan growth. Before moving into questions and answers, I’d like to again draw your attention to the company’s very strong capital position. We believe the minimally capital-incentive earnings momentum from our private banking and investment banking businesses combined with the core earnings power of our middle market banking channel positions us extremely well to continue executing our aggressive strategic growth plans. Of course, our primary method for creating long-term value for our shareholders remains the execution of our growth strategy for the Bank and Chartwell. Since we launched this company, we’ve demonstrated our ability to efficiently and effectively deploy capital towards that end; you can expect that commitment to continue. That concludes my prepared remarks. I’ll now ask our Mark Sullivan, our Vice Chairman and Chief Financial Officer to join me for questions and answers. Operator, please open the line for questions.

[Operator:]

[Operator Instructions] The first question comes from Michael Perito of KBW.

[Michael Perito:]

Jim, starting on the expenses, you guys are obviously growing at a very high rate and usually the result of that is expense growth. But it sounds like and it seems like the private banking channel actually had some leverage to it, and the expense build out as you guys grow and penetrate these intermediaries more, isn’t this going to be as big, so can you give us any help on how you guys are thinking about your longer term expense growth rate as you guys continue to grow?

[James Getz:]

Let me address some of the general concepts that you have and then I will turn it over to Mark to give you thoughts on expense increase. We believe very strongly that we, for the most part, have the infrastructure in place for not just private banking but also our commercial banking sectors. And what I mean by that is we have the most expensive people in place, we also have the systems and support in place, we’ll more than likely continue to further enhance our power system which supports our private banking area. We outsource our backroom operation to Fiserv. So you are not going to see real dramatic increase in expenses and costs going forward into the future, because we have it all in place. If you look at each of our commercial banking locations, we believe that each of those locations can be readily a billion-dollar bank in itself. So we have five of those locations, two of them are pressing on $500 million and the others are somewhat under that, but that’s where our focus is. On the private banking side, we are asking ourselves with needs to exist to take that $1.2 billion of the $5 billion over the next three to five years. We have a lot of momentum to proceed forward on that and our focus will really be on enhancing the top line revenue going forward. Mark?

[Mark Sullivan:]

More on a micro level, Mike, if you look at Q3 non-interest expense, it’s actually a bit under Q2. And there is no one item, it’s pretty much across the board. I do think Q4 is as we expect Chartwell and investment management fees to increase, I think the compensation aspect of that will go up with it. So Q2 is probably a better benchmark than Q3. So we will see an increase in Q4, but again on a macro level, what Jim as reflected on a big picture, we will see follow out where – we are not expecting to see any significant increases in the categories of non-interest expense as we go into 2016 and the future.

[Michael Perito:]

If I try to put some rough numbers around that, I mean it sounds like really the only material item that could increase is really just the comp if you guys succeed. So I mean, are we like 3%, 4% on an annual basis a realistic number or too high, too low or...?

[Mark Sullivan:]

I think it’s realistic. I think certainly low single digit, somewhere in that 3% to 5% is reasonable.

[James Getz:]

What you want to keep in mind is not just the Chartwell, but also at the Bank, everyone working at this company is on a formulated program whether it’s within the context of the group or as an individual. So as the company progresses from a next standpoint from an EPS standpoint, the people working here will in fact benefit from it. If we don’t accomplish what we’ve lined up, it will have a negative impact on the competition levels.

[Operator:]

The next question comes from Matt Olney of Stephens.

[Matt Olney:]

I want to ask about the private banking loan channel, pretty nice growth in the third quarter; we’ve over 31% annualized here. You’ve got nice momentum. What’s the outlook? Can that momentum continue at that clip over the next few quarters?

[James Getz:]

We’re very comfortable that that momentum will continue and could even tick up somewhat going forward. Did I answer your question directly?

[Matt Olney:]

It does. What about pricing on that product? Any change from what we’ve talked about in the past?

[James Getz:]

The pricing has remained very stable, [around 2.25%] over LIBOR and it’s actually been in range for that since we introduced the program. So we really haven’t had any pricing pressure on that product at all.

[Matt Olney:]

And then going over to the margin, I think last time you guys talked about extending duration on CDs, any commentary on that and then what’s the overall commentary as far as the margin outlook?

