Q2 2019 Earnings Call
Greetings and welcome to the be Okay Financial Corporation second quarter 2019 earnings Conference call.
At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad. As a reminder, this conference is being recorded I would now like to turn the presentation over to Steven now Chief Financial Officer for be Okay Financial Corporation.
Please proceed.
Good morning, and thanks for joining us today, we'll hear from Steve Bradshaw, Our CEO Stacy Adams Executive Vice President of corporate banking and I'll also provide some remarks about the quarter.
Scott Grauer Executive Vice President of wealth management, and Mark Martin Our Chief Credit Officer of also joining us for the question and answer session.
PDF of the slide presentation, and second quarter press release are available on our website at www dot the okay Dot com.
We refer you to the disclaimers on slide two as it pertains to any forward looking statements we make during this call.
Ill now turn the call over to Steve Bradshaw. Good morning, Thanks for joining us to discuss the second quarter 2019 financial results. We are pleased to report another strong quarter for be Okay financial in fact, we achieved the highest level of quarterly earnings in the history of the company both from a net income and an EPS perspective, I'm incredibly proud of the effort for the entire be okay financial team the power of our diversified business model as well as our efforts to gain greater efficiencies across the company really show themselves this quarter.
As shown on slide four second quarter, net income was $137.6 million or $1.93 cents per diluted share that's up 24% from the previous quarter and up 20% from the same quarter a year ago.
The growth was driven by a number of key factors loan growth continued its strength this quarter, particularly in our specialty lines of business in commercial real estate.
Our focus on our energy and healthcare segments continues to deliver above market loan growth for the company, while a reload in commercial real estate following the wave of pay downs in the first quarter was also a large contributor.
Net interest revenue expanded 3% this quarter, though net interest margin remained flat at 3.3% Stephen will cover the underlying factors in more detail momentarily.
We added $1.2 billion of short duration fixed income mortgage backed securities. This quarter to help support net interest income as we expect interest rates to continue to decline in the near term.
Fee and commission revenue continued its upward trajectory this quarter expanded nearly 10% our brokerage and trading and mortgage banking revenues were the main contributors on strong mortgage backed securities trading and mortgage loan production volumes all triggered by lower mortgage interest rates during the quarter.
Our multi year effort to gain greater efficiencies has held expenses in check which continues to drive earnings leverage across the company.
Following the integration of Cobiz last quarter expenses returned to a more normal level this quarter.
The credit environment continues to be stable consistent with our results for the last several quarters. Our continued loan growth was the primary driver of our $5 million loan loss provision.
Turning to slide five period end loans were $22.3 billion, an increase of $497 million for the quarter.
We continue to feel optimistic about loan growth for the balance of the year due to the strong commitment growth we've seen over the past several quarters, particularly in energy and health care.
Assets under management or administration were 81.8 billion, that's up $2.9 billion from the last quarter benefiting from strength in the equity markets along with strong organic asset gathering success across several of our investment in fiduciary lines of business.
And we saw an opportunity to further invest in our company at a favorable price this quarter as we bought back 250000 Boe cash shares of $80.50 per share in the open market.
Ill provide additional perspective on the results at the conclusion of the prepared remarks, but now I'll turn the call over to Steven nail to cover the financial results in more detail Stephen Thanks, Steve.
As noted on slide seven net interest income for the quarter was $285 million up 3% from the first quarter.
Well, we've been able to significantly expand net interest revenue due to continued loan growth. The change in course of interest rates has impacted net interest margin.
Net interest margin was 3.3% flat from the previous quarter.
Second quarter net interest margin was supported by 3.4 million interest rate credit recovery.
And an increase in discount accretion from Cove is up from $7.8 million in the first quarter to $13.4 million this quarter.
While these items combined to help margin by 10 basis points total therefore pressure points on net interest margin that combined to fully offset these benefits.
First lower loan yields from variable rate loans priced off of LIBOR or were a factor this quarter.
Second we continue to see some exception deposit pricing from our commercial clients. However, at a decreasing pace.
And lastly, as Steve mentioned, we expanded our fixed income mortgage backed securities portfolio by 1.2 billion as a measure to protect for a down interest rate environment.
These additional securities will be additive to net interest income, but we'll have a dilutive effect on the net interest margin calculation, which will be fully realized in the third quarter.
While we are working to defend net interest margin significant interest rate cuts, we will continue to apply pressure.
Omitting the interest recovery on accretion benefits the yield on average, earning assets was 4.31% a six basis point decrease and the yield on the loan portfolio was 5.09% down two basis points.
The yield on the available for sale securities portfolio increased six basis points to 2.63%.
The overall cost of interest bearing liabilities increased four basis points to 1.7%, including a nine basis point increase in interest bearing deposits to 1.13%.
