Enterprise Financial Services Corp Q1 2023 Earnings Call
Good morning, My name is David and I'll be your conference operator today at this time I'd like to welcome everyone to the Enterprise Financial Services Corp, Q1, 2023 earnings Conference call. Today's conference is being recorded all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and.
Answer session, if you'd like to ask a question. During this time simply press the star key followed by the number one on your telephone keypad, if you'd like to withdraw your question Press Star one to once again, thank you Jim Lally, President and CEO you May begin your conference.
Well, thank you David and thank you all very much for joining us This morning, and welcome to our 2023 first quarter earnings call. Joining me. This morning, as Keene Turner, <unk>, Chief financial and Chief Operating Officer, and Scott Goodman, President of Enterprise Bank and Trust.
Before we begin I would like to remind everybody on the call that a copy of the release and accompanying presentation can be found on our website. The presentation and earnings release were furnished on SEC form 8-K yesterday. Please refer to slide two of the presentation titled forward looking statements and our most recent 10-K and 10-Q for reasons why actual results may vary.
From any forward looking statements that we make today.
Our company entered 2023 with a great deal of momentum loan pipelines were good our newer markets and businesses were contributing as expected credit wasn't great shape and clients are doing very well.
Along the way the industry disruption experienced in early March tested our relationship model and the results from our first quarter in particular, how we ended the quarter with respect to deposit growth liquidity cost of deposits.
Growing capacity and capital ratios show that we pass this test with flying colors.
During our fourth quarter call I spoke about the relationship aspect of our depository businesses.
We knew that 2023 would be a year that would require us to find the appropriate balance between retaining and growing this space, while being mindful of competition and rising rates.
While we did not know is that this would be put to the test in a matter of days and weeks in early March.
I was impressed but certainly not surprised by two things.
First our team's commitment and ability to reach out to our clients to explain what was happening and to reinforce our strength and differentiation versus those who are experiencing issues and.
And secondly, the incredible competence that our client base had in our company.
Since then we have been working with these clients to remix the deposits sneak in the appropriate balance between yield and safety using all products and resources available to them.
Jim will provide much more details on this in their comments.
The financial highlights for the first quarter can be found on slide three.
While we can't entirely control how events impact us I do like our position we start from a position of strength, both from an earnings and balance sheet perspective.
<unk> net income was $56 million or $1 46 per diluted share for the quarter and we were and we produced a return on assets of 172% and return on tangible common equity of 20%.
Our profitability is supported and aided by our short duration asset sensitive balance sheet that is a result of the execution of our business model.
Despite intense deposit competition and pressure in the first quarter, we were able to expand our net interest margin by five basis points to 471%.
With two fewer days in the first quarter net interest income grew to $139 million.
While deposit Remixing and repricing in the quarter was intense our total cost of deposits for the month of March was just over 1%.
This again reflects the strength and position of our balance sheet and my confidence in our ability to continue to generate superior asset yields and growth to mitigate pricing pressure on funding and deposits.
Earnings combined with our strong strong asset position. In addition to a well managed investment portfolio resulted in a tangible common equity to tangible assets ratio expanding during the quarter to 881%.
Additionally, our earnings helped to contribute to just under $2 per share to our tangible book value during the first quarter, which closed at $30 55.
Okay.
Turning to slide four you can see that our loan growth remained strong during the quarter as it increased $275 million. This represented an annualized an annualized growth rate of 11% and like in previous quarters. This growth emanated from just about all of our businesses and regions with a focus on quality and a full.
Yep.
We were able to fund this growth with our deposit growth as this grew by $325 million during the quarter and included the use of brokerage Cds at quarter end, our loan to deposit ratio stood at 90% and due to the aforementioned.
All of our deposits.
88 percentage of deposits to total reduced to 38%.
We recognize that the ability to fund our expected loan growth with core deposits will be our greatest challenge for the remainder of the year.
We're seeing all the great work, we have done over the past several years diversifying our deposit base and geographies paying off we.
We're prepared to defend our deposit base and know that deposit costs will continue to rise. However, our C&I focused variable rates weighted loan portfolio should provide a good buffer to defend our NIM.
Credit quality remained pristine with continued low charge offs low charge off activity and low level of nonperforming assets and a healthy allowance level.
Slide five shows where we will be focused for the remainder of the year I.
I would expect that the momentum with which we entered the year, we will continue for the foreseeable future.
Those of you who those of you who know us well know that we typically perform extremely well when theres a bit of uncertainty.
We grew well coming out of the great recession, we acquired two companies during the Covid pandemic and I'm confident that we will do what it takes to defend well what we have while having an eye towards taking advantage of what our markets will give us to work to acquire new clients, new teams and possibly new businesses.
With that I would like to turn the call to Scott Goodman, who will provide much more details about our markets and our businesses Scott.
Thank you Jim and good morning, everybody.
Q1 was a quarter defined by follow through on a steady and well balanced loan pipeline.
And active outreach to our client base for consultation defense and exploration of new opportunities around deposit relationships.
While the events in March certainly ramped up the volume of client touches in many ways. This activity was not a departure from the advisory based approach and consultative sale processes that we have traditionally driven our business model through the years.
