Q3 2019 Earnings Call
Welcome to the old National Bancorp third quarter 2019 earnings Conference call.
This call is being recorded and has been made accessible to the public in accordance with the Fccs regulation FD.
<unk> body presentation slides can be found on the Investor relations page at old National Dot Com.
And will be archived there for 12 months.
Before turning the call over management would like to remind everyone that as noted on slide two certain statements on today's call maybe forward looking in nature and are subject to certain risks uncertainties and other factors that could cause actual results to differ from those discussed the company's risk factors are fully disclose and discuss within it.
As you see filings.
In addition start to fly its contain non-GAAP measures, which management believes provides more appropriate comparisons.
These non-GAAP measures are intended to assist investors understanding of performance trends reconciliation for these families are contained within the appendix other presentation I know I turn the call over to Jim Ryan for opening remarks Mr. Ryan.
Good morning.
I would characterize our third quarter results, that's consistent with our stated strategy and slightly better than our own expectations.
Net income was $69.8 million an earnings per share of a 41 cents when adjusted for merger charges a debt securities gain net income was slightly higher at $70.5 million. We were pleased that adjusted earnings per share is up more than 10% from a year ago.
And your view our results you'll see that are core margin change was inline with our previous guidance. We also had a strong quarter near fee income businesses, but do expect them to return to their nanny seasonal patterns and lastly, we demonstrated good expense control.
As you can see on slide three our adjusted return on average assets was 1.4% and our adjusted return on average tangible common equity was a strong 17.2%.
During the quarter, we did see record new commercial loan production.
Commercial real estate leaves loans grew nicely, but were offset by continued elevated levels of commercial industrial twice, so wonder businesses and lower flying usage as a result total loans were essentially flat for the second quarter.
I remain confident American losing clients or opportunities because we are competitive in fact, our markets remain strong and our clients continue to be optimistic as evidenced by a record commercial production.
Today, our commercial pipeline remains a strong $2 billion.
You have come to expect from us given the global backdrop and inconsistent economic data. We're also staying disciplined and continued to focus on lending at our footprint.
Total deposits increased 2.4% annualized and total cost of deposits in September with 49 basis points versus 52 basis points for the full third quarter. We've deliberately started to reprice. Our core deposits are actually Teresa fed moves and the inverted yield curve.
Loans deposits are also a strong 84% and we remain a low cost core deposit funded bank.
Regardless of the interest rate environment today, we believe the key to long term success is a low cost core deposit base.
We remain focused on improving our operating leverage despite the challenging revenue environment operating <unk> operating leverage improved 60, 624 basis points year over year, and our adjusted efficiency ratio was a low 55.2%, 6%, which approved 341 basis points year over year.
Exceptional credit quality remains a hallmark of our company with our lower in house lending limits and diversified mix in a granular loan portfolio.
Average, new commercial credit remains well under $1 million despite the record production.
We recorded $1.4 million in provision net charge offs, only 800000 and those that have followed us for a while can appreciate we're very quick to identify weakness in credits we are hard graders and we work through issues in a very timely fashion.
Already P H did fall slightly to 1.31%.
On the capital front, we did repurchase 2.2 million shares at an average price of approximately $16.80 this quarter.
Despite these repurchases tangible book value per share grew by 3.2% and tangible common equity to assets stood at a strong 8.95%.
We expect to be opportunistic with remaining authorization as we have been year to date.
Right, it's going to provide more details and participated they won't increase to the allowance for loan losses related to the adoption Cecil.
Under current economic conditions, we don't see a material change in our children reserve for legacy portfolio as a result in more conservative lending standards in mix. However, we do need to establish a reserve for the acquired loans accounted for under purchase accounting.
As I mentioned in prior calls we spent the year internally focused and I've challenged or executive team to think about ways, we can get better.
We've generated some terrific ideas. We've also partnered with a leading consulting firm to help us think through somebody that's work I wanted to provide you with a quick update.
Today, we are moving towards redefining at restructuring the way we do business. This includes examining everything from how we deliver products and services <unk> paper across the company to how we allocate capital and much more.
The goal in the program is to improve the overall efficiency of the organization, while improving our flight experiences.
