Q2 2022 CapStar Financial Holdings Inc Earnings Call
Yeah.
Okay.
Good morning, everyone and welcome to Capstone Financial Holdings second quarter 2022 earnings conference call hosting the call today from capsule or Tim schools, President and Chief Executive Officer, Mike Fowler, Chief Financial Officer, and Chris Tietz Chief.
Chief Credit policy Officer.
Please note that today's call is being recorded replay of the call and earnings release and presentation materials will be available on the investor page of the.
The company's website cut start dot com.
This presentation, we may make comments, which constitute forward looking statements within the meaning of the federal Securities laws. All forward looking statements are subject to risks and uncertainties and other factors.
That may cause the actual results performance or achievements of cap star to differ materially from those expressed or implied by such forward looking statements listeners are cautioned to not place undue reliance on forward looking statements a more detailed description of these and other risks uncertainties and factors are contained and caps.
<unk> public filings with the Securities and Exchange Commission, except as otherwise required by applicable law capstone disclaims any obligation to update or revise any forward looking statements made during this presentation. We would also refer you to page two of the presentation slides for disclaimers regarding forward looking statements.
non-GAAP non-GAAP financial measures and other information with that I will now turn the presentation over to Tim schools, <unk>, President and Chief Executive Officer.
Good morning, and thank you for participating on our call. We appreciate your interest in cap Star and I ask you to bear with US This morning.
Victor here, we changed our.
Software and so this will be the first time this quarter should be patient with us as we navigate this new software.
Challenging to adopt it on the earnings call.
Today, we're excited to be speaking with you from Asheville, North Carolina, where it started off the call $60. This morning, I think it's gonna be 100, Nashville today. So it's nice to be here and this is where we announced last week will be opening a new office, it's an outstanding and healthy growing market. It also is one we're very familiar with it.
Its last 12 community banks since 2008.
It's often served out of Charlotte, we feel it presents cap, sorry tremendous opportunity Chattanooga and Knoxville investments.
I'll provide some highlights of these shortly.
In the second quarter, we reported <unk> 45 per share pre tax pre provision to assets of 117 and a return on tangible common equity of 12, 7%.
I'm, particularly proud of our results as they demonstrate the strengthening of the core bank, which for todays purposes, I'm defining as excluding our mortgage SBA and Tri net businesses do.
Due to the headwinds I communicated produce businesses last quarter in the sense rapidly changing market conditions. The second quarter net contribution of these three businesses was minimal.
This is meaningful as the core bank essentially earned about $8 80 per share annualized, which I believe would be a record.
This positions cap star very well when you incorporate the underlying growth opportunity of Nashville, and our community markets.
The expense, we have embedded in our recent Chattanooga and Knoxville.
Investments.
And what our mortgage and Tri net business historically have provided in a more stabilized market environment.
Potential we believe is in our SBA business.
The underlying four key drivers of our company are performing very well.
First year over year revenue growth, excluding our specialty banking businesses and PPP increased 13% led by a healthy increase in loans.
Our net interest margin expanded 44 basis points from the prior quarter largely due to a favorable change in earning asset mix and an increase in market rates.
Third our productivity management is outstanding with.
With core banking expenses down one 5% year over year.
<unk>, our overall efficiency ratio, which now stands at 56%.
In combination with the revenue growth I mentioned previously.
Year over year core bank pretax pre provision growth was 38%.
And lastly credit quality remains outstanding we're past dues reached their second consecutive record of 12 basis points and charge offs remain low.
Importantly, you've seen thoughtful and balanced capital allocation discipline with the announcement of three de Novo expansion markets over the past two years to include Asheville, and further expansion of Chattanooga This quarter.
The paying of an increased dividend as well as share repurchases.
Before turning it over to Mike to cover the highlights of our key trends I'd like to discuss the progress.
Of our recent new market investments.
If youll please turn to page five of this mornings presentation youll see the targets we've established for each expansion market and the early results of Chattanooga and Knoxville.
This is new for us so we're still learning and refining needless to say, we're pleased with our progress to date.
I find slides six and seven that would be the most meaningful in today's deck.
It shows the transformation that is occurring at cap star as well as the opportunity.
Over the past three years, our team has significantly increased the franchise value of cap star.
From a footprint and performance standpoint.
We are now in four of the southeast most dynamic markets.
Have improved efficiency.
<unk> ability.
And earnings.
And our year to date, one year three year and five year total shareholder returns were greater than industry and local peer performance.
I'll, let you read through the commentary on Nashville, and our continued Chattanooga investments and moves forward to pages 13 and 14.
Here, we have attempted to provide some thoughts on what the potential of these recent investments could be.
Obviously, there are many variables that could make these results better or worse than.
In second quarter, our current Chattanooga, and Knoxville investments contributed a positive <unk> <unk> per share.
On page 13, we've lifted what their future incremental contribution might be under stable market conditions, and if we execute at the level we aspire.
Similarly page 14 shows the same for Asheville, and our newest Chattanooga investments.
As we all know to novellus com with front end startup cost, but provide the opportunity for significant future accretion if successful.
What is so exciting is there are many other aspects of cap star, which should also increase their contribution during these periods.
Mike If you. Please now cover the financial highlights of the quarter.
Alright, Thank you Tim good morning, everyone.
On page 17.
A few highlights.
As Tim noted, we feel we had a very strong performance in our core banking markets offsetting near term headwinds our specialty businesses.
Our net interest margin.
$3 41 in the second quarter was up 44 basis points from the first quarter.
Our efficiency ratio 56, 3%.