In that regard our ability to deploy specific event, driven talking points content and product sets into our existing marketing.
RM and sales management systems resulted in rapid transparent and productive client engagement.
I am very proud of how our client facing.
And operational teams across the company responded to the circumstances.
But our clients cities and have created many new opportunities as a result.
Turning to loans summarized on slides six through eight.
Growth in the quarter was $275 million or 11, 4% annualized and 12, 2% year over year net of Triple peaks.
Over the past year, we've experienced growth across all major categories of the business as we continue to prioritize the diversification of our production and the resulting loan portfolios for.
For Q1 broken out on slide eight.
<unk> typical levels of origination were complemented by a slightly lower payoff activity.
And a modest increase in revolving line usage is to produce these results.
Growth in C&I reflect success in Onboarding, new regional commercial banking relationships as well as the aforementioned uptick in revolving line usage.
Growth in commercial real estate and construction development are reflective of new asset acquisition and investment opportunities with larger existing relationships as well as draws on fixed lines representing progress on construction loans closed in prior quarters.
And our specialty loan categories sponsor finance posted solid growth of $43 million in Q1, as we saw a number of closings get pushed from a typically strong fiscal Q4 into the first quarter.
Sponsors continue to deploy a strong base of capital and their existing funds.
With some patience and discipline around purchase multiples.
Life insurance premium finance also experienced growth of $43 million in the quarter with steady new originations and a typical seasonal uptick in advances for premiums paid on existing deals.
Following strong growth in Q4, SBA was essentially flat for the quarter.
Origination activity was consistent with typical Q1 levels, however, elevated payoff activity muted net growth.
Competitive pressures from traditional banks and lower fixed rates have been a headwind to retention of existing loans.
We are defending solid credit profile loans in this book with alternative rate structures, and we continue to execute well on the production side of the business we.
We also expect this channel to be well positioned to take advantage of any potential credit tightening or liquidity restraints that may affect the loan appetite from traditional bank lenders.
Tax credits posted a modest reduction in outstandings, reflecting paydown activity on the sale of tax credit inventory, which is typical of the first quarter in this business.
There has also been some delay in the closings of new projects due to higher interest and construction costs as developers source additional funding.
Overall, though we expect originations to ramp back up and also anticipate activity from newer state affordable housing programs to add some additional new opportunities going forward.
Regionally, we posted growth across our footprint as reflected on slide nine.
The southwest posted strong results totaling $85 million of increased loans in the quarter.
The region benefited from continued traction from our newest team in Texas as they on boarded new business, including several significant new relationships with food distribution industrial storage and medical service companies.
Arizona also closed larger loans for new asset acquisitions with existing clients and the storage and hospitality industries.
In the Midwest region that Kansas City and St. Louis teams produced solid origination activity, including funding of a new industrial development with a large existing engineering client and acquisition of equipment with a new transportation company relationship.
This region also benefited most from the elevated revolving line activity given the heavier C&I and makeup of those portfolios.
And in our West region of Southern California, the portfolio added up modestly in the quarter, adding two annual growth year over year of $75 million or four 7%.
We began to gain traction in the second half of 2022, as we cultivate and expansion of strategy in this market, having added new C&I talent to the acquired base of commercial real estate originators in our la and Orange County markets.
Hey off and pay down activity has moderated from the levels experienced earlier last year.
And the C&I pipeline activity has been building.
We also successfully expanded some key legacy relationships in this portfolio during Q1, including new closings for hospitality investor retail and industrial clients.
Turning to deposits, which are broken out for the last 12 months and the quarter on slides 10 and 11.
I'll provide some high level commentary and color around what we're seeing from clients and then Keene will provide more detail on funding costs and category movements in his comments.
Year over year deposits are down 540 million or four 7%.
The largest area of decline as noninterest bearing accounts with nearly two thirds of that occurring during Q1 of 2023.
Offsetting a material portion of this decline has been strong growth from our specialty deposit businesses, including $307 million of growth in Q1 as shown on slide 11.
Okay.
During the first quarter, we grew deposits overall by $326 million.
Historically Q1 has been a seasonally soft quarter for deposit growth in our company with outflows from tax dividend and bonus payments.
This year net of brokered Cds, we grew overall customer deposits by $75 million.
We did see significant remixing of balances, particularly during the month of March spurred early on by the publicity of bank failures driving depositors' towards perceived risk free alternatives.
And more lately due to elevated focus on deposit rates.
Consequently declines in noninterest bearing accounts have been shifted mostly to the categories of money market interest bearing demand and time deposits.
Slide 12 shows the regional breakout of deposit portfolios.
Net of brokered deposits, which are reflected within the Midwest balances.
Client balances in the geographic markets declined modestly during Q1.
Aside from typical seasonal declines related to bonus and tax payments, we did see some consumer clients living concentrated balances to larger banks.
As well as larger commercial clients investing some excess balances in higher yielding accounts in U S treasuries.
In general, though we are not losing core relationships and we have been successful in using FDIC insured options such as Ics in theaters to hold onto a larger balanced commercial accounts.
We have also selectively structured a variety of pricing options to retain high valued relationships.
Our specialized deposit channels, which are broken out on slide 13 <unk>.
Continued to perform well.