We're just completing this comprehensive analysis every business every department every function within the company.
From this analysis, we are developing initiatives that we plan to execute over the next year.
As we complete I read you would find ways initiatives, what I can share with you now is it appears we have meaningful opportunities to leverage our infrastructure improve our operating efficiency and drive more revenue.
Given the extensive nature of this review we plan to provide more detailed information around the opportunities identified in our next quarterly earnings call at that time should to be able to provide details regarding the benefits. We anticipate the related cost of implementation in a timeline for achieving good results.
A quick update on M&A, our strategy hasn't changed we were made an active look very selective buyer, where a patient and continue to wait for the perfect goods for what we remain focused on execution as.
We have fully integrate our client partnership and have realized all of the cost savings now.
Minnesota operations continue to perform in line with expectations in remain enthusiastic around the opportunities in that key market.
Next right is going to walk through this quarter's details.
Thank you Jim.
Turning to the quarter on slide for both our GAAP earnings per share and our adjusted earnings per share were 41 cents.
Adjusted earnings per share excludes $1.3 million merger related charges as was $400000 in debt securities gains.
Moving to slide five adjusted pretax pre provision net revenue was 27% higher year over year.
This result was driven by increased scale from our most recent Minnesota partnership.
Low credit cost strong low cost deposit base and a continued focus on expense management.
We also improved operating leverage by 624 basis points year over year.
Slide six shows the trend in outstanding loans, it's Jim referenced our commercial loan production of $680 million was the largest in our company's history, representing 52 million dollar increase over prior quarter.
We ended the quarter with a record 2 billion dollar pipeline and commercial activity remains strong.
Despite a record commercial loan production and saw the theory growth total loans fell slightly in the quarter.
They did levels of payoffs along with lower line utilization this quarter contributed to the slight decline.
Loan portfolio yields excluding accretion interest collected on non accrual declined seven basis points and new production yields were down 24 basis points <unk>, 4.15%.
Moving to slide seven period end deposit increase during the quarter declined slightly on an average basis. Our total cost of deposits is unchanged quarter over quarter at very low 52 basis points. We continue to actively managed deposit costs in this down rate cycle and are pleased there September total cost of deposits was 49 basis 0.3 basis points below our third quarter average.
With nearly $1 billion in deposits index, the fed funds and proactive management of our exception price book, we're confident in our ability to thoughtfully managed deposit costs lower in response to future fed actions.
Slide eight shows our year over year change in loan mix as well as our earning asset mix for the third quarter. We've continued to remix the loan portfolio towards more productive commercial and commercial real estate loans and out of indirect another loves.
The investment full portfolio yield was down 16 basis points quarter over quarter, the 13 basis points in the decline due to higher premium amortization, resulting from the sharp decline in long term rates in August .
Next on slide nine, let's see the detailed changes in our third quarter net interest income corresponding margin.
We're pleased with the performance of the margin given the challenges presented by the interest rate environment.
Net interest margin, excluding accretion was in line with our expectations at 3.26% compared to 3.39% last quarter. If you recall second quarter core margin included 13 basis points of interest collected on nonaccrual loans, which was significantly higher than normal normalizing for the higher than expected accretion and lower interest collected on non accruals the margin show five basis.
Points of compression.
Four basis like this decline was attributable attributable to higher premium amortization.
The work we've done on the balance sheet over the past year has allowed us to defend our margin well and should help mitigate future margin headwind from this challenging yield curve.
Slide 10 shows trends in adjusted noninterest income our third quarter noninterest income increased $3 million over a strong second quarter performance due to ongoing strength in both our mortgage banking and capital markets revenue lines. Also include on the slide as our purchase versus refi percentage for the mortgage business lower interest rates in third quarter led to an increase in refi activity, which accounted for 45.
Understand if our production.
Next slide 11 shows the trend and adjusted noninterest expenses as you can see we experienced a significant decline in adjusted expenses as we fully realize the benefits apply partnership cost saves following our second quarter systems conversion.
Also worth noting is the reduction and not occupancy expense this quarter, which included a $1.9 million property tax accrual reversal that will not recur in Q4.