As an improvement of two 4% versus last quarter.
Our pre tax pre provision.
One 7% of assets. There is also an improvement of nine basis points versus last quarter.
In terms of growth categories, our assets and we will talk more about this and discussing the margin in a minute.
But just by very very strong loan growth again this quarter.
Assets are effectively unchanged.
This was a continuation of deploying our excess liquidity into <unk>.
Higher yielding loans.
Tangible book book value per share.
Down 2% from last year. However.
However.
And as Jay discussed throughout the industry.
If you exclude the OCI impact of higher unrealized securities losses.
The general increase in market interest rates tangible book value per share is up.
Two 1% versus last quarter and is up 13, 1% versus last year, reflecting ongoing solid profitability.
And as Tim noted.
Credit metrics remained very strong.
Capital remains very strong we continue to tap capital above are above our peers.
Yes.
On page 18.
You can see the drivers the 44 basis point increase.
Net interest margin for the quarter.
Essentially as I noted a second ago remixing, the balance sheet deploying excess liquidity into loans.
And number two the benefit.
Ads rate hikes to date 150 basis points since March.
Net interest income was $24 4 million, an increase of $3 3 million.
Last quarter again with no increase in earning assets.
Our cash declined from 11, 2% of assets last quarter.
And 14% a year ago.
Two to three 7% on average for the current quarter.
In terms of the NIM.
Our net interest income outlook.
We have seen as expected and consistent with past.
Cycles of rising rates as the fed moves deeper into rate hiking cycle.
Deposit betas or pricing rates are increasing and we have seen that to some extent in the last month.
But our strong loan pipeline continues.
That our production provides opportunity for continued net interest income growth.
Another thing you hear in the industry, we do expect some loan pricing tailwind.
As competitive pricing response to the dramatic increases we had seen earlier this year.
Some of our competitors have lag there are increases in response to market rate increases we've seen some evidence of that have some catching up and we do expect some tailwind on that current going forward.
From an interest rate risk perspective as.
As we've said in the past we are targeting to be positioned fairly neutral risk neutral.
Our net interest margin could continue to benefit and we expect it will modestly from further rate hikes.
However.
Potential modest decline could occur.
Yes flattening scenario.
Which is certainly not not unlikely.
On page 19 regarding deposit costs.
Our deposits declined $40 million during the quarter.
Driven primarily by correspondent bank activity.
Not surprisingly.
Our bank customers are deploying their excess liquidity into logs as well.
It could be facing some deposit outflows so not surprising to us that we have seen some modest decline in our correspondent bank balances.
Outside of correspondent banking, we certainly have seen some instances of deposits leaving.
But in total our other deposits have been in the aggregate are fairly stable.
The deposit costs for this quarter.
An average of 23 basis points.
Or four basis points increase versus last quarter.
As many of our peers are doing we're striving in this rate environment to maintain disciplined pricing on both sides of the balance sheet.
But in terms of this slide disciplined pricing on the deposit side.
<unk> continues to raise short term rates.
We certainly focus on optimizing profitability.
While ensuring we remain competitive.
A combination of specials.
New products and competitive pricing on our standard products.
Designed to retain and attract.
<unk> core profitable relationships.
Sure.
On page 20.
Sure.
Our average loan growth in terms of loans held for investment.
Was 19, 8% excluding PPP.
Darren a transfer of $106 million of Tri net loans, which we'll talk more about in a minute.
Currently held for sale to held for investment.
End of period.
The growth was 16, 9%.
TPP at this point is really gone, we're down to less than $1 billion at the end of the quarter.
In terms of PPP loans.
We continue to have very strong production in the quarter. We had production of 217 billion, which represents an annualized number of $870 million.
And you can see the history, there that represents a continuation of <unk>.
Focus on.
Consistent organic production.
As you heard Tim say in the past, while we certainly focus on production, we're focusing on profitable production.
Commercial loan pipeline remains very strong currently exceeds 500 million with strong contribution across all markets.
In the quarter.
Our average loan yields increased 28 basis points versus last quarter.
28, 22 basis points due to the loan coupon.
11 basis points actually do too.
A correction last quarter, which we discussed on the call of deferred cost.
Our loan origination cost.
Our pricing achieved a match funded spread in the quarter at the time of funding of 170 basis points.
As you've heard us say in the past.
We target.
200, and up targeting an average of about 250 over match funded federal home loan bank curve.
This quarter, we have seen some pricing pressure.
But some of that $1 70 represents.
Well.
Originations lower than targeted spread given given lag competitor response, the market rates as we said in the last quarter. We continue to have a lot of discussion with the line in our markets.
We try to maintain discipline in our pricing, we certainly have some degree of flexibility for important relationships and important transactions.
The other thing in that number though is.
Where we do it where we do give rate locks.
And we have tightened those up we're giving them less often we're giving them for shorter periods of time.
But the $1 70 represents the mat spread between the rate on the loan.
Fixed rate loan and match fund the cost of funds as at the time of funding.
In many cases that spread was wider.
When the rate was actually committed to the customer.
On page 21 talk about noninterest income.
As Tim said this is an area, where we certainly have some specially fee businesses that have been very important in the past and we believe we will continue to be very important over time.
But we're seeing some headwinds.
We continue to see growth in core bank deposit service charge and Internet and debit transaction fees.
But we are seeing headwinds in mortgage related to both volumes, obviously with mortgage rates up sharply. This year refinance activity has has dried up as it has for the industry.
We're also seeing as a result.
Lower volumes consistent with prior cycles, we have seen some compression in spreads.