On slide eight fees and commissions were $176.1 million, an increase of nearly 10% for the quarter. The growing trends. We mentioned last quarter continued to unfold as declining rates fueled activity in wealth management and mortgage.
Lower mortgage interest rates, coupled with seasonality led to a $197 million or 32% increase in mortgage applications and commitments over the previous quarter.
Mortgage revenues were up 18% and gain on sale margins increased 18 basis points.
Increased operating leverage in this segment from our Rightsizing efforts continues to pay dividends.
Brokerage and trading revenue increased over 28% for the quarter, primarily driven by strong mortgage backed security trading results.
All other fee revenues increased $2.4 million or 2.2% over the previous quarter largely due to seasonal factors.
I'll also mention that our total economic cost of.
Changes in the fair value of mortgage servicing rights net of economic hedges was $7.3 million. This was due primarily to the combination of continued significant mortgage rate volatility that fell outside our hedge protection.
Turning to slide nine we continue to carefully manage expenses to drive operating leverage.
Total operating expenses were $277 million down $10 million from the first quarter, which as you'll remember contain $12.7 million of cobiz integration costs.
We are proud of the efforts we have made on the expense front, which has brought us through our 60% efficiency ratio target for the second quarter efficiency ratio of 59.5%.
Omitting integration expenses from the first quarter.
Personnel expenses decreased 5.6 million this quarter as we are now realizing the full benefits of cost efficiencies from the Cobas acquisition.
Non personnel expenses was up $8.3 million omitting integration expenses from the first quarter.
Business promotion expense increased 2.9 million, primarily due to increased seasonal advertisement spending as well as some remaining advertising expenses related to marketing our be okay financial brand in the Colorado and Arizona markets.
Insurance expenses up 1.9 million largely due to adjustments to deposit insurance expense related to cope is integration.
Increases in professional fee and services $1.7 million in mortgage banking costs of $1.6 million or partially offset by a decrease in net losses and expenses are repossessed assets of $1.4 million.
In addition, a $1 million charitable donation was made to the bow Ks Foundation in the second quarter.
Slide 10 has our current outlook for 2019.
We expect mid single digit loan growth with continued strength in energy healthcare in general Cnine lending.
Loan loss provision levels will be influenced by loan growth, but will likely run at similar dollar levels when compared to the past few quarters.
Interest rate decreases forecasted by the market will continue to put downward pressure on net interest margin.
Revenue from fee generating businesses, particularly brokerage and trading and mortgage could continue to benefit from lower interest rates as we've seen this quarter.
We will attempt to maintain an efficiency ratio at or below 60% as long as the environment remains favorable for revenue.
Our capital strategy going forward, we will support organic growth.
And modest opportunistic share repurchases, we expect to improve capital ratios over time.
And lastly, a word on Cecil our seasonal implementation team continues to develop the models processes and controls necessary to implement the new credit standard.
By January Onest 2020.
Currently we do not expect a material change in our existing allowance for credit losses, primarily due to our loan portfolios relatively short average lives.
However, we will need to recognize an allowance for expected credit losses on approximately $2.5 billion of acquired loans.
Although those loans were marked to fair value at the acquisition date, which included an estimate of expected credit losses Cecil requires duplicate recognition of expected losses in the allowance.
Cecil Arcelor requires us to recognize expected credit losses, and an approximately $3.3 billion of residential mortgage loans that we transferred into mortgage backed securities.
These loans are guaranteed by the veterans administration, and we have some exposure to credit losses that exceed the guaranteed amount.
As a reminder, initial recognition of Cecil will run directly through retained earnings and not the income statement in 2020.
While we currently do not expect seasonal to significantly affect the company. The ultimately impact will depend on the composition of the loan portfolio as well as economic conditions and forecast at the date of adoption.
Safety kinds will now review the loan portfolio more detail I will turn the call over to Stacey.
Thanks Steven.
As you can see on slide 12, total loans were $22.3 billion up $497 million for the quarter.
So looking at the table you can see the strength continues to be broad based.
Total cnine was up 2.7% for the quarter.
Our expertise in energy continues to be the driving factor and was responsible for the bulk of CNR growth this quarter.
Energy was up $216 million or 5.8% for the quarter.
The lower than normal churn trend in the energy portfolio. We've discussed continues as companies continue to be slower to divest or sale and the current market environment.
Our health care channel was up marginally this quarter, but it's not a cause for concern.
When we had strong production in this space higher levels of refinancing into the permanent market in the second quarter impacted overall growth rates.
We continue our focus in the senior housing space, which is not only a great business from a growth perspective, given current demographic trends, but is also an excellent credit niche given our strong relationships with high quality operators.
The commercial real estate portfolio was up 2.4% for the quarter was strong commitment volume following pay downs experienced in the first quarter.
While we continue our discipline around concentration limits in the space.
We have a proven ability to reload commitments in this portfolio.