Our adjusted efficiency ratio for the third quarter was 55.26% to 341 basis point improvement from the third quarter of 2018.
<unk> expense discipline is an important part of our culture and despite the revenue headwinds impacting the industry remain committed to generating positive operating leverage.
Slide 12 has our credit metrics.
Credit conditions remain benign as we experienced positive migration during the quarter and nonperforming and underperforming loans continued to hover near cycle lows.
Reported $1.4 million in provision expense during third quarter booking net charge offs of $800000. We've added pure data to our credit side the sport for comparative purposes, while we run higher nonperforming loans than our peers. We believe our practice of recognizing credit issues early and actively engaging with far worse leads to better outcomes as evidenced by our below peer average charge offs.
Slide 13 demonstrates our strong revert reserve coverage and low risk balance sheet with 60 basis points of reserves against organic loans and 324 basis points in loan market gets acquired loans. We believe that we have adequate reserve coverage.
Before we turn away from credit we want to provide you with an update on our chief transition to Cecil progress towards complying with the new standard remains well on track for January Onest implementation activities in the first fourth quarter will be focused on drafting disclosures and finalizing our controlled and governance framework.
Looking to the day, one impact of diesel we currently estimate an increase to our allowance for loan losses of approximately $35 million to $45 million. A large portion of this increases related to these dabbling in it but allowance for $2.7 billion of acquired loans with relatively modest increase in reserves on the remaining legacy book the range reflects the uncertainty the future of macroeconomic.
But assuming economic conditions remained stable, we would expect you need to be near the lower end of this range more detailed information, but will be provided in our fourth quarter call.
Slide 14 provide some key takeaway from a third quarter performance. We're pleased with our results driven by good execution against our stated strategy. We continue to have a disciplined approach a credit risk management, resulting in net charge offs of just three basis point and near cycle low nonperforming loans.
We're driving positive operating leverage improving our efficiency ratio increasing profitability metrics, while loan growth was lower than our expectations. Both production and pipeline reached record highs and we remain optimistic that our ability to produce quality loans without compromising on credit discipline and finally, we are pleased with the stability in our margin, which was down just five basis points quarter over quarter.
Leading accretion income and interest collected on nonaccrual loans.
Slide 15, if we felt in our third quarter starting point in our outlook for the remainder of 2019, we expect commercial loan production to remain strong based on both the size and quality of our pipeline. We expect core net interest margin to be under some pressure from the shape of the yield curve heading that last quarter of the year.
That's a slight suggest fees and expenses should follow normal seasonal patterns and we remain very focused on continuing to drive positive operating leverage our fourth quarter tax rate is expected to be approximately 23% on enough to eat basis, and approximately 20% on a GAAP basis. We continue to expect tax credit amortization to be de Minimis lastly, the cost save from our clients.
Order shifts have been realized and we're very optimistic about opportunities in Minnesota with that we're happy to answer any questions that you may have and we do have the rest of the team here with us, including Jim Sandgren, Daryl Moore and John Moran.
[noise] [noise] Dorothy we'll take questions at this time.
This time I will like to remind everybody in order to ask a question. Please press Star then the number one on your telephone keypad, we will pause for just a moment took a topic you in a roster.
Your first question comes from a line of Scott Siefers with Sandler O'neill.
Scott.
Good how are you.
Good good. Thank you I. Appreciate you taking my question I think first question is just on the cost base got some really positive momentum here in the third quarter as you head articulated would be the case. So that was a good result, just curious as to what you're thinking for the fourth quarter I think in your prepared remarks, you had suggested that we fully realized the.
And savings is it possible that we could see another downdraft in expenses or would more flattish kind of be though the way you're thinking now that the cost savings are all in there.
Yeah, I think flattish from here I, just got just point you back to the 1.9 million dollar occupancy expense line item that won't be recurring that keeps us on the low twentys going forward.
Okay, perfect LOE and <unk>.
Alright, perfect. Thank you and then appreciate the disclosure on the Cecil day, one impact I guess to the Accenture you're comfortable I'm just curious if.
If you have any thoughts on what the day to a impact will look like as well you know do the the purchase accounting benefits to those sort of go away or just sort of get re.