And we are also facing in our markets, which are very strong housing markets very strong demographics, Sam touched on earlier, but we are seeing which is not uncommon.
And the industry limited housing supply, which is also impacting our mortgage originations.
Try that.
Had a fair value Mark.
185000.
Due to the adverse impact of rapidly rising interest rates.
That was partially offset by modest gains on sale of other loans.
Our other income.
Down for the quarter.
And that is primarily due to a onetime boldly death benefit last quarter of 860000.
We go to the next page 2022 we wanted to give you a little more color on China.
Trying to add.
As many of you know is a business that generates interest and fee income.
By originating and selling high quality on the JD as fixed rate commercial real estate loans for properties on long term triple net leases to national tenants.
<unk> began more than 10 years ago at another institution.
The leader of that business was recruited to cap star in 2016.
Since that business was launched at cap star in late 2016, it has generated more than $25 million of cumulative revenue.
No credit losses.
Due to an average origination or sales cycle of about 10 weeks.
Trying to add has never operated with an interest rate risk program, it's used business levers to manage that market risk.
And it has not been materially impacted by rate movements and past rate cycles. However, recent events, we have seen a dramatic increase in market rates in the second quarter.
I think tri net originations values to decline.
The rapid increase in market rates in addition to reducing the value of Tri net loans.
It also caused a decline in the demand for these loans. So we have seen investors pause.
We believe largely due to the uncertainty in terms of where where longer term rates are headed.
As I noted on the last slide in the second quarter, we did transfer $107 million of Tri net loans from held for sale to held for investment.
In terms of the outlook.
We have paused further originations at this time.
We have approximately $100 million of additional loans.
Then process or loans that are held for sale that have a potential unrealized or realized loss.
In combination with the recent reduction in demand we are evaluating the market to sell these loans, we might consider that placing them into held for investment which could come at a realized or unrealized loss.
We are pursuing hedging strategies to mitigate market risk in the future and will only restart originations when we see clear indications of market stabilization and liquidity normalization.
On page 23 noninterest expenses.
Continue to have strong expense discipline.
With our productivity mindset across the organization.
Total expenses are down.
700000 versus the last quarter.
Cincy ratio as I noted earlier 56, 3% down more than 2% from last quarter.
Significant part of that driver is salary and benefits, which were down $1 1 million for the quarter.
Number one to increase deferred costs associated with loan growth with new loan originations as well as the Q1 severance and retirement expense of 385000.
And number three lower mortgage incentive accruals and benefit expense, reflecting lower mortgage revenue.
I'll now turn it over to Chris to discuss risk management.
Thank you Mike moving to slide 25 as in the past asset quality levels remained strong with continued improvement presented on this page you see the evolution of events that could ultimately result in credit loss that is as losses emerge. The early warning indicators of loss are evidenced in increasing delinquency and <unk>.
Adverse classification.
Both of these early indicators are trending favorably for us and our losses are reflecting that trend over time.
Relating to delinquencies last quarter. We told you that we were very pleased with record low past dues, but aspired to continued improvement we exceeded our expectations achieving 12 basis points for June 30, representing another new record low for us our credit and operations teams have done an outstanding job of bringing consistency.
Oversight and processing of payments and after elevated results in past quarters, we are seeing the improvement evidenced in the results.
In addition, turning to criticized and classified asset level improvement from pandemic highs continued to be achieved on our five year average for special mentioned loans is approximately one 6% and we are currently at 77% are.
Our five year average for substandard loans is approximately one 5% and we are currently at 1.35%. While we are near the five year average of substandard loans. It should be noted that this subset of loans requires the longest period for resolution as a result, the range over this five year period is very narrow width.
A low of 90 basis points and a high early in the pandemic of 239 basis points. Therefore, we are pleased with the current level of 135%.
Needless to say we are also proud of our continued low charge off rate, which averages $81000 over each of the last eight quarters.
This reflects our strategic decision years ago to focus our attention on traditional community bank borrower profiles that are smaller and better secure as a result, our losses, our net charge offs. This quarter are zero basis points, representing $15000 net.
While our asset quality is outstanding we remain diligent for uncertainty in the economy. This is represented by our commitment to robust independent external loan reviews.
Expectations that our own internal credit administration process continues to work diligently towards early identification of borrower stresses and the appropriate rating of credits and we are also in the process of completing our external annual stress tests from a trusted vendor to gauge our preparation for an uncertain economy.
One point of note given the uncertainty of the current environment and in preparation for potential economic downturn, Kevin Lambert and his credit teams have identified borrowers in cyclical industries for additional scrutiny and we are adjusting our underwriting guidelines and oversight accordingly in areas representing intrinsic risk profiles.
Finally, turning to page 26, adhering to our methodology and balancing both loan growth and favorable asset quality trends, we closed the quarter with an allowance for loan losses of 109 basis points factoring in our fair value marks on acquired loans. We feel this is an appropriate level and we.
We are satisfied with the performance of our portfolio.
That I will turn it over to Tim.
Thank you Chris as you can see our teammates are performing at a high level and we continue to enhance the value of our franchise with.
We're striving to serve the financial needs of our customers in a more personal and responsive manner, while managing our margins expenses and capital prudently.
The inflationary and rate environment bring unique challenges, which we are not immune to that we do not believe them to be systemic and we remain focused on doing what we do well and doing our best to be strong risk managers that concludes our presentation and we're happy to answer any questions. Once again. Thank you for your time.
And investing in cap Star we appreciate your support.
To ask a question at this time, you will need to press star one on your telephone.
Once again Thats star one to ask a question. Please standby will compile the Q&A roster.