More broadly core loan growth outlook for the back half of 2019 remains optimistic as long as the larger economy continues to show strength.
On slide 14, you can see that credit quality remains strong as it did in the first quarter.
Non accruals were up 31 million during the quarter, primarily due to three energy loans in the late stages of resolution.
These are isolated situations and do not point to anything systemic in the overall portfolio.
Net charge off moved to 14 basis points, the lowest level, we've seen over the last five quarters.
Potential problem loans, which are defined as performing loans that based on known information caused management concern as to the borrower's ability to continue to perform totaled 161 million at June 30 down from 169 million at March 31.
Based on an evaluation of all credit factors, including overall loan portfolio growth changes in non occurring and potential problem loans and net charge offs. The company determined that a 5 million provision for credit losses was appropriate for the second quarter of 2019.
We remain appropriately reserved with a combined allowance of 0.92% of period end loans and leases.
I'll now turn the call back over to Steve branch offer closing commentary.
Thank you Stacy again, it was another record quarter for be Okay financial I think this quarter really showcase not only our diversified business capabilities, but also our ability to execute well across all lines of business and markets. Many of our fee businesses performed just as we would expect in a falling rates market as we added $15.6 million in revenue on a linked quarter basis, we remain convinced that our unique business mix and geographic focus will position us for continued strict no matter what economic environment is on the horizon.
At the halfway point of 29 team, we remain optimistic about the outlook for the remainder of the year. We continued to deliver strong loan growth fee revenues are accelerating and our expense discipline is driving leverage and has moved us through our 60% efficiency ratio target and credit quality remains strong.
In closing I also mentioned that the overall momentum we are building in Colorado and Arizona on the back of the final systems integration of Cobas last quarter is growing.
We are now very focused on realizing the synergies are bringing our two companies together and have seen traction in several areas of the organization.
It's obvious that the expense efficiencies have been achieved but ultimately we will realize our return for the investment we've made in the Colorado and Arizona markets by growing our share in serving our customers with a highly competitive array of products services and advice across the market.
With that we will take your questions operator.
At this time, we'll be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad.
And ladies and gentlemen indicate your lines in the question queue. You May proceed Sir if you would like to move your question from Q.
Participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key.
Our first question comes from the line of Ken Zerbe with Morgan Stanley . Please. Please proceed with your question.
Great. Thanks, good morning.
Good morning.
I was hoping you start off just in terms of the Cecil commentary that you had on slide 10, I think you're one of the first things stay at least even address it and then kind of printed form but.
Are you able to quantify what level of reserve you might need on that $5.8 billion of combined collision guaranteed loans.
I think we'll do that in the third quarter, we will continue to work our modeling our estimation, but we did want to give.
You all a little bit of an indication of two areas, where cecil requires additional allowance above our current allowance. So that's that's the idea is give you a bit of an.
Magnitude of the number of loans or the amount of loans that fall in those two buckets and then we'll be prepared after the third quarter to give some guidance around the range for the entire reserve.
Gotcha, Okay, and then is it fair at least directionally to assume that because you've written down the cobiz loans and because not all the guarantee loans or.
Sure.
Only a portion is not guaranteed that the reserve is going be something so far less than your 90 basis points that you currently have in your existing portfolio.
For for those two particular buckets, particularly the second bucket certainly it's not going to carry on a full reserve if you will because theres only the tail as you mentioned.
That were exposed to.
Gotcha Okay.
I guess and then maybe shifting gears a little bit the discount accretion from coda is obviously is very high this quarter.
Keep providing guidance in terms of where you think that might trend in threeq and beyond.
Yes. This is difficult to do try to provide a little bit of guidance last quarter on on the level turned out to be a little higher.
So I'm not providing any guidance around what we think it will be in the third quarter although.
I would tell you that I think around 20% of the accretion.
Has been recognized so far and so we've got.
That's a pretty big bucket of dollars left that will flow into income sometime over the next couple of years.
Okay, and then maybe if you break out the 13 ish million dollars, how much that was sort of scheduled or expected accretion versus unscheduled.
I would say about 4 million or so.
Was it was a little bit higher than we expected.
And you know it was generated from some accelerated pay offs in the real estate portfolio.
As well as the public finance arena.
But I will tell you that not all of those are loans that paid off and left the bank.
Many of those loans are re underwritten.
In the end up in our kind of portfolio going forward.
Gotcha, Okay, and then sorry, if I could squeeze in one last question in terms of the MSR valuation adjustment I thought I heard a number of $7.3 million.
Just want make sure that was a negative this quarter and that offset the within your derivatives or is your sense of security gain type line is that right.
Yes, they actually the mortgage servicing rights themselves declined $29 million and then we covered.
Through our hedging activity about 75% of that or net 7.3 million negative.
Got it okay perfect. Thank you very much.
Our next question comes from the line of Peter Winter with Wedbush Securities. Please proceed with your question.