Categorized into that the provision you guys have any thoughts that you're comfortable sharing at this point.
Well I think what I can share with you. Scott is is that that the legacy book in provisioning for new loan growth will be relatively small change moving forward, so not immaterial impact or how we provision going forward for loan growth.
Okay.
Alright.
That sounds perfect great I appreciate it thanks Scott.
Your next question comes from a line of Chris Mcgratty with KBW.
Turning Chris Hi, good morning.
But quick question on kind of like the capital on the growth dynamic you looking over the past year, you've done a lot of capital [noise], despite being fairly aggressive with the buyback I guess it with the bigger question is what what turns a loan growth from here anything you're kind of any views on you know the prepayment activity what might make.
That abate a little bit and also kind of like you've got about a million have shares anything from keeping the company from authorizing additional buybacks. Thanks.
I'll, let Jim talk with the loan growth and I will comment on the share buyback.
Yeah, you know it is both Jim and Brendan I pointed out you know pipelines continue to be really strong production is great. You know hopefully we feel slow down in payoffs, but you know private equity continues to be aggressive a lot of companies continue to sell they don't have succession plans lot of the commercial real estate continues to look to refinance in the United seconds.
The market so.
We would like to see that slow, but but short of that we're really just focused on what we can control and that's taking care of our customers and are continuing to show a record production. So that's where our focus is and then hopefully we'll just see as a slower.
[noise] level up a pay downs the other thing that hit us in the quarters as Jim pointed out was the lower a line utilization and so that impacted balances a little bit. So hopefully we can see that I'll. The turn in the fourth quarter. So I can help.
Regarding the stock buyback you know it's been a good capital management tool and what we're close to the end of our authorization you know I would think we want to have that tool our tool kit if ah if the kind of relative value represented itself to us next year too.
Okay.
Oh, great credit numbers were very good can you provide a and update on the AG portfolio, what the any kind of stress there any kind of updated thoughts.
Chris This is Darryl.
Really we're gonna have to get into November to really know what's going on there first is just our farmers, bringing crops in the field second is the level of payments that are farmers are going to get we're really not going to know that for another two to three weeks and that'll have did have an impact on their strength.
You know we've talked a little bit about this before our AG portfolio was now I'm. Most of the customers are we have in the portfolio still have adequate equity in their land. So we've only got about 315 $320 million and adding outstanding. So that is not a portfolio today that concerns us a lot just simply because of the size and.
I don't think Theres a lot for us today, given the current dynamics a lot of loss content portfolio.
Okay, great and maybe bring and one for you the tax rate enough in the fourth quarter. The tick up that you expect that Kinda Fair Forum for 2020, as we look into it.
Yeah, I think that that's a fair fair number for the next several quarters yet.
Thank you.
Your next question comes from a line of Nathan race with Piper Jaffray.
And then it goes.
Good morning question first maybe the securities portfolio says you know obviously some growth this quarter just given the deposit inflows in the challenging loan growth. So I guess from here in the fourth quarter or do you expect it to be a steady state or should we expect some shrinkage is loan growth picks up and perhaps deposit growth slows so yeah.
Yeah, I think I think it's a little higher we pre purchased a when we had some opportunities with the rate environment, given some deposits and and given the cast those are coming off that portfolio. I don't think will grow up from here if anything like may come down a little bit in the fourth quarter.
Okay perfect helpful and Jim just on the operational overview. That's that you guys will be wrapping up shortly just I'm just any sense I guess at this point and I. Appreciate this early in the process in terms of its going to be more of an expense or.
Or.
Or revenue driven exercise at this point.
Oh, I think the beauty as will benefit on both sides of that the reality is that it's it's a top to bottom review that we hope to deliver better client experiences on the other side of it and I'm confident that we'll get more efficient effective we just reduce redundancy and overlap and then and then we'll drive more revenue as a result of it too so.
It's really on both sides of it and it's it's too early to determine how much is one way or the other but it's definitely a.
We're definitely interested in driving more revenue going forward I think the decided to get a little bit cost saves upfront.
Okay, Great I appreciate guys taking questions.