One moment for questions.
Our first question will come from the line of Graham <expletive> from Piper Sandler Your line is open.
Hey, good morning, gentlemen, it sounds like a nice day in Asheville.
So I just I just wanted to start on Tri net.
I saw obviously are pausing production, there and kind of just taking a step back to assess things, which obviously makes sense.
I'm just kind of wondering if you have any foresight into when or what kind of environment. It might take in order to return to the market here.
And then also trying to understand what the revenue cadence might look like in that case.
I'm just wondering if you got you might kind of ease back into things a little bit rather than jumping I'll fall back in at once.
Yes. This is Tim and I'll start first and then I'll ask Mike <unk> to add anything they'd like to it's obviously a great business. It's existed for some 10 to 15 years had a couple of banks with the same gentlemen.
He has been here for eight years and.
The number actually is closer to $30 million.
Of total revenue that is generated with no losses, now obviously theres been operating expenses, but it's been very profitable and in a capital generator for cap stock.
It's common sense right youre booking seven year maturity loans that have maybe at 20 year amortization.
So those loans have always.
Worked through in a 10 week period.
When rates move that fast.
A short period unexpectedly on a seven year duration the value goes down so that's sort of the current situation.
Hasnt really been an impact in the 12 to 15 years. This business has been in business. So at this point, we believe in the business and if you look at the history of cap Star.
Certainly thank the last two years are not the beacon to look to.
It was the opposite right, we really over earned but if you go back to 2018 and 19 like I've said in first quarter, we believe in a in a more traditional rate environment, which there is not such a thing, but an environment. Unlike second quarter, we believe.
Leave that the business development capabilities, we have in our historical spreads that we could earn on or about $750000. A quarter. Then it could be a 3 million dollar contributor. So we don't foresee that in this market I'll, let them expand more.
But it's largely.
You know I don't want to say that this necessarily caught us off guard I mean, I guess, you could say that but but the program has not had an interest rate risk management program. So we certainly do not want to.
Expose.
Or create any more exposure it could be subject to rapid rates between now through the end of the year, where theyre still calling for maybe another 150 basis points, even though these are valued more on the longer end of the curve.
So I think we just want to see rates stabilized. Some and then the second issue is even if rates were stable I think just with the uncertainty of the rates the inflation the potential recession, we've seen the traditional buyers paused a little bit step back some.
So even if we even if rates stabilize and we book them at what we thought were.
No margins that could be sold for a profit. This is really meant to be a gain on sale off balance sheet business for cap star, We don't want to while we view. It is valuable we don't at the same time want to use up valuable liquidity, we've got great growth in Nashville, and Chattanooga, and Knoxville and Nashville.
And we want to make sure we reserve our balance sheet for that so I'm throwing a lot at you.
But maybe I'll stop there and see if you have a further question or Chris or Mike could add any bank.
No that answered several of my questions altogether.
My next one is really going be on why why don't you just balance sheet them, but makes sense with the growth you're seeing elsewhere.
So I guess just moving on to deposits.
They were down a little bit this quarter, obviously with the correspondent bank activity picking up a bit.
Can you talk just a bit about your strategy on the side of things and how the newly added teams in Chattanooga in Ashville might play into that and then also just generally what direction you see total balance is heading in the near term.
Yes, Great question I think that that's exciting for us when I came in we were growing the loan side. When I came in at 19 five years before I got here. If you took out all shared national credits and all participations, we have grown loans, 3% a year for the five years before and now we're growing them.
20% a year with no participations, so on the right side of the balance sheet, we need to crack that same code.
<unk>.
We're now 14 years old when I came we were 10 or 11 and loan capabilities come first so this summer we've had an active deposit first of all we started in the fall of 19, when I came we changed the incentive plans region. Our products, we really got started and then the pandemic.
And we had an inflow of deposits. So you sort of got comfortable and actually we changed the tone and we said we need loans, we need to lend all those deposits out.
And so.
Don't want you to think we're just start when we really started in the fall of <unk>, but then we paused and so we're back at it we had I can't remember April may we formed a deposit strategy Committee.
And came up with a full five or six point plan on re looking at incentive plans communication products, we spoke to a lot of banks across the country that are high performing banks on what products are they doing and so forth and at the end of the day, it's just got to be execution, and we're really focusing on.
<unk>.
And we don't want it to become talk or the quarter or the March how do we become a deposit first bank that in capital as the backbone of any bank.
So.
Traditionally a lot of banks.
Don't go after deposit only customers that go after borrowers and see if they can get some deposits where youre always going to be.
No.
Looking for deposits.
I'd say, that's the biggest thing.
Ramp and we're just we're excited about it obviously when you bring on new markets. It's also easier for them to get loans. So.
I'm friends with arc Seaver, and Justin Stricklin, formerly of southern first and they've done a great job of organically go into new markets emphasizing the need to fund their own market and that's our mantra, but we've got to hold them to it and we've got to execute.
Okay.
I guess would you say that deposits you'd see them growing here in the back half of the year or do you think that there might be some more of that correspondent bank activity that brings balances a little bit lower in the near term.
I think the whole industry youre going to see some sideways to may be down. The next six months I mean, it can be interesting I looked at first bank technical and service first I think all three of them deposits were down surface first down $800 million I think 15% annualized as what Mr. <unk> said, so we feel real pleased with our success.
It's challenging and not for cap star, you've got depositors and getting zero to five basis points for the last several years and really a lot of the period back to 2008.
So if they can get 1% to 2%.
And so you finally have people shopping.