Good morning.
Good morning morning, Peter.
The efficiency ratio came down nicely this quarter and I'm just wondering.
If we do get.
Call it two or three fed rate cuts.
Is it still says to sustainable.
To keep it at that 60% level in the back half of this year.
Well I think I'll provide this is Steven Peter I provided the guidance that we are sure going to try.
But it really depends on.
The denominator that revenue growth I think as the environment changes drastically where revenue growth.
Opportunities are less because of the lower rate environment, which certainly it's going to put some pressure on NIM and some pressure on net interest income.
I think our fee businesses are going to do quite well in a low rate environment, but part of it depends on the revenue side of that equation, but definitely we are going to.
Attempt to maintain it at that 60 or better.
On on.
Does your forecast assume.
Right.
Cuts.
Yeah, I think what I'm really looking at is kind of what the markets building in that's anywhere from two rate cuts the three rig cuts and so on.
Im telling you all that if we get that we will have pressure on our NIM and.
Of course, we're going to continue to grow loans, we believe.
And that's going to generate some opportunity for net interest income growth.
But part of that will be offset by lower overall net interest margin.
If rates, if we get rate cuts throughout the rest of the year.
Is there any way to quantify what the impact to margin is for each 25 basis point rate cut.
In that you can break I'm not get haven't provided guidance around what I think the NIM will be in the third and fourth quarter, if we get rate cuts, but I'll tell you that.
Given our LIBOR based loans in the asset repricing on the loan side.
It's usually 80% of a rate cut.
Because of all the ones that are variable.
On the wholesale funding side all of that were rolled down pretty much 100% with rate cuts.
I think the wildcard in the in the margin probably for US and everyone is really what happens on the deposit side.
And whether or not deposit betas will be higher on the way down.
Compared to on the way up and frankly, I'm not sure that will be the case.
So there I think thats the wildcard, but those are some components that you can think about for our balance sheet and how that plays out in our net interest margin calculation.
The other one I will point out is that we did add that $1.2 billion of securities portfolio.
To guard a little bit against the economic.
And economic outcome if rates do go down.
It takes the edge off a little bit, but it also dilutes our net interest margin given that those those securities are at a much lower spread than say for instance, our other earning assets in the loan category.
Okay, if I could just squeeze in one more question just on the expenses.
I would have thought on a core basis, they would have come down quarter to quarter, just with the cost saves that you got from.
Cove is but there were some other items that caused that to increase.
I'm just wondering it as are any of those kind of onetime events and and the expenses could decline in the third quarter.
Well I will say and I pointed to this in our in our first quarter call is that we were going to spend some additional dollars of business promotion to promote our be okay financial brand in Colorado, and Arizona, and we did that and you will notice that business promotion I think went up $2.9 million. So I don't expect that category to be as high.
In the third quarter.
You also had a few extra expenses there related to mortgage but again the mortgage revenue side was much higher.
So you know again, Peter I think we're going to try to maintain a 60% or better efficiency ratio.
I don't know of any extraordinary expenses are coming our way in the third and fourth quarter. So I think we have a good shot of achieving that but I think it matters certainly on the on the revenue side.
Okay.
Thanks, a lot.
Your next question comes from the line of Brady Gailey with KBW. Please proceed with your question.
Hey, good morning, guys want to Brady.
So if you look at.
Kind of the reasons why you guys beat estimates this quarter a lot. It was it was in the fee income.
Lines and if you look at it brokerage and trading I mean over $40 million revenue or just into Q, that's got to be a.
Record.
I know your guidance you talk about all brokerage and trading could continue to see benefit from lower rates is that $40 million number.
Sustainable or do you think that you'll see some some downside to that number going forward.
Hi, This is Scott grauer.
We have.
We clearly in the first quarter because of the composition of our product mix on the institutional trading side have.
Benefitted from the mortgage environment.
With lower rates and so that was a catalyst.
Really that began and into first quarter and is pushed on through second quarter.
That being said.
Regardless of the movement.
Within range here.
In mortgage rate sector, because of our mortgage securities trading we're well positioned.
Because of work that we've done to restructure.
Our institutional trading desks and capitalize in that segment.
So we feel pretty confident about the product set that we have.
The staff that we have in our positioning in the market. So we're.
We are dependent upon mortgage rates to to outpace, but we feel pretty good about how we're positioned in the segment today.
All right.
And then just a little more color on the $1.2 billion of bonds that were purchased with what was the timing on that intra quarter it and looking at the average balances it looks like we purchase that.
Kind of right in the middle of the quarter and what what was the average yield on that and if you look just at the impact in Threeq you from those additional bond balances.
Seeing the full impact what what's the NIM dilution just from those bond purchases.
For this particular quarter.
It would only be.
A basis point or so it's not a lot it's part of the.