Your next question comes from a line of Terry Mcevoy with Stephens.
Good morning, Terry Hi, Good morning, everyone I'm, just a follow up on needs question need the internal review I guess my question is is why now as an outsider you know and I was going to be pressured mortgage could be pressured next year is it simply there's revenue pressure now's the time to find incremental cost to keep the efficiency ratio stable and.
The efficiency ratio already 55% you know very respectable can can that go lower from here in connection with this plan.
So the why now question I think part of the part of that why now is you know obviously, we're entering a difficult interest rate environment, which is gonna be net interest margin growth challenging right. So that's part of it in part of it as you know on brand new to the C. I think we all felt like there was better ways, we can improve our client experiences and so.
Really the management team went off starting very early on in a year and talked about hey, or are there ways. We can do change to get better and so we've been working on them for the better part of the year and.
Well getting close to its rapid this thing up but it's really been focused not just delivering a better overall client experience.
Thanks, Jim and then my follow up question going back to see so if I looked at the third quarter reserve and just add in the $34 million to $45 million relative to loans I'm at 76 to 84 basis points I'm. Just wondering will the do you disclose the unfunded commitment liability will that be included in the in the new reserve.
Next year, and then any other adjustments on the Mark portfolio and ultimate I'm trying to come up with a reserve to loan ratio next year.
And I should should I be adding anything to the range I am I I came up with it originally.
Yes, Terry I think I think you're on the right you're on the right track, we we're not disclosing the range or what the overall reserve ratio will be right now, but but your math is <unk> logic follows.
Okay. Thank you.
Thanks Terry.
Your next question comes from the line of Jon Arfstrom with RBC capital markets morning, John Hey, Good morning.
Question on the margin outlook I <unk>, you guys had a pretty good quarter.
On a core basis did better than than we thought you based on what everybody else has been doing but.
<unk> I understand you're saying some pressure, but help US you know kind of walk through the puts and takes in terms of how you want us to think about the margin you know when Q4 and maybe early in 2020.
Yeah. So I think we're going to see some asset yield compression both on the loans and the investment side, but we have we have some levers to pull and the borrowing side as well as deposits. We have almost 20% of our deposit book is is except in price and a big chunk of that is floating after we ought to pull that lever a pretty.
Quickly the other thing I'd just point to the premium amortization headwinds, we said we experienced in the third quarter not likely to repeat themselves and fourth quarter, just given I think assuming that we don't have another 30 50 basis point drop them in long term rates. So we feel really comfortable with a with a margin compression similar.
What we saw quarter over quarter.
<unk>.
Okay. Good.
Okay, and then [noise].
Couple of other things the average.
New production loan size. It some 50 I think the point you're trying to make there is that you know you're not necessarily taking bigger swings.
And then it's a granular portfolio, but just curious where you think that number could go overtime or do you plan to keep it under a million.
It's definitely trending higher or you know as we entered Minnesota some of our newer markets. So you end up having a lot of loans on the small side and a handful loans on a larger side, it's definitely trending higher from you know it was a half million dollars a one point in time, but Ah, but I don't.
We don't look at it in terms of we're trying to target a specific size, but it is just a reminder, that our portfolio I think is a little different than most $20 billion banks, where I think we are still a because our bank that's focused on medium to small sized businesses and you know we don't go off and do you know large shared national credits or no Big club deals.
For the most part which is very small portfolios for us. So I think we're just just trying to remind everybody that I think that helps us in the future. If a if the markets get little more choppy in terms of credit quality yeah. Okay.
And then I guess the <unk>. The last question the normal seasonal patterns you are on fees you call. It all we understand it again I guess the question is what are you, saying there that you just expect.
Primarily mortgage to pull back a bit in Q4 is that is that the big picture message. Yeah. I think I think that's the big picture Messes that mortgage you know I think you'll see it's still relatively strong, but it's going to return to you know fourth quarter is always a smaller quarter in that business for us.
Okay alright, thank you.
Yes.
You have a follow up question from the line as Chris Mcgratty with KBW.
Yes.
Great. Thanks, just following up on a the impact to see so for 2020 <unk> in the slide deck, you give your expectation for [noise].