Moving money around wiring around you've got some people investing in treasury bonds, you can get a one year treasury bond today, its 315, and one year Cds at banks or 150. So you see so it's an interesting market right. Now again is it systemic and is it is it long term I don't think so.
It is really a highly unusual we've gone from an unusual pandemic environment. We're all wondering what's going on and now this inflationary environment. So.
I can't give you an answer because I don't know, but I can tell you. We're working hard on it I can tell you everything we worked hard on we've made progress like the loans like the past dues like anything.
And so we're going to work real hard, but I think for the industry is probably I've seen some banks report.
Hey, we think will be up next quarter, we think will be up to next six months. We hope we are but I think that's going to be a challenge I think that at least through the end of the year with rates going up and in a lot of shopping they could be flat to slightly down.
Okay Cool and I just got one more.
It's just on the expense side of things so.
So I guess that bank on the expense guide excludes mortgage SBA and Tri Ed.
Just trying to get to a total expense number going forward do you mind, just outlining what a typical efficiency ratios are in each of those specialty businesses, maybe just SBA in China more so than any of the mortgages.
So we're throwing a lot of things that you are or our consolidated efficiency ratio was 56% this quarter.
Somewhere in our materials I think we report a bank only efficiency ratio. That's what we historically report that only excludes mortgage on that slide.
Today in my verbal comments, when I was talking about the core bank earnings.
Went ahead and took out Tri net and <unk>.
And.
SBA in my comments, but on that expense slide you are looking at that that bank only efficiency ratio would only exclude mortgage would have everything.
On our looking forward slide at the back where we say bank only approximately 16% to 16 and a half per quarter that is everything but mortgage app.
And it includes the new investments in Chattanooga, two or what we call Chattanooga too in Asheville.
Okay, great that answers the question, but thanks Tim.
Okay. Thank you.
Thank you and one more in for our next question.
Our next question comes from the line of Kevin Fitzsimmons from D. A Davidson your line is open.
Hey, good morning, everyone.
I guess on the subject of deposits in margin so.
It's a pretty interesting shift and environment and Tim I guess, you've covered some of this already but maybe from the angle of.
Our ability to grow NII and what the drivers are going to be.
And where that so I mean, I think we've been coming off.
Past few years have an environment, where it's been all balance sheet and the margin has been compressing.
And now we're shifting to the.
The margin is higher but maybe the average balance sheet doesn't grow all that much because you guys with your markets, you're probably continuing to grow loans, but you've got to fund that in and cash is going down in deposit.
Given what we're what we've been talking about with deposits.
Maybe securities is used to fund some of our loan growth. So.
Just curious like how you view that.
Ability and what those drivers are going to be to grow NII and particularly like you you seem like you went out of your way to make the point that.
The margin had a real outsized.
<unk> this quarter and optics.
So on that front is the mix shift mostly played out like maybe your cash is getting to a point where that's.
Probably shouldnt be expecting 44 basis points next quarter, but I know thats a lot, but just that kind of angle. If you can address.
No I think Thats I think thats get on.
Ed.
We did a great job and so we certainly benefited from.
A modest amount of asset sensitivity and we benefited from a mix shift and so you are very observant that you know.
When you measured our sensitivity before cash would've been in that measurement right, which has a good data and now thats been put into a mix of variable and fixed rate loans. So you would anticipate.
Lesser upside in the future on the margin as far as growing.
No.
We're calibrating, what I think was already a terrific franchise.
<unk> got our loan capabilities.
We've gotten our expenses in line, we're managing our capital.
So.
Again as I just said we identified early in 2019 that need to develop deposit strategy all of them coming in.
Didn't really continue working on that so we've got this earning asset engine that is growing 20% a year actually it would have been higher we had a $10 million payoff or pay down the last day of the quarter and we had a $5 million loan debt funded the next day. The first day of July so it would have been $15 million higher.
Which to end of period would have been 27% so.
Last three quarters, we've done 20% annualized each quarter, so I answered sort of the margin expansion.
We're going to work on deposit capabilities I think we have a tremendous opportunity there.
But how do you grow in the meantime, and I think it's going to be a balance.
Deposit capabilities coming online.
Maybe a modest reduction in securities I don't know that they can go down that much more and then I think youll see.
As we build deposit capabilities some introduction.
<unk>.
Cvs, our brokerage Cds or some wholesale funding sources like FHFA.
Which.
If you get to the end game.
Ideal bank I'd love to have customer funded loans and customer funded deposits, we didnt start there on on either side.
We at one point had 32% shared national credits in total participations were probably 45%.
On the other side, we had correspondent banking and we had really a lot not a lot of hate to say that but we had a fair amount of hot money.
So we're transforming our balance sheet, so I see the funding coming from increasing deposit capabilities. We're actually we've got a correspondent banking division just like Mr. Broughton does at service first we're looking at expanding that even though some of those banks are using their liquidity, we could take share there.
Some banks that are in the middle of selling right now that a correspondent banking departments and some of those employees were talking to and then I think the introduction of some wholesale sources.
Okay. Thank you.
And then on.
On the new markets, particularly Asheville, I'm, just I know it's early but.
Some of that.
There's a lot of overlap in that market between TD and FAA Chen.
And I know.
That's where we.
One of those is where you got your leader and then service first also stepped in recently to that market and got their leader from the other player.
So given so I'm wondering on one hand could that market ramp up faster given the overlap but on the other hand, you got a player like served as far as stepping in the same time does that.
Almost.
Is that a serious headwind and then separately I'm just curious what your thoughts are on now that you got from <unk>.