[Mark Sullivan:]

We have continued to look to attract two and three-year CDs in the portfolio, the pace that we saw in the first and second quarter did abate somewhat in the third quarter. And again, I think people are looking to maybe stay shorter in anticipation of rate increase down the road. So it’s more biased towards six and 12-month during the quarter. But we have added about $80 million in two and three-year since the beginning of the year. As far as the overall NIM, I’ve said this many times before, but you really [indiscernible] any comments on NIM here at TriState with the caveat that our growth in loans and investor managed fees are going to continue to outpace any NIM compression that we experienced and we continue to deliver strong growth in net income and earnings per share, it’s very the focus. Again, over the last five years, rates continued NIM compression, our net income compound annual growth has been 26%. So as private banking continues to lead the way in loan growth, we will continue to see NIM compression. But the growth in loans and growth in non-interest income, primarily investment management fees, are going to continue to be the driver of our growth of net income and earnings per share.

[Operator:]

[Operator Instructions] The next question comes from John Moran of Macquarie.

[Unverified Analyst:]

This is actually [David] showing for John Moran. I just have a quick question. Do you any update on the [indiscernible] I know that you guys lowered the piece mix, but what’s the balance, any updates on when you see that balance to deplete? And do you think you will be taking any losses on those?

[Mark Sullivan:]

Right now the balance and I may have mentioned in the earlier discussion, but it’s $54 million. And you may recall, John at least recall, we’ve indicated that we will be around $50 million at the end of the year. We are calling close to the end of the year, we are close to $50 million and I expect we will meet the goal that we’ve set. So it’s really has become a bit of an immaterial number and you shouldn’t assume that those are all substandard credits, because they are absolutely not. So these are quality credits, but it’s a segment of the market that we opted to exit. So we are right in line with what we plan to do. We’ve executed pretty effectively on this and we’ve been able to get out of these all for the most part at par.

[Unverified Analyst:]

And then another follow-up, do you have any thoughts on M&A activity in your capital view, you indicated that you wanted to expand asset management, and I’m curious the progress or any updates that happened in the last three months?

[Mark Sullivan:]

We’ve been very active in the market, [Chim Little], the Chief Executive Officer of Chartwell and I spent a consequential time visiting companies with vetted several companies’ we’re seeing several companies a month. So we would anticipate that at some point over the next 18 months we will have something accomplished, but what you want to keep in mind is this is a type of business you want to make the right decision and so we are not going to allow time to cause us to be away from the right decision, much of it has to do from a cultural aspect, we are looking for the right critical mass, we are looking to be accretive to our shareholders, we are looking for the people to be able to culturally fit in, we are looking for the products to complement Chartwell and we are looking for it to be under the Chartwell monocle. So it takes some time in doing that, but I feel very confident that we will get something done in the near-term.

[Operator:]

The next question comes from Bryce Rowe of Baird.

[Bryce Rowe:]

I wanted to get a feel for the capacity of reserve credits or reserve bleed, I see in the 10-Q for June that you had a specific allowance against impaired loans of $7.7 million. So wondering of the movement on the allowance this quarter, what is the specific reserve against impaired loans now? And again, what ultimately can the allowance get down to as a percentage of loans from a base case perspective?

[Mark Sullivan:]

The specific reserves of are 6.1 at this time, we had a charge off of 1.5 during the quarter. So specifics are 6.1. And relative to the loans that are associated, we feel that they are adequately covered that all the pain has been taken and these reserves are adequate.

[James Getz:]

In that regard, let me point out something to you Bryce that might be helpful. We have now $2.7 billion loan portfolio, but we have $19 million of non-performing loans, which is a relatively minimal, but trend lines are important to look at. If you go back and look at our classified credits that we had in December 31, 2014, it was around $39.5 million and a today it’s about $24.2 million. So our classified credits or non-performance have really declined pretty handily over the past several quarters.

[Bryce Rowe:]

One follow-up, I think this has been asked on previous calls, but just want to make sure we’re correct here. With the lower risk loans that you are putting on, obviously, regulatory capital, you don’t need much to hold against as lower risk loans, but just curious is there still [indiscernible] target from a tangible common equity to tangible assets perspective that you’re targeting on the low side or will you get lower than that 8% level?

[James Getz:]

Our [indiscernible] today is like 8.74 to 9, and absent – and I’ve managed an acquisition, it will stay in that 8% range with an asset management acquisition, typically 95% of the purchase price is going to be goodwill and intangible. So that could drive it into the mid-to low seven range, which given the rationale for the decrease, we’re very comfortable with that.

[Operator:]

[Operator Instructions] The next question comes from Michael Perito of KBW.

[Michael Perito:]

Actually I was going to ask the capital question, but thanks for the color.

[Operator:]

There are no further questions at this time. This concludes the question and answer session. I’d like to turn the conference back over to Mr. Getz for closing remarks.

[James Getz:]

Thank you very much. Thank you for your continued interest and commitment to TriState Capital and we look forward to working with you in the future. Have a great day.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.