Kind of a 10 basis points that I try to highlight but it's not a big component it will be a bigger component in the third quarter from the dilutive impacts because to your point, we didnt buy those securities all at the beginning of the second quarter, we bought them kind of throughout the second quarter. So we averaged a bit lower.
Then what will average in the third quarter.
All right and what was the average yield that those were purchased.
To 50 to 60, I am not sure exactly Brady, but somewhere in that range.
There are some so certainly they have a a spread to the cost of funds.
And as course, if rates go down and our wholesale barring that support those bonds.
If that reprices down and of course, we'll gain spread as we move down.
To help protect a little bit of that downside from lower rates.
All right.
And then finally for me in fees were up.
A little bit it looks like most of the increase was related to energy.
I know some of your peers have also seen similar trends with energy Nonperformers that maybe just an update on.
The health of your energy loan portfolio.
Well I think from our perspective, we still feel very good about the health of the portfolio I think we had three credits that we moved to non accrual this quarter really late cycle really all deals that that probably the economic outcome could be different but you've got management teams and equity sponsors and frankly other banks, who you are or just kind of done and have some fatigue.
And so you may end up with some modest non economic outcomes as a result of that but we recognize that loss content through the impairments and charge off I certainly recognize that in our allowance evaluation.
And we're not seeing new problems really come through these are all kind of late cycle from from the depth of the downturn. So we still feel very good about where energy is.
The broader issues from a macro perspective in energy really are the closing of the capital markets and the fact that thats having.
In some respect a positive effect, because we see stickier loans on the energy side, but the broader issue is going to be long term exit strategies for a lot of these companies as they work through that there aren't a lot of buyers because of the capital markets being closed, but the health of the portfolio, we feel very good about.
As we move through now and going forward.
Yes, Brady this mark on one thing I would add is that.
We do this as Stacy mentioned Weve identified our key problem loan. We also recently ran our stress test on the portfolio, where we ran.
With oil in the flat for low 40 environment and gas in kind of a 210 to 15 range and our results didn't identify any significant issues that we weren't already aware of so they've already been accounted for.
Got it thanks guys.
Thank you.
Our next question comes from the line of Brett Robinson with Piper Jaffray. Please proceed with your question.
Hey, guys good morning.
Good morning.
I wanted just to talk about energy a little more you know a lot of other banks you mentioned capital markets have pulled back from energy somewhat can you just talk about.
Your differentiated strategy, there and if energy continues to be.
One of the bigger segments for growth or do you have limits on how much more energy.
Do you want to do and then just kind of why you're.
Why you're still growing energy and how you think that's different than some banks that have pulled back from from energy lending.
You know, it's it's the same story I feel like maybe I'm a broken record maybe it's boring at this point, but we're not underwriting energy today any differently. We always have and we were committed to the space when oil and gas were you know underwater in the energy industry was going undergoing a lot of stress we feel confident about our process. We have more engineering and engineers on engineering tax on staff than most of the largest banks who are.
Providers of capital in this space, we think it's a core competency and it's it's important to a lot of our our broad base business is not just energy lending, but across the company. There is a lot of places where we have tentacles into the energy space. So we are exceptionally committed there and we think we've done.
Better than most in terms of identifying borrowers and customers who are a good fit for our underwriting.
I don't I don't.
I think as we look forward and think about the growth rate some of that growth has been because there hasn't been exit strategies for these private equity companies the loans have been stickier.
I looked at you know relative growth rate. So maybe a couple of years ago. We were lamenting. The fact that that commitments were growing at 15% to 20% made outstandings were growing.
Low to mid single digits.
Now you have a little bit of the inverse the outstandings are coming up utilization is is entering a period to period, our commitment growth annualized through the first six months of the year is about 6.5%. So thats different than you know the the 20 plus percent youre seeing on the year to year on the energy side.
The other piece of that is if you look at energy as a percent of the portfolio. It's almost identical to what it was a year ago. So we've seen good growth in energy, but we've seen growth in other areas too that is help energy continues to be balanced segment of our portfolio.
One other note I would make is that.
During the 2014 eight in energy downturn, which is really the worst since the eighties, we had net charge offs, averaging only 37 basis points across that whole period and in any 10 year 15 year period, our charge offs in the energy have been 25 basis points. So it's been fairly consistent and it's not like we won't maybe have additional charge offs on energy in the future that wouldn't be out aligned with our historical performance.
Okay I appreciate the color there and then the other thing I wanted to just go back to just the margin and DTA is obviously.
Been a challenge you guys as you think about the back half of the year can you just talk about what you what you're expecting from the DTA perspective, do you have any insights into.
Whether those balances might flatten out and then specifically can you talk maybe about Kansas City, Kansas I know you've had some changes in my bank just that market in particular seem to have a little lower DTA this quarter any thoughts on that market.