And are contributing strong growth in a turbulent market for deposits.
These business lines comprised of community associations property management, and third party escrow accounts provide a steady source of new accounts with somewhat limited competition.
Other specialty balances are inclusive of sponsor finance and declined in the quarter.
The majority of the loss balances in this category totaling roughly 30 million were associated with companies that had been sold by our fund sponsor clients, but which had retained their accounts and enterprise.
Generally these tend to leave over time as the new ownership groups consolidate with their existing banking relationships. However, we saw this behavior accelerate in March due mainly to the fallout from the bank failures.
Finally, we provided additional detail on our core funding mix and account activity for the quarter on slide 14.
This data further supports both the diversity.
And our relationship anchored orientation of our funding base.
Balances are spread across four main channels with 38% of total funding and noninterest bearing accounts.
During Q1, our sales process continued to generate positive results with net increases in new account balances versus closed accounts across all major channels.
The net reduction in number of commercial and business banking accounts is primarily due to consolidation and account closures associated with the Remixing of account types and the movement of some balances to treasuries and nonbank alternatives.
There is also a granularity to these portfolios as you can see from the average account sizes.
Our practice is to require the operating accounts for all CNI loan clients and 80% of our commercial balances are tied to treasury management or online banking products, which adds traction to these relationship deposits.
We've also seen a significant improvement in our insured deposits. We spent time confirming account titling and other similar attributes with clients during the latter part of March.
This is most prolific in our specialized deposit areas as we view account titling as a competitive advantage in both HOA and property management.
We ended the first quarter with approximately 70% of the deposit portfolio insured or collateralized.
With that now I'd like to turn the call over to Keene Turner for his comments Keith.
Thanks, Scott and good morning, everyone I'm going to start my with my typical comment on the quarterly financial results and then I'll address the supplemental information that we provided.
Turning to slide 15, we reported earnings per share of $1 46 in the first quarter, our net income of $56 million.
Our net interest margin expanded from the linked quarter, which combined with growth in earning assets helped to modestly expand net interest income.
Additionally fee income was comparable to a seasonally strong fourth quarter, leading to modest expansion of operating revenue in the first quarter.
The provision for credit losses was more significant for the first quarter, but not driven by adverse loan trends and noninterest expense were seasonally higher in the current quarter.
All things considered we are pleased with the performance of net interest margin.
Loan growth and funding.
Our return profile, thus far reflect a strong base on which to build the remainder of 2023.
Turning to slide 16, net interest income for the quarter was $139 5 million compared to $138 $8 million in the linked quarter, an increase of <unk> $7 million. Despite two fewer days net interest margin expanded five basis points in the first quarter.
To 471% on a tactical basis.
The margin performance reflects the expected result from fourth and first quarter increases to the fed funds rate combined with continued growth, albeit at a more modest rate than we had forecasted.
More detailed follow on slide 17.
Earning assets grew $194 million on average in the first quarter and yields increased 44 basis points compared to the linked quarter.
Investment balances were higher by $84 million on average reflecting purchase activity in the prior quarter combined with an increase in the fair value of the available for sale portion of our portfolio.
Yield improved 12 basis points over the fourth quarter due to the full quarter impact of the securities we purchased last quarter.
We have already elected to pause additional portfolio investment in the first quarter and we subsequently halted reinvestment of the majority of cash flows during the market upheaval.
Portfolio loans grew $275 million in the first quarter and when combined with strong growth in December of 2022 were higher by $371 million on average compared to the prior period.
The total loan yield improved by 46 basis points in the first quarter, which includes a five basis point negative impact from purchase accounting amortization and an additional one basis point reduction for receive fixed swaps.
New loans are booked at a yield of 653% in the first quarter.
Interest bearing liabilities increased $355 million on average and the cost increased 65 basis points from the prior quarter.
Average deposit balances declined $89 million in the quarter, including $282 million decrease in average noninterest bearing balances the decrease in noninterest bearing balance noninterest bearing accounts was driven by two distinct factors first a combination of customer deployment and rate focused early in the quarter resulted in modest.
Net declines and remixing of balances into higher rate money market and CD accounts and second and most materially a flight to safety late in the quarter resulted in balances moving into reciprocal accounts order other institutions for diversification of risk.
The $450 million decline in noninterest bearing balances during the quarter approximately $350 million of that occurred in the last three weeks of March.
Interest bearing checking and money market balances grew $90 million on average, but increased $445 million within the quarter.
As noted this was primarily a result of funds moving from noninterest bearing accounts to higher yielding products for the FDIC insured reciprocal products.
We also made the intentional decision to bring in additional balances often at higher interest rates to support balance sheet liquidity. During the last few weeks of the quarter. These actions helped to defend against net reduction imbalances that occurred as a result of industry stress late in the first quarter.
Time deposits increased $145 million on average, including $71 million of brokered funds.
Total brokered time deposits grew $251 million within the quarter as we elected to add term funding and avoid rely on reliance on our borrowing lines.
Brokered funding adds an element of stability to the overall funding base, while we work through a combination of industry challenges and typical seasonality.
<unk> advances were higher by $102 million on average as we utilize short term debt as a bridge funding alternatives during the quarter until brokered Cds and other deposit strategies could be completed.