Accretable yield contribution it gets dropping like 80 million Bucks historically, you've always outperformed that because of prepaid how do we think about you know the variance to that $18 million next year is that kind of what you're expecting given the step down because of accretion in seasonal or any kind of help there would be appreciated.
Yeah, I think that I think that's still an accurate look based on contractual expectations. As you said prepays won't need. It may result in that's happened a little more in 2020, I think the only seasonal impact yet to be thinking about is that that market is no longer available to offset charge offs, but we don't think thats going to be a hugely material number.
Her for us going forward.
Okay, great. Thanks.
Your next question comes from the line as Kevin Reevey with D.A. Davidson.
Kevin Good morning.
First question is related to what percentage of your loan commercial loan book is variable and then of that amount Oh, what percentage of the book. It has for a little was and where you are where are you in terms of floors on the book So on the commercial say Kevin at were at 52%.
Variable, we have about 11% of our loans have floors, but they're pretty far outside the money most of the floor impact we have really through the kind of macro hedges that I portfolio.
And that I'm, sorry, you said the 11.
Total portfolio, 42% variable Kevin started in the 11% is that did have floors is that of the commercial book or the total book So total book.
Got it.
And Oh, <unk> M&A or what are your M&A, probably already been down now you've got a you know you've got a nice presence in Minnesota Youre in other markets I'm trying to how do you think about your M&A priorities from a geographic standpoint, and then from massage standpoint.
Yeah I think.
We've been pretty public around that wander threed shoot a $4 billion kind of ideal size for us and at this point, we're focusing most most of our energy in footprint and markets that we'd like to continue to build scale in other places we're kind of sub scale and we've got nice told but it's nice to continue to grow scaling it in a few of those markets but.
Our newest markets, including Minnesota, and Wisconsin, and Michigan remain high Ferraris for us we'd like to continue to build out you know parts of Kentucky, but well, there's kind of limited opportunities there, but but those newer markets continued to build scale in our kind of fastest growing markets our highest priority.
Great. Thank you very much.
Your next question comes from a line of Scott Barry with Boeing in Scattergood.
Hi, Scott Good morning, Hey, good morning, guys.
I just had one question related to be internal review that you're doing that kind of strategic plan you've been referring to is that have any impact.
In terms of your M&A outlook.
<unk>.
Maybe potentially restrict you were making a little bit more cautious.
No no I think it puts us in a great position to obviously you know as we continue to get more efficient more effective and and drive more revenue I think any puts us on a better a better see going forward. So.
No I don't think you're really changes or appetite at all.
Great great. Thank you.
And then you know most of my other questions have been answered, but I I was just curious if you did touch a little bit on you know.
The growth that you're seeing the one portfolio, we're getting to production rather you know where is that kind of shaking out geographically across your markets and then maybe if there's anything noteworthy any thoughts on the competitive dynamics markets markets that you're saying.
Yeah. Scott. This is Jim Sandgren, you know, we continue to see some nice growth and it's got a lot more newer markets, Wisconsin, Minnesota production levels continued to be very very strong.
Loophole consistently a strong production region for us as well.
From a competitive standpoint, you know, it's it's it's still pretty pretty competitive out there very aggressive.
You know it and it's a combination some of the bigger banks are moving a little bit downstream. So we're starting to see them.
I'm, a little bit more than we have in places like Minnesota, Indianapolis and livable.
And then you know there's there's some goofing, that's a little bit sometimes.
US and structure that we see in some of the smaller banks, maybe even credit unions on some real estate deals and that's where I think when you need to stay very very disciplined but you know for the most part obviously, we can continue to grow and showed strong production and just fight off the a the payoff so its a nice.
Most of our markets and you I think we continue to feel optimistic at this point and customer still feel a relatively good.
Excellent. Thank you that's a that's helpful. That's all for me.
Thank you [noise].
There are no further questions at this time I will turn it back over to our speakers for closing remarks.
I appreciate everybody supporting all the good questions. This morning, and as always our John Anzalone L. are gonna be mail and run they're going to be available for questions. All afternoon. Thank you very much.
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