Well, we had we saw this quarter of a continued migration of D.A. into interest bearing out in our commercial clients. Now. Your question is ready to go down or if they are expected to go down.
Latter part of the year will we see that flatten out you know, perhaps they will.
There is volatility in that portfolio. There are some big balances in there that move in and out.
But yeah I would expect some maybe some stabilization of the DTA balances as we go forward I don't know if you're getting.
So I agree with Stephen there I think as rates begin to go down you'll have earnings credits that will respond to that and so you'll have commercial folks who will have to have more in DTA to cover services related to that.
But it's hard to know order of magnitude, which I think maybe the heart of the question that you're trying to ask there and until we kind of experience that and see how the market responds.
It's going to be tough to answer that Stevens.
Earlier analysis around the real question is deposit betas is the is exactly the right ones I mean, that's the unknown as we go through.
A modest downtick in short term rates, what happens to deposit betas.
Yes. This is Steve and as it relates to your question about Kansas City, We've got.
Kind of a handful of.
Relative to their portfolio in Kansas City larger.
Customers on the DTA side, and so we always see more volatility.
In that particular market. So I don't think it's particularly indicative of anything other than the fact that you get a large deposit or who's using funds or moving funds and it moves the needle there.
Disproportionate to the impact of the company.
Okay, Great appreciate all the color.
Our next question comes from the line of Gary Tenner with da Davidson. Please proceed with your question.
Thanks, Good morning, I wanted to follow up on the brokerage and trading business in terms of the rate environment or is it more important to be thinking about the absolute level of rates or.
Directional movement within a quarter in terms of driving volume in that business.
I would say that it's directional it's also spread.
In the various categories that influence that.
We because we.
Talked in earlier when I responded to the question I talk specifically about the mortgage backed securities area.
And our activities there. The reality is we've seen a kind of a stabilization in somewhat of a pickup even in the municipal sector. So.
We have an opportunity given our product set and our diversification of the segments and sectors there to to really.
Benefit as spreads move whether from mortgage backs to treasuries or in the corporate sector or as we've seen a little bit of an improvement in the municipal side in the second quarter. So.
It's probably more directional than absolute.
Okay. Thanks, and it looks like there was some further expansion of the unsettled securities purchases on the balance sheet. This quarter, one from about 450 million last quarter to over 800, this quarter and you talked about growing it I don't know to what degree you grow it further but I'm curious what the kind of relative margin drag was this quarter versus the first quarter from that.
Yes, it was incrementally that much more.
If you're looking at the receivable balance.
That went up on average a couple of hundred million.
And that's the real.
Balanced it impacts the margin. So it went up 200 million, but it wouldn't have that significant additional impact on the margin.
Okay, Great I think Thats, just one more question on oil and gas.
I appreciate your comments earlier I'm really more curious on a macro basis, there's been a lot of talk about.
Why oil prices Havent responded or more of some of the geopolitical issues.
You know.
And I'm just curious if you have any any any thoughts on kind of what that means from from a demand perspective, and if you have any any any concerns there.
No I think it's awfully hard for us to be in the prognostication business on oil prices and so thats why when we underwrite we underwrite to the forward strip when we evaluate our book we do it according to the forward strip our customers can hedge that.
There was volatility I mean, you think back a year ago, we were in the mid to upper Sixtys as we went into the third quarter. The first quarter prices were down second quarter. They've come up. This is a long lived asset and part of the reason the portfolio performs well overtime is because it's so now the industry self correct you know as prices come down.
Rig counts come down oil supply comes down and it takes a little while for that equilibrium to surface, but it does happen that way and that's part of why we like it.
Obviously, the volatility that creates creates heartburn from time to time, but if you really evaluate the portfolio I could total return and look at losses over time relative to the revenue. It is a fantastic business for us to be in as a core competency. We have you know strong history. There our performance through the downturn that that to me is a very difficult stress in our performance. There I think created outperformance from that portfolio is perspective, and I think we continue to maintain the discipline.
Associated with that.
Thank you.
Our next question comes from the line of Michael Rose with Raymond James. Please proceed with your question.
Hey, guys.
Just wanted to go back to deposits it looks like Colorado was that.
Big driver decline so.
Do you think those cobiz balances are going to start to stabilize here.
And then how where do you get uncomfortable as it relates to the loan to deposit ratios. It continues.
To move higher.
Yes, I will point out that there is a pretty significant decline on DTA in Colorado.
A big chunk of that is one client and they're in kind of the fund administration business. So they move a lot of bounces around and so I don't read a lot into that particular.
Drop, but yes, we have stability there.
I think we're going to view co Biz acquisition, we're going to view it both on the loan deposit as well as their full performance at the Colorado level and the Arizona level. So we've we've completely incorporated all of the cobas businesses into our businesses and so the what we're going to manage and watch closely is the full market.
The impact that we have and the results that we get from the from a market view.
Second part of your question was.