In total the ending <unk> balance was unchanged from the end of the fourth quarter to the end of the first.
Maybe noteworthy here is that we do expect to see <unk> as a part of the funding stack moving forward as it provides flexibility for certain of our specialized deposit categories.
These categories collect balances early in the month and then deploy them. After the first couple of weeks.
Our cost of deposits increased during the quarter as we continue to experience some of the pricing lag we expected from last year. Additionally, a combination of competitive economic and industry base factors push rates higher and the change in our deposit mix cause additional increases in our deposit costs beyond what we had anticipated.
Our average cost of interest bearing deposits increased 62 basis points from the prior period, which equates to a 72% beta compared to the fed funds effective rate.
With that said our cumulative interest bearing deposit beta for this rate cycle stand at 32%, which is in line with our historical level and is only 18% for total deposits with that said we are pleased with the cost of deposits in the quarter was less than 1% given where the fed funds target is and we are sitting here today with a total cost of deposit.
At an estimated one 5%.
With all that said, we see a path from first to second quarter to maintain a stable to slightly increasing level of net interest income, albeit that comes with some level of net interest margin compression. We believe that we will continue to see remixing and increased competition. However, the asset side of our balance sheet allows us to mostly absorbed those costs assumed.
We can weather the repricing and Remixing war in the second quarter. There is an opportunity for us to expand net interest income dollars thereafter.
Slide 18 shows our credit trends, we experienced modest net recoveries in the first quarter and the overall asset quality remained stable nonperforming assets remained less than 10 basis points of total assets.
We recorded a $4 2 million provision for credit losses. During the first quarter that was primarily related to the investment in signature bank subordinated debt.
Our total investment was $5 million and was equivalent to the largest individual portion of sub debt or alone we would hold.
Slide 19 presents the allowance for credit losses, the allowance for credit losses increased by $1 4 million in the quarter to cover loan growth the allowance for credit losses represented 138% of total loans compared to 141% at the end of the year.
When adjusting for government guarantees the allowance to total loans was 153%.
On slide 21st quarter fee income of $17 million was stable with the fourth quarter. Although the composition of fee income did change slightly between certain categories. Overall fee income remained at a consistent percentage of operating revenue in the first quarter.
Turning to slide 21, first quarter noninterest expense was $81 million, an increase of $4 million compared to $77 million for the fourth quarter compensation and benefits was the main driver of this increase primarily from seasonally higher payroll taxes and 401K match also the run rate is reflected as a reflection of continued <unk>.
<unk> investment in the associate base, both in the form of net hiring activity as well as the partial period impact of merit increases.
Deposit service expenses declined from the linked quarter. We did expect this line item to expand sequentially and we're pleased that it did not however, it requires some further explanation.
First as a reminder, the fourth quarter included the cumulative impact of a competitive decisions, we made in that quarter of roughly $1 million to maintain certain client relationships and.
And second we were accruing the line item to reflect that clients will be able to largely have expenses to offset against the earned credits. However, this ended up not being the case and some of that exploration occurred in the first quarter.
The run rate for the first quarter, we estimate was around $14 million and we expect that to expand from the first to the second quarter by $1 million to $2 million, reflecting both continued growth in balances and rates.
Overall, we expect noninterest expense to increase to 83% to $85 million in the second quarter, reflecting both an increase in deposit service expense and anticipated higher commissions.
The first quarter's core efficiency ratio was 55% an increase of 240 basis points compared to the fourth quarter, driven primarily by a rise in both interest and non interest expenses in the quarter.
With some moderation of our net interest margin and net interest income expectations. We do expect core efficiency to move up slightly in the coming quarters to be roughly 52% to 53% borrowing better fees or that we're too conservative on net interest income.
Our capital metrics are shown on slide 22.
Strong first quarter earnings and a $24 million improvement in accumulated other comprehensive income resulted in nearly 7% expansion of tangible book value per share to <unk> $30 55.
Right now our earnings profile and high capital retention rate are supporting our flexibility and being defensive from a capital accretion perspective, while we are also comfortable building the franchise with existing and new client growth.
We have always been thoughtful about our capital actions and how we manage the balance sheet.
Not doing too much of any one thing.
And this is reflected in our tangible common equity ratio nearing 9% and our common equity tier one ratio over 11%.
While we look at the investment portfolio on Slide 23, you can see that we apply the same principles and philosophy managing here.
While we used held to maturity to help manage volatility intangible common.
Tangible common equity in accumulated other comprehensive income we did so in a manner at a measured level that the after tax unrealized losses on held to maturity or approximately 40 basis points of tangible common equity and total available for sale and held to maturity losses are approximately 150 basis points on common equity tier one.
So roughly nine 7% common equity tier one capital, including all unrealized securities losses.
Separately, we use the investment portfolio for two purposes, we have a shorter term component, which is roughly 60% of the portfolio for liquidity cash flow and municipal deposit pledging purposes. This would represent agency mortgage backed and CMO T bills and other government sponsored securities the remaining 40%.
We invest in 10% to 15 year, New issue municipal Securities. We utilize this portion of the portfolio to stabilize our extreme asset sensitivity because our loan portfolio of short duration with a two and a half year weighted average life and we have a portfolio of mostly scalable variable rate SBA loans.