Three markets in place switching if you include Knoxville.
In terms of new market expansions.
Where's your appetite for it.
Adding new ones and I know.
In past conversations you have said.
Theory.
Why not to these all day long on the other hand, if we're going into an uncertain environment.
You have to watch what inning each of these are in so I'm just curious your updated thoughts on that thanks.
Outstanding questions first of all service versus not in this market.
Service first hired someone from first horizon in Charlotte.
Which is a hour and a half away. So they are not operating in ashville. So that doesn't mean, they may not come call appear but theyre not theyre not here.
On the on the other question I think that.
And like you could always do a capital raise which we're not going to do but give limited capital and with limited deposits. So it's.
As far as all day long you can't you have to do that within constraints of your balance sheet.
I'm real pleased with our four markets right now.
Would I would you can never say never but I would say the next 18 to 24 months.
Cap Star I'm really excited about page 13, and 14 in our slides.
And I don't think that is focused focused us I think that's reality.
And so if we execute hard I'm really focused on how do we bring that into earnings and how do we mature these four markets now.
Pinnacle has done such an outstanding job and it is just a terrific company.
And they are definitely the leader in Nashville, and so how we can we continue to improve our positioning and gets them and do a little better.
And then in these other markets somebody called US I don't want to say, who but one of the top three market share banks in Knoxville actually called Us when we hired the team in Chattanooga in October and said you just hire but number one team and all the chatter and that was a competitor.
Well the team we just hired as friends of theirs. That's also viewed as all stars. So I think it's without question. We've got the top team in Chattanooga. We've got 10 commercial bankers that are kind of outstanding team and Knoxville and now ashville. So I think we have more than we need and.
We will work the next 18 to 24 months to make those better.
Got it thanks, Tim.
Yes. Thank you.
Thank you one more in for our next question.
Our next question comes from the line of Jennifer Denver from Truest. Your line is open.
Hey, this is Brandon King on for Jamie how are you doing.
Hey, good morning.
Good morning, good morning.
Had a question on the correspondent banking I know you mentioned as far as statistic would take market share there and that was kind of the source of the decline in deposits, but I'm wondering what percentage of deposits correspondent banking today.
I don't have it right in front of me, but they generally run about give or take $250 million give or take what's the balance like.
Let me, let me pull that up very quickly I think the percent, let me check I believe it was about 15%, but hold on just a second.
So they are at 344.
Two.
Saturday.
So there are about $300 million right now.
Okay. Thank you 13%.
Okay.
That's helpful. And then I saw that there was some series of purchases in the quarter I know that obviously, the priorities of internal investment dividends and share repurchases and M&A.
With the.
Incremental investment in Ashville market.
Could we see a similar pace of share repurchases in <unk> kind of in the back half of this year.
I think thats, an excellent question and I certainly.
We were trying to buy I don't know if we have our average price we purchased that in there, but we were buying in the $19 range or something.
And again I wanted to do balanced and disciplined allocation and I certainly think our price is attractive here. If you look at $20 50.
Especially in light of if you look at the earnings trajectory.
But.
I want to use that capital to grow the balance sheet and I think if you look at an IRR that's more valuable so I wouldn't model really that same pace.
We'll be opportunistic if we feel that it's just such an attractive price that we ought to toe in but as we've been communicating our priorities.
And this is consistent with most investors I speak with that own our stock is investing in our business.
Growing the company.
Dividend increases and then buybacks at the right price and as you know we increased the dividend this past quarter from <unk> to <unk>. So we paid that off for the first time. So great question, but I don't think Thats something I would model on.
Okay. Thank.
Thank you very much that's all I had.
Have a great day.
Sure.
Thank you one loan for questions.
Our next question comes from the line of Fannie strictly from Janney. Your line is open.
Hey, good morning, guys.
Just wanted to get a clarification on your guidance for SBA fees.
Is it saying that quarterly rate going forwards equal to first half of 'twenty, two total meaning around 500000, a quarter or do you mean that the rate in each quarter in the first half of 2022 is a good go forward, meaning around 250000.
Do you say it one more time.
Sure. So I just wanted to get clarification on the SBA piece. It was the guidance, saying that the quarterly rate going forward should equal the first half total which is around 500000 in.
On revenue or do you mean that the rate in each quarter.
In the second half should equal around 250 basically.
No on SBA and Thats, one we just we have such high prospects and I know we've talked about it before.
We've demonstrated in a couple of quarters, we can do it we're challenged on getting the consistency and in speaking with our team.
We thought last quarter second quarter was going to be higher on some of the transactions flowed over this quarter, but.
They have communicated that they feel that this quarter will equal the total of the first half. So I don't have that right in front of me, but I believe that was 600000 or so so they believe that this quarter will.
We will be that and that they can continue that going forward now that's not guidance, but that's the best information they are providing and really have been communicating and working with them and they feel they can do it really communicating them. We feel we've got the capabilities to do 750 to a $1 million a quarter.
We just haven't been able to consistently do that also want to stand corrected one of my teammates just showed me.
I had not been aware of it no one's mentioned it but some of them did show that I guess service first in July also announced.
Ashville, so I'll look into that I know I've seen their sharp one but did not see Nashville.
Got you and that was exactly I was looking for on the SBA piece. Thanks.
And then I know the potential for a special dividend was discussed at one point just given your strong capital levels I didn't see it in the deck. This time is that still on the table or have you decided to save that capital just with all these lift out opportunities in <unk>.
Central regular dividend.
No that was just mentioned is hypothetical about how.
All of the different all the different options that a bank has and I really was just talking about.