What loan to deposit ratios you, obviously continue to incite, yes, I mean, it's creeping up to 90% we've had it higher than that at this company before.
None of us probably want it to go much above 95.
And again I think it's a matter of.
How well can we gather deposits I've stated before that one of our goals leading into 2019 was to try to fund the majority of our loan growth with deposit growth that we haven't done that.
So far this year.
So we'll continue to look at that.
And I would say you know.
Mid nine Ninetys is not that uncomfortable for us, but certainly I think we would address it and want to want to keep it somewhere below that 95% range.
Okay, and any concerned if the debt and equity capital markets for the energy companies remain kind of seized up or dry.
You could see some some outflows in deposits as they draw down to support their business grows.
I think I think that's absolutely one of the outcomes that you could see if they prices stay at this level or go a little bit lower they're going to use cash flow to help them drill because equity may not be there and frankly, the banks aren't going to be really excited about.
Funding entirety of drilling programs of borrowing bases are.
Pretty full so they are going to have to do that out of cash flow.
I think I think seeing a energy deposit volumes impacted.
By that is a very good analytical see through there.
Okay, and then maybe just one more for me.
Can you disclose what the.
The impact on the margin was from premium amortization this quarter and maybe what it was last quarter. Thanks.
It's pretty small for us we don't we don't have a lot of.
Premium amortization on the regular bomb portfolio that we're pushing through in any given quarter. So I would I would say it's insignificant.
Okay. Thanks for taking my questions.
Our next question comes from the line of Jon Arfstrom with RBC capital markets. Please proceed with your question.
Thanks, Good morning, everyone warning warning.
Stephen do you.
However, the percentage of the loan portfolio with LIBOR based you may have said it but I am just curious.
Well, let me put it this way so 70% of our loan portfolio is variable.
80% actually reprices within a year, but 70% is variable and.
I would say.
A pretty high majority of that is LIBOR based it used to be a more split between LIBOR and prime but its certainly migrated much higher towards the LIBOR side and of the LIBOR based loans, 90% of them are 30 day.
So it's a pretty short on the curve.
That's the entire portfolio or just the commercial piece.
Yes.
That's the entire portfolio, okay, 70% barrel.
Okay.
And then offsetting that you mentioned the wholesale.
Funding piece with a 100% beta what is the size of that.
Big.
It's.
You know the.
10 billion.
$10 billion of our.
Of our funding is from that from the wholesale categories.
Okay.
Quickly and that's the piece, you're saying, there's a 100% beta or thereabout, I mean units going to track very very closely down.
Keep in mind that larger securities portfolio than than most peers. It's been how weve managed this bank for ever and the result of that over time has been a much more stable net interest margin and net interest revenue base than our peers, but but also a lower NIM to some extent because of that the size of that securities portfolio, but thats a real buffer in times of.
Falling interest rates.
Yeah, I guess, we're all trying to figure out what kind of an impact.
Lower rates would have been I guess.
It sounds like it's reasonably manageable from your point of view.
Yes, I mean, I am I don't have that makes some sense.
I don't think we have ever positioned the balance sheet, where we get.
Hammering on the way down or or gain significantly on the way up I mean, we've we've always stated we try to manage relatively neutral now that's not a definition of half a percent one way or the other it could be as wide as.
3% to 5% one way or the other but that's relatively neutral when you compare to other other banks.
Okay. Good that helps a lot.
I appreciate that.
Stacy for you you made a comment about core loan growth as long as the economy continues to show strength.
Are you seeing anything that's changing your view on the economy showing strength.
Not at this point I think.
You see growth really over the last couple of quarters really across the board in all segment.
See an eye real estate healthcare.
Energy is obviously been exceptionally strong I think you know just.
Just because you think about these things as you get into 20, you worry about.
Things like a presidential election, and how the uncertainty around that process could impact borrowers ability to our borrowers desire to create more leverage.
And so you worry a little bit about that headwind as you think about 20 from.
How will borrowers respond to that but in terms of just whats happening day to day and the economy is actually pretty good and borrowers are doing you know the things you would do in a in a good economy, but theres still good discipline.
Both from the borrower perspective in it you know I would even tell you. This late cycle on the banking side I'm impressed with general discipline across the board in the sector.
Okay. Good.
And then just one on mortgage sustainability of mortgage I guess.
The way it looks.
You may not have an MSR hit.
This coming quarter like you did the last quarter, hopefully, but anything else to call out in terms of the sustainability of the topline mortgage revenues.
Yeah. This is Steve.
We've done a lot to take.
Expense out of that business unit in the last 18 months or so so.
We've caught kind of a nice sweet spot here as we've seen the application volumes.
Drive pretty strong we're seeing gain on sale margins increase as well I think were up 18 basis points.
In the second quarter.
I think as long as we see rates kind of below that for four and a quarter threshold.