In the first quarter, we sold $8 $8 million of SBA loans and recognize the half a million dollar gain.
<unk> on the sale.
The SBA sale was a practice for contingency planning as we have not executed any sales since acquiring seacoast in 2020.
Also in January we sold roughly $30 million of lower yielding securities at a gain and reinvested the proceeds at a higher yield.
And it's worth reiterating here that the loan portfolio was almost 65% variable rate. So while our six year investment portfolio duration may seem long on the surface. We use it purposely and we kept it proportionate in size to our long term balance sheet targets, despite having billions in excess cash in 2020 in 2021.
With locally investing that cat investing.
And that thing that cash to be cautious of its resiliency and that strategy along with investing methodically over numerous quarters supports our current capital position profitability and flexibility moving forward.
And finally on slide 24, we provided some additional context on liquidity I'll first start by thinking that roughly 70% of our deposits are insured or otherwise collateralized, reflecting collateral pledged to municipalities use of Cedars account titling for trustees and custodians and in some cases surety bonds for our specialized deposit businesses.
That means that the remaining 31% is above insurance Laurence and is within the available $4 billion of liquidity that we now have you might expect we spent a good portion of March pledging additional collateral in case, we needed to be defensive given the turmoil that occurred in banking.
Finally, and worth noting many of the balances that are greater than the insurance limits are with long time clients, who have full banking relationships here and have grown with us over decades.
With that we feel our prospects are sound to fund the balance sheet with deposit growth in 2023, and our position in the profile, particularly in specialized deposit lends itself well to support that growth even in the face of an environment focused on deposit insurance. Additionally, Additionally, while the cost of deposits has increased we believe our lending businesses.
They are adequately positioned to continue to deflect and absorb some of those costs. While returns may decline modestly theyre doing so from a high starting point and our earnings profile remains differentiated in robust with that I. Appreciate your attention today and we are now going to open the line for analysts questions.
Thank you.
At this time I'd like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad will pause for a moment to compile the Q&A roster. We will take our first question from Jeff <unk> with D. A Davidson your line is open.
Thanks, Good morning good.
Morning, Jeff.
I didn't.
Don't know if I missed it from Scott our team just the outlook on the loan growth and pipelines sounded optimistic and some seasonal items that could come in but just wanted to kind of understand what what's your outlook. There is an on net growth for.
For the remainder of the year.
Sure Geoff I can give you some color.
I think.
Maybe on the specialty side of the business does continue to be very steady performers.
I think maybe the only outlier was tax which we've seen as I mentioned seasonal decline related to tax payments and some of the construction projects just kind of waiting to rebid I think we're seeing that and we fully expect that that niche to perform as expected for the remainder of the year the rest of it.
Those businesses continue to plug along I think we've seen that in our <unk>.
In prior quarters very steady businesses.
Within the regions we're seeing.
Good opportunities solid pipelines overall.
Where.
Seeing may be some stress competitors back away from the market slightly and I think we're going to get opportunities to look at higher quality loans number one and I think also prioritizing strong pricing there as well. So I think we feel very good about the opportunities that we're leaning into and I think.
Bodes well for the pipeline for the rest of the year.
To put a number to that Scott.
Ed.
Low double digit growth this quarter.
It sounds positive but.
High single digit yes.
Yes, Jeff This is Jim let me handle that one so I would tell you we're still confident in that.
Mid to high single digits for the year, and I think being a little more judicious relative to pricing and what have you will.
<unk> one thing with you Scott mentioned in his comments, we're not seeing the payoff activity as much and what we're not going to do is when we can acquire a great <unk>.
Families and great businesses in terms of bringing on new relationships, we're going to do it because it really enhances the value long term for the company.
Great. Thanks, Jim.
Let's see just wanted to maybe hop over to maybe while I've got you Jim.
Just on capital as it climbs I know you've been you were.
Conservative through the pandemic.
We've got more cloud swarming, but as that capital does climb.
You had been quick on the buyback, but any any thought there are we're preserving or kind of acquisition opportunities to come.
Just any any thoughts on the capital side, Jeff I think I think our posture is this is that first and foremost of capital that can use for our growth objectives.
We've got a sound, we've got sound credit quality right now.
I think there's a bit of slight recessionary times that we'll all have to combat through all of this so we're going to be.
Basically stay put relative to buybacks at this time.
On acquisitions. So that's a long term view, we're always interested we have to figure out when the dust settles what can we use acquisitions for to enhance the value of the company.
But thats something thats, a little bit longer term for us at this point.
Okay.
Last one maybe for Scott I'd Love to just kind of here just from a high level as you look at the specialty loan.
Break out just wanted to.
More stressed environment as you look at and I appreciate the breakout of the office detail that was great, but within the specialty loan.
Books.
Kind of your highest and lowest credit risk as you see it in those portfolios across SBA sponsored life insurance tax credit what areas are a higher or lower on the risk profile from your perspective.
Yes, I think if you look at the two ends of the spectrum their life insurance premium finance, just given the liquid collateral.
Behind those loans.
That's the lower risk end of the profile.
Where we have to watch that portfolios is yields.
And we have been.