I think the point I mentioned that I was trying to explain that our core if you look at like I study service first allotted this quarter I think there tangible common equity was eight 3% or something in ours ours is 10 two.
<unk>.
But if we see a radically did a one time dividend K cost $8. Two thanks, what I think what our return on tangible equity was already 12, 7%.
It would be if we ran it service first capital levels. So that was really sort of hypothetical but it's one of the many options, but we'd like to get there by actually investing in our business.
Got it that makes sense.
And then just one last one for me.
I appreciate the detail from Chris on the proactive approach to the cyclical industries the.
The slides on classifieds declining and everything else, but I was just curious anecdotally are you seeing anything new from competitors. Thanks.
They're doing the concerns you in terms of doing deals that don't make sense, maybe some strange terms or pricing.
I'm just curious what's out there in your markets.
Yeah, well I'll, let Chris add I'd say first of all we've got great competitors and.
I'm one that I was always taught you wish everybody to win so I don't want to talk to you about any competitor and I would just say that in a rising rate environment.
The main thing I'd say is we're seeing a lack of pricing discipline and.
And when I say that I don't know I don't want to come across it I think they are being aggressive.
But.
If you use any kind of funds transfer pricing methodology.
Understand your true cost of funds. If you go most banks would use the FHFA curve. If you go look at what our match term funding is your base rate has gone up.
So just like if.
You look at the inflation in the World just like people are passing along inflation costs.
Disciplined banks, if we all work together should looked at our base costs are going up.
And borrowers should pay more.
And we're not necessarily seeing that from all banks, which makes it hard for you to maintain your discipline I mean, you could totally turn your growth.
We heard yesterday I don't want to say what bank, but a very high performing reputable bank is doing.
Lee is it five or seven year.
Five year 20 year amortization commercial real estate loans at 425%.
Don't have the FHFA hurtful that but I think if you pull that up what's that going to be $3 15.
Five years ago about $3 40, so the base rate would be $3 40 that mean that bank is doing loans at a 100 basis points spread we target a minimum of 200 and an average of $2 50 and have always gotten that.
So I'll, let Chris or Kevin speak about credit without mentioning specific banks, but I haven't really heard that I think I think we've got good competitors with good underwriters right now the biggest challenge is a lack of discipline on pricing, but Kevin or Chris any comments on.
Clearly pricing is the first thing and.
And foremost to a lesser extent, we will generally require more cash equity in transactions, particularly in the commercial real estate area that some competitors, but we're finding that generally in our markets. There is discipline in the equity requirements of the underwriting on many of these transactions. So.
<unk> is number one it's just absolutely number one, but we're still seeing rational competition at least on structure and underwriting.
Got it that's good to hear I appreciate the color everybody and thanks for taking my questions.
Thank you one moment for our next question.
And our next question will come from the line of Brett Reber.
<unk> from Hovde Group your line is open.
Hey, this is Taylor in place for Brett Thanks for the comprehensive discussions so far in all the candor surrounding Tri net.
For the pipeline C plus 500 million for commercial.
What about the other loan segments and also sort of.
It's obviously been strong in.
The trajectory is good like does this lineup with what you thought maybe a quarter or two ago or has it exceeded.
Or have been below expectations in your view.
Yes, great question.
I would say it has exceeded it surprised us.
All thought pay rates are going up is that going to a really slow loan demand and it's actually they're growing and expanding so I would say surprise.
That is what we call our commercial pipeline. So that's our on balance sheet core bank.
Market lending, obviously does not consider business banking, our consumer that comes through our branches because thats more instantaneous.
And then the three units that I can think of.
They would have any material other pipelines would be the specialty businesses I'm referencing so our mortgage division's pipeline wouldn't be in there.
<unk> pipeline wouldn't be in there, nor our SBA unit, which we're really trying to increase their funnel. So that we can get that up to the 750000 a quarter I'll, let Chris comment on on Tri net as we just said we've paused. So their pipeline is going to be zero, but maybe Chris can talk about the residential.
Mortgage and the SBA pipeline.
So so first of all Tyler.
Relating to all the mortgage.
Environment, we're very proud of our mortgage operations, which are primarily focused in middle Tennessee, and the Nashville market. It's a strong residential market and I will say that the challenges that we've had there. This year have not been volume the market is a little bit frothy in terms of activity levels.
There is a limited supply that is tending to calm down just a bit as it has in other markets, but we had similar volumes as we had budgeted which are close to 2019 levels, but where we're challenged right now is in the interest rate environment.
Fees are way down on the on the mortgage sales.
<unk> volume is good we're postured as a top five underwriter and originator in the middle Tennessee marketplace, and we think we're postured because our business model is primarily focused on purchase money transactions and not on refi transactions where posture to continue.
Perform well there despite the cross wins that we have on the gain on sale premium.
Our government guaranteed world.
We added to our.
Our business development.
Team early in the year and that is starting to.
Yield benefits to us and so that's part of where we see the accelerating contribution from that area.
And we continue to be focused on looking for additions to the business development unit as well.
Of the things that's interesting to me is that the servicing income, which we don't report separately.
As has basically doubled each of the last three years and we look at that trend to continue but we also have the cross wind right now.
On our gain on sale for the guaranteed portions of those gains are down 30%. This year over where they were last year. So we're getting much less return on the same volume output, but we're going to stay as a steady producer and that trying to increase that.
Invest in business development and look forward to when the rates stabilize in the premiums returned to previous levels.
Great. Thank you. Thank you for all the detail and I guess, maybe one more for me.
Obviously.