On the 30 year.
We're going to continue to see good volume, we're certainly in the middle of the season right now.
So we haven't seen anything that would suggest is going away.
Over the course of the second half of the year, but it's a much more profitable segment for us because of our expense work. So this is a.
This is good timing for us I think on the mortgage side, yes, okay. Thanks, a lot guys nice job. Thanks.
Our next question comes from the line of Matt Olney with Stephens. Please proceed with your question.
Okay, great. Thank you good morning, guys.
Morning.
Thank you more about the loan growth one of the portfolio as you pointed towards with health care as far as seeing some good strong pipelines and good growth the back half of the year.
Any more details you can give us on that and any any specific sector you can point to within healthcare.
You are seeing some good pipeline growth.
Our real business development focus inside of health care is around senior housing.
Assisted living and skilled nursing memory care.
Independent living as well.
We think that that that's a really good opportunity. We we've had great credit outcomes there historically.
You have some risk inside that portfolio around reputation risk you have some risk inside that will probably around reimbursement risk, but that has been something that we've managed through.
20 years inside of senior housing and something we understand and can work through.
And that's really where the segment that we're focused on inside of health care health care risk that we've seen and frankly over the last year seen a few losses related to that that we work through is you know when you look at out of network things or you work look at areas, where you don't have dr. guarantees embedded with the credit on a on a standalone style facility those have been the areas of healthcare that have underperformed and we've really worked through that so our business development focus is really on the senior housing side Weve added talent in that space in the last 90 days or so that were really excited about we think will help augment our growth there as well and so we continue to be extremely optimistic about our our strategies inside of health care.
And Stacy from a macro standpoint that there are some data points at that point towards the overbuilding in some of the senior housing facilities.
Is this something that your borrowers are being impacted by right now.
They can be and were awfully careful when we look at a construction of new facilities and things like that where you know what the what the capacity for a particular area even sub areas inside of larger metro areas is.
There has been pockets, where that's certainly been the case and I think that we've done a good job of avoiding knows our teams broadly do a really good job of analyzing where there's been over building and so we really tried to stay away from that.
We look at areas, where there's some some states are certificate of need state. So that creates a barrier a particular in the skilled nursing side.
So were we.
We feel pretty good about that we're there where the some of the health care for senior housing pressure has come from is really on.
The big players, who say the re to gobbled up facilities.
And they havent paid as much attention to the operators and the operations of the facilities. So they have underperformed, we're seeing some divestiture from those big players, which is not where we play in this space.
And which is we think will over the next 12 months or so create outsized opportunities for the regional players in local players, which is really where our sweet spot is to acquire some facilities and improve the operations of those because that that really is the most important part about the senior housings betas, the quality of operations and the ability to have good outcomes and a good experiences for the residences.
Okay. Thanks for the color Stacy and then Steven now I guess lots of moving parts in the balance sheet here I'm trying to appreciate what the average earning assets may look like in the back half of the year.
You've got the 1.2 billion dollar increase of MBS book you mentioned.
We see higher security higher traders trading securities the strong loan growth towards the back half to Q. It feels like that the average earning assets could.
BB up in Threeq, you almost $2 billion versus Twoq.
Am I thinking about that growth right from Twoq to Threeq, you on average earning assets.
Yeah, you're probably pretty close and they will continue to grow loans.
On average they should continue to grow in that kind of mid single digit or so level.
I don't think will incrementally add that much more securities portfolio. So you'll get the effect of the average full quarter average on the securities portfolio.
In average, earning assets, but we wont incrementally be adding that much more to the available for sale portfolio.
And then the funding of all of that will just follow I mean, we'll we'll either funded through.
Some sort of deposit gathering activity or or in the case of.
Those average securities they kind of self fund through the wholesale.
Barring categories.
That helpful. Yeah that is helpful. I appreciate it.
Thank you guys.
Thank you.
Our next question comes from the line of Jennifer Demba with Suntrust. Please proceed with your question.
Thank you good morning, I think altogether.
Topics have been covered this morning, but just wanted to.
Ask about your M&A interest at this point I know Cobiz is has been on the books too long.
Yes, Jennifer this is Steve I think our focus is still squarely on making sure that we generate.
Investment return the growth.
In the Colorado, and Arizona markets, we clearly got the expense saves that we had targeted and did a lot of hard work, there, but but really the real work now is growing in those markets.
So I'd say our appetite for further M&A is pretty muted at this point I think we're focused on making that be absolutely successful for us going forward.
Okay, great. Thank you.
Thanks, Jennifer.
Ladies and gentlemen, we have reached the end of the question and answer session and I would like to turn the call back to Steven now for closing remarks.
Okay. Thanks again, everyone for joining us. This morning, if you have any other further questions. Please call me at 918595, 303 zero or you can email our IR side at IR at VLO Ks Dot com have a great day.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
Okay.