<unk>.
Pretty steady in terms of our expectations are and we've been able to get the growth we're looking for.
But that's certainly.
Something that we can turn off and on a little bit easier I think on the sponsor finance side, probably not surprisingly at the other end of the spectrum just given the nature of that book is cash flow based with a little higher leverage profile.
Said, we look really hard at that portfolio. We review every loan in detail.
Quarterly.
And right now we're really pleased with the performance of that book.
The leverage is typically in the three times and under range.
Coverage is strong so but that would probably be the one that we're continuing to watch closely given the economic environment.
Okay.
SBA, maybe with government backing.
Tax credit you put those kind of in the middle in terms of risk profile of those four.
Categories.
Yes, I would say, it's closer to life insurance right then sponsor.
As I mentioned and we're continuing to be bullish on origination activity there.
What we've had to do in terms of holding some of the book has shifted a little bit to a fixed structure, which hold some of those loans on the books, but does affect the ability to sell those loans in the market and we'll just continue to evaluate that risk versus reward as we move forward, but I think you know.
That sector, certainly as we see banks pull back from traditional lending.
As the yield curve normalizes and as the economy desktop and Thats, a counter cyclical niche that.
And that will should do well for us over time.
Great. Thanks, Scott.
Next we'll go to Andrew Liesch with Piper Sandler Your line is open.
Hey, good morning, guys. Thanks for taking my question.
Yeah.
The funding of the loan growth recognizing that.
Reinvesting in the securities portfolio doesn't talk that's going to be a priority anymore. So I'm just curious what are the cash flows coming off that.
<unk>.
Okay.
Is that going to be sufficient to fund loan growth it sounds like youre, bringing on some FX there'll be.
And keeping some of those funding mix just kind of curious.
The outlook of funding the loan growth.
Yes, Andrew Thanks for the question because I think maybe my comments misled.
A little bit of where we are so.
We do not anticipate long term remixing out of the investment portfolio into loans I think we haven't really remixed anything already we're just we have investments in city area and that cash that we didnt reinvest that as just kind of sitting there.
Wanted to get through the next.
90 days, so to speak in 60 days whatever it is and.
Then I think resume balance sheet management as normal and in our view the balance sheet has the right size and it has a target for the investment portfolio and where we were at the end of the year largely reflects that so our assumption when we model out net interest income and margin that we're going to keep the investment portfolio.
So relatively the same size, obviously fair value of them move that around a little bit, but reinvest the roughly $250 million of cash flows that we expect this year and we think thats a sound approach from an interest rate risk management perspective, and then I think based on my comments, although maybe the timing of this is uncertain I think there is a.
Path to generally customer funding the growth that we expect for this year I think enterprise has historically struggled to grow deposits in the first half of the year with the commercial base we've got.
A lot of tax payments and after year end bonuses that that come out of the system and then certainly what happened in March caused some additional pressure there and maybe put a fire back foot a little bit in terms of use of brokered versus overall flows but I.
I think our path would be forward that particularly as we ramp up the effort in.
Recent weeks and then as we move into the second quarter and the remainder of the year that we're able to grow customer funding.
We'll have some stabilization of the competition and the Remixing and the industry.
While we will use <unk> to manage the ups and downs of the specialized businesses. We expect that we're going to get growth overall and will generally have some reasonable path to core funding the balance sheet.
In the second half so I think thats, our expectation I think that drives <unk>.
<unk> opportunity to defend the level of earnings per share in the.
The operating revenue.
And we don't see it.
Remixing, albeit might be slightly more profitable in the short term at.
It creates I think some longer term challenges and that concentrates interest rate risk in an environment, where I think we're more exposed to down rates. Then then we probably want to be so I think as Jim said continuing to build the franchise and moving forward with acquisition, our relationships and really trying to find the funding along the way.
Got it.
You've covered all the other questions I had I will step back.
Great. Thanks, Andrew.
And I'd like to remind everyone. If you have a question Thats star one on your telephone keypad next we will go to a Damon delmonte with <unk>. Your line is open.
Hey, Good morning, guys hope everybody is doing well and thanks for taking my questions I joined late so I apologize. If this was covered but when you look at the deposit mix noninterest.
Noninterest bearing or down to 38% of total deposits from 43 last quarter.
Ken can you just give a little perspective as to kind of where you see the ultimate remixing kind of landing for the for the noninterest bearing deposits.
I would say, we don't necessarily have a hard and fast percentage that we've looked at we are down subsequent to March 31, and that's primarily business flows on tax payments and a lot of that as you would expect comes out of DDA. We are seeing some remixing still on the Cds in theaters shock.
<unk>.
But we also saw some good activity in the specialized space that made up for that in the first half of March so.
We know it's down and I think our forecast suggests there's further remixing whether that settles in at 35 or 31 or some other magical percentage.
I really cant forecast that I think we generally to Scott's.
Scott's comments have identified.
And our tracking vigorously the deposit flows more so than we ever have and we're just making sure that if something left we're we're at the table to follow up and see what we can do that to get that back structurally so.
I think our overall expectation of that certainly deposit costs are going to rise.
I will say.