Credit quality is in great shape, and not a surprise, especially given the market you operate in.
Looking at I was just curious about the half million qualitative reserve to the current economic environment. Maybe you can educate me on like maybe the thinking there.
That's just the model telling you to do so or are just looking at just general macro factors in and being prudent there.
Yeah, we tried to we tried to tie those two factors too quantitative a view or measurement point as we can and yes. There are some things that are out there that would start going the other direction that's reflected in those considerations.
Okay.
Well, thank you very much I appreciate it.
Thank you one moment for questions.
Our next question comes from the line of Catherine Mealor from <unk>. Your line is open.
Catherine Your line is open.
Thanks can you hear me now.
Hey, Ken.
Okay, Great Hey.
Just wanted to follow up on the loan growth in the ground.
A really nice pace the past couple of quarters, and then 30% that your guide is still low to mid double digits.
With all these new hires is there any reason that the growth is pulling back or you just kind of be conservative.
I'd say being conservative and make sure we can fund it if anything I think it could be 30%.
I mean, it's amazing I mean, we're doing.
The legacy Bank our call.
I'll just when I got here and you've heard me say, the 3% and I sort of ask.
Whats everybody's goal and there was no goal.
So.
Just to be honest, we sort of got out a napkin and said okay. Our loans are at this number we're not doing any more participations. We wanted to grow 10%. If you take that number times, 10%.
When you say the starting number is going to have principal paydown and amortization of 15%.
Is that total dollar we need to do divided by four.
And Chris that number was what.
45 45.
Everybody in the bank knows it was $45 million Catherine and so you could have gotten into the elevator and everybody would have said $45 million and.
So we got the legacy bank to $45 million, which I would say.
Was was.
Nashville in Athens.
And then we've added Chattanooga, and Knoxville, and Theyre doing their own 45% or $50 million per quarter. So that's where we sort of gotten to the 100 a quarter and then you put Chattanooga too that we're calling it in Asheville on it.
So I think it certainly could be 20% plus but.
The most ideal situation is for your deposit line and your loan line to grow in parity over time, if you want to build a real high quality bank. So I think what we're talking about right now is our pipeline is so big.
Let's.
Now we're in a position of strength, let's be disciplined on what we do.
We don't want to run customers off, but let's really focus on the 200 basis points spreads and higher on the loan side.
That may make it 15% instead of 20 or 15, instead of 'twenty two and then work on the deposit side and we think that will build a better bank, but I certainly think we have the capabilities that we could post in the 20 range plus of quality loans, if we wanted to.
Great.
And then on the expense.
It was interesting to me that your bank level expenses or skill the $616 5 million guide which is.
What you had last quarter, but we're adding on ashville. So is it just safe to say that you are.
Aster with savings from other places or has.
That market, we could see that expense growth kind of move into next year.
Well keep in mind actual at this point is going to be to employees. So that's what that is if we built a team like Chattanooga there'll be more expenses coming, but but that 16% to $16. Five does have the four new people in Chattanooga and the two people in Nashville, So that does have the six new people <unk>.
<unk>.
Is it is.
It's growing revenue, but we're looking I mean, I, just and again, it's not anything with cash or every bank I've been and I could do a presentation on expense management at banks It would blow your mind.
And banks in general are not there are some obviously service first their efficiency ratio is very mindful of expenses National Commerce, where I was taught was.
I mean I've been in banks with people had a multifunction printer device every five feet from acute when you can walk 15 feet and get rid of a third of them.
Got software systems that people never use that are still on the books.
It's amazing when you get into banks and so.
There is a system right now we have I'm not going to say, which one that that is coming to end of life and the.
The vendor said, we'll give you a great special.
You sign within 48 hours and pay us quarter of $1 million I'm not joking $250000.
We will let you go on our new system.
Well, we have options, we can go on somebody else's system for free.
So what we told them and and so we gave mic solar 10 banks that I think very highly of Lake City Bank in Indiana, Five Star Bank in San Francisco Citi Holdings, Skip in West, Virginia, I gave him 10 banks and asset call. These 10, Cfos and ask what system. They use on that on that system.
And we got the name of five or six different systems and have interviewed them all and we actually have found a system that we actually like better.
That is price better.
And the salesperson that was at the first company that asked us to pay $250000. It now at this company and wants us to come there without paying the $250000.
My point is sharing all of that is not to get on that.
<unk> got to manage it every day.
And you've got to manage your expenses like you manage a pipeline and loan growth and the message internally and everybody has to believe me we don't want to be cheap, we don't want to work with the lights out and run on the Rems. It's worked frugal and run a company like <unk> would your house and.
So I'll just stop right there, but we're just doing a good job now that ends right.
You can't you can't cut yourself to prosperity, but I do think there are opportunities to operate smarter and better in.
Higher more productive people.
And that is allowing us to add some people without having to add expense.
Got it very helpful. Alright, thanks, so much for.
All the commentary this quarter.
Yep go generals.
Thank you.
I'll turn the call over to Tim schools for any closing remarks.
So we just appreciate your calling in and we appreciate you following our company and hopefully you hear that we are actively managing and trying to make it better every day and increase the prospects of our employees and our shareholders.
When theres challenging times during the pandemic with credit or we're facing right now in the interim with China that we're on it and we're actively managing it and we're transparent in our communication.
We hope everybody has a great weekend and that you have as much fun as we're going to have in Asheville.
Have a good day.
And this concludes today's conference call. Thank you for participating you may now disconnect everyone have a good day.
The conference will begin shortly to raise Johan during Q&A, you can dial stolen.
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Okay.
Okay.
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