Significantly from where they were from the first to the second quarter, but maybe not so materially from the 125 basis points that I indicated we were at in March and that does assume some level of Remixing and I think that overall when we look at the overall cost of the deposit base and how it's behaved relative to where fed funds.
And then when we look back historically to wear.
How it behaved in the overall cost where it was like in 2019 were at a similar level of cost for that deposit base today with almost twice the fed funds rate. So we feel pretty good about that and we've got a little bit of room to give there on the DDA percentage, while still maintaining net interest income and profitability.
I know you wanted a number but I don't have a good one there, but that's how we're looking at it and how we're thinking about it.
Okay. That's good color. Thank you.
And then did you say that the.
The loss on the sub debt security was $5 million.
Yes, we will.
There was no loan growth during the pandemic and PPP, obviously, a lot of banks are issuing sub debt.
We participated to a modest degree in both the investment and loan portfolio.
Signature was one of <unk>.
Very few 5 million positions most were.
Our $1 million to $3 million position then.
Signature at the time had a better credit rating than we did in an issuing at a nice coupon and so we bought a small piece of that so again not ideal, but we did we.
We did like we do with everything we deploy cautiously and we try not to get.
Drunk on anything and so we're happy we kept that parameter to $5 million.
Okay. So if we back out that $5 million from the loan loss provision this quarter.
It kind of leaves you with not much of a provision for this quarter. So how do we kind of think about the provision in the coming quarters.
Yes.
So what's interesting is that the underlying economic data.
Unemployment and GDP and our model actually improved from the fourth quarter and I think you.
Rollback the calendar for the prior six or eight quarters I mean, we fit in.
We tried to be conservative because we kept feeling like the economy was going to.
Have a more negative sentiment and we built a lot of those things into our qualitative factors and the good news is that credit quality and asset quality continues to be stellar and with the passage of time, what happens is that the key factors that we have got more and more baked into the forecast and so.
We have to be mindful of that and rotate out of that and be intellectually honest with with what's going on so.
That's really what's driving that overall composition and then obviously also it's just both certain places where the growth how the growth formulates and the quarter end.
Where we get the origination activity. So it's really a combination of those three factors. In addition to a sequential reduction in the level and the reserve for unfunded commitments from <unk> to <unk> that that really drove that so I think you've got a modest provision for new loan growth, but then underlying that there is some.
Favorable remixing as well as composition between allowance for loan losses, and unfunded commitments, that's kind of baked net into that provision number.
Got it okay.
I saw that I had for now thank you.
Youre welcome Thanks Damian.
Okay next we'll go to Brian Martin with Janney. Your line is open hey, good.
Morning, guys, Hey, Bryan.
Just going back maybe I missed it joined US late in a little bit as well just on your kind of your margin commentary just can you talk about just where the March margin wise I think you gave the spot rate for the funding, but just for the March margin was and just kind of how you're thinking about NII or margin perspective, I apologize if you already covered that.
I didn't give an actual numbers, but obviously first first quarter margin was $4 71 March was $4 64, and then our spot margin right now is just under $4 six.
Loan yield is roughly six 4% and then as I indicated we've got about a one 5%.
<unk> that we're assuming on deposits and triple checked that this morning through the first 24 days of March and that data is still holding up so all else equal is onto that we've got some level of degradation of funding cost in there for the remainder of April and then May and June but.
When we look at that combined with the growth that Scott and Jim talked about that's what gets us to that.
Second quarter net interest income dollars potentially being level here to the first quarter.
Okay, and then as far as kind of the balance of the year. It sounded like I thought your comment was it was your hope was to see that $1 of NII sequentially going up in the back half of the year is that.
Yes.
I think Brian the way we're thinking about this is.
The level of competition intensity and Remixing.
Is it still there, but it's lessening and.
I think all of the big major moves in all of the massive shifts out of DDA into theaters or a CD or just plain out of the bank and having to replace those with incremental funding I think our sense is that the chunky knits have that is slowing.
And we will continue to experience some of that in the second quarter, but that is if we can really get much of that remixing behind us we have the benefit of day count moving forward.
And our asset origination is we're being as.
Thoughtful as we can about where to allocate that and as disciplined as we can especially with Scott comments about others potentially pulling back. So there is a path to that and thats really dependent on the second quarter kind of being the.
The final remixing quarter, so to speak.
And.
Being able to get back to some semblance of business, albeit with higher deposit costs across the across the industry and for ourselves. So.
I think there's a path I think for me to say that I can really predict two quarters out from here is extremely challenging we don't control the environment, but I mean, I think that's how we're thinking about the rest of the year, but even if it <unk>.
Worse than we anticipated and we generally defend the net interest income dollars that we have I think thats still potentially shapes up to be pretty good and pretty strong for us to build on for the upcoming years.
Gotcha, perfect and I think you talked about also lessening some of the asset sensitivity I guess is that I guess.
I guess, how to how are you thinking about potential rate.
Rate cuts I'm, just kind of managing the balance sheet. There if you do see that.
Yes, so we have done some some swaps so some receive fixed swaps principally on variable rate loans, we had set out to do.
A decent portion of that.
We've only executed a modest percentage at this point. So if we're going to try to do $500 million to $1 billion or at half to 25% of that level. So we're doing something.
We will continue to play that out of the interest rate environment shapes up we certainly want to do I think a little bit more of that to protect the downside.
And that is we did see that in a basis point here and some margin in the quarter. So it is having.
Some effect, but really the.
The investment portfolio to also help that and.
We're just trying to sit tight and see what happens in terms of pressures to.
Accumulate cash and shrink funding, which creates additional asset sensitivity.
And.
Then going and putting on our receive fixed swap. So I think what we're trying to do is resume business as usual and unused slopped opportunistically to maybe change that.
The downside minus 100 minus 200, a couple of basis points here and there if theres an opportunity. So that's how we're thinking about it gotcha cool. Thank you and then it sounded like Jim you said that maybe kind of the same stance as last quarter on the buyback I mean, I guess just wondering what.
What's kind of where is the point, where maybe if you are building capital in.
Business kind of goes back to usual that you get back to looking at the buyback or is that something that just you think if the remainder of the year much of it it's probably just off the table just until some of the dust settles here.
I think that what you said is correct Bryan your lips to God's ears about getting back to normal and when it does we'll certainly reassess that.
Hey.
And maybe just one for Scott I guess.
Just on the trends in credit quality is very very strong just on the trends in criticized this quarter was there anything.
Positive or negative on the criticized front that trend wise that you're seeing that you're watching.
No no major trends, it's pretty flat, Brian and as I said, we're looking hard so.
We feel really good about the quality of the portfolio right now.
Okay, perfect and just maybe the last one for me I was just keen on initially with some of the Lumpiness within.
Fee income just any any thoughts on the tax business.
Back this quarter.
From what we saw last quarter, just how should we think about that as just kind of bigger picture on fee income outside of kind of the lumpiness of the other private equity in the <unk>.
Yes, I would say Theres really no revelations on the change in the posture on fee income I think as the environment pressures margin.
I think that the tax credit business from a fair value perspective does does hedge that slightly and we saw that last year with some of the negatives last year with margin rapidly expanding.
So this quarter was was really a reflection of just a modest fair value change in just even every quarter if rates don't change as we move forward just present value of cash flows you pick up a couple of hundred thousand dollars just a fair value.
Along with the longer term 10 year so for rate.
Moves down slightly.
Obviously your discount rate declines and then youre going to pick some of that back up so there's a little bit challenging to predict the sensitivity hasnt changed about $800000 for 10 basis points.
And I think our.
Expectation moving forward is that second and third quarter will be fairly light on the nonrecurring items and then we'll have a seasonally strong fourth quarter on tax credit and maybe we'll have some private equity or Cte hit along the way, but generally our expectations. There are a couple of million dollars for each in total.
Got you okay.
That's all I had thanks for taking the questions. Thank.
Thank you Brian .
And we do have a follow up question from Jeff <unk> with D. A Davidson go ahead.
Keith I wanted to quickly follow up on the expense expectation to $83 to 85.
A little surprised that were lagging up again, I guess with the.
The seasonal kind of payroll 401k step up in the first quarter I know you mentioned.
What you did on the deposit costs and expect to step up and commissions, but just trying to.
Figure some of those comp costs in Q1 figure they might roll over a bit.
Trying to get to where you were in Q1 to continue to increase it in the second quarter.
Jeff the way I think about the transition from <unk> is that I think generally comp tends to the level.
So investments in the business in <unk>.
Pickup in.
Other items kind of tends to lag and maybe it's down a little bit but the commentary on commissions I think reflects.
More of the continued.
Growth in progress that that Scott noted.
And then really the big driver there is if.
I think the turnaround in the deposit cost obviously, we were down in the quarter and the first quarter. So that showed better than we anticipated, but we're let's say, we're probably back to the level, where if you followed it through in sequence that.
We were kind of already be in the in the second quarter. So it didn't it didn't really totally stepped down and thats a combination of two factors that the space continues to be competitive in many of the banks that are struggling with funding our larger and fierce competitors in that space number one and number two we continue to grow that that business not underlying business pretty.
<unk> had a healthy growth rate and so that also contributes to.
To that expense there so I hear you on.
On the comp and benefits and maybe we're.
Tinge conservative there with expecting $2 5 million in the run rate, but we are continuing to add.
Two positions and strengthened the organization selectively.
And so I, just I don't want to over promise there, but really the biggest driver is on that deposit business.
I appreciate it and I just wanted to confirm is that 83% of you guys that that good for the remainder of the year as you just.
<unk> alone and then we will I think I think deposit service charges continue to move up throughout the year I think we expect that business to continue to grow and expand and then to the extent that there is any interest rate increases.
That moves up 25 basis point that moves up probably half a million a quarter just from a rate increase so.
For what it's worth in terms of how to how to think about that and whenever you're putting in your <unk>.
Your models for fed funds.
Got it thank you.
Youre welcome Thanks, Jeff.
Okay I'm not sure that there are no further questions at this time I will now turn the call back over to Jim Lally, President and CEO for any additional or closing remarks.
David and thank you again for joining us this morning, and your continued interest in our company.
Everyone have a great day, and we will talk again at the end of the second quarter. Thank you.
This does conclude today's conference call you may now disconnect.
Okay.
Yes.
Yes.
Yes.