Q2 2019 Earnings Call
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Kevin Muslim K.E.V. I and.
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Capital.
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Hey, I E R.
Which conference would you like to join today.
Howard Bancorp earnings call.
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Good morning, and welcome to the Howard Bancorp Inc. second quarter 29 chain financial results Conference. My name is Sean tell an automobile operations fit today placed night. This conference is being recorded.
At this time all participants are in a listen only my age a brief question and answer session will follow the formal presentation.
If anyone should require operator assistance during the conference. Please press Star then zero on your telephone keypad.
I will now turn it over to George Kaufman Executive Vice President and Chief Financial Officer of how it Bancorp Inc. Mr. Kauffman. Please go ahead.
Thank you.
Good morning, everyone.
I'd like to begin by thanking everybody for joining the call. This morning.
I'm actually stated my name is George Kaufman I'm, the Chief Financial Officer for Howard very core.
Before we begin the presentation I'd like to remind everyone that some of the comments made during the call may be considered forward looking statements.
Our Form 10-K for 2018 as well as our quarterly reports on forms 10-Q, and our current reports on form eight k. all identify certain factors that could cause the company's actual results to differ materially from those projected in any forward looking statements made this morning.
The company does not undertake the process to update any forward looking statements as a result of new information or future events or recent developments.
Our periodic reports are available from the company either online at the company's website or via the Fccs web site.
Again, I'd like to remind everyone that while we think our prospects for continued growth and increased performance are good. It is our policy not to establish with the markets any earnings margin or balance sheet guidance.
With that said I'd now like to introduce Maryann Scoli, the CEO and chairman of Howard Bancorp.
Thank you George and I'll add my thanks to to work is for those of you that are online I want to also know say George and I are joined today by Rob Kearney Sharp President Randy Jones, our chief credit officers. So when we open the question and answer session. We should be able to address any questions that you happens you drill down into these numbers.
Im actually going to begin with brief reiteration of the presentation that was sent out yesterday both to provide additional time for those that may not have had an opportunity to study it but also to begin to add some commentary that may enlightened some of that.
We begin with our forward momentum, which is our view of the strategic accomplishments that these numbers reflect most importantly, we think that the second quarter, Doug showed significant tangible progress towards the higher growth and the higher return franchise that weve discussed repeatedly.
Commercial loan growth resumed with $50 million in the second quarter of 2019, a little over 3% within the war.
Our expense focus continues its reaping rewards and improving profitability and as we'll discuss a little bit later, we've announced further movements to further increase the efficiency.
We're pleased to see that our asset quality continues to migrate to a more normalized set of ratios coast. The turnaround numbers that we experienced in the early months after the first melanoma merger.
We have a very strong capital position that is everyone would really remember allowed us to announce earlier in the quarter the option of a share buyback program.
And believe that we are uniquely positioned to take advantage of the ways of consolidation disruption in our market in particular with mergers and acquisitions being announced very frequently the impact on market and our customers.
The financial highlights on the.
Fifth page of the presentation.
Indicate that our net income was 2.1 million those reported earnings represent earnings per share of 11 cents, which was down from the 22 cents per share in the first quarter. However, if we exclude the infrequent expenses, mostly associated with the branch optimization second quarter core net income was 4.7 million representing growth in the core EPS numbers to point to fall in line with consensus estimates.
Our total non interest expenses will also opt given those infrequent expenses.
But on an ongoing core basis or 15.2 million.
Over $4.3 million and infrequent expenses. The majority of that 3.6 million was related to the branch optimization changes that weve actually discussed for the last two quarters on these earnings release call.
They these most recent changes and cuts in five branches are expected to lead to $2 million in annual operating savings in 2020.
And most significantly provides us not only with our branch network that we believe reflects more the behavioral preferences of our customers, but that will have an average of $100 million and deposits per office, so stronger than the majority of our peers.
Total loan growth during the quarter was 53.8 million with $50 million in the most important commercial loan category.
Total loan originations remained strong and totaled $119 million and so while as the press release noted we do continue to see.
Payoff activity, especially in the very competitive commercial real estate sector. The loan origination volumes have been large enough unsustainable enough to now shows significant net growth in the quarter.
The net interest margin for the second quarter was relatively stable, but did reflect an increased cost of funding largely related to a drop in transaction deposits, which in turn was largely related to the movement of some balances.
From one customer's account into investments in fixed assets in their own business. So not a movement to another company and not in any way a mitigation of the customer relationship, but something that did impact our cost of funds.
Excluding fair market value adjustments, which always are relatively modest even after our acquisition history core NIM was 3.44 versus that 3.53.
And on the capital side, our book value per share increased to 15 92 at the end of the quarter tangible book value increased to 11 94 per share and we will has become our practice show the impact of some of those intangibles on our return numbers going forward.
The six page of the presentation does a little bit of a drill down on that infrequent expenses that we've referenced in both of these last two slides as noted most of the 4.3 million was related to the branch optimization in turn the branch optimization was mostly lease termination payments. Some lease hold improvement write off these were related to three closed branches and two branches that will be consolidated into one.
Again, these branch optimization infrequent costs, which we signaled for the last two quarters.
Our expected to create approximately 2 million in annual pre tax operating savings so less than a two year earn back on that.
And these numbers have led to the consistently improving profitability ratios that we show on page seven we note the reported numbers.
For numbers and we know those numbers against the first quarter, we reported in this chart and especially after everybody will again focus on the return on assets.
Versus the return on tangible assets again, reflecting our history is that an acquirer.
And then given the significant CDAI expense incurred in the last merger ask everybody to focus on the average assets net of those CVI expenses too low loud purely for more comparability with some peers.
The loan growth story as I indicated earlier and as we said in the press release is one of the most positive outcomes showing in this particular quarter and those loan growth trends are put into context on page and where we show not only the loan growth of $53.8 million or the 3.3% as noted earlier, but the fact that the majority of this growth was driven by the commercial loan growth, which is the element of our asset mix that differentiates us from others.
It shows that the commercial loan originations were particularly strong even in an environment, where commercial real estate in particular is impacted by more volatile payoff activity and that the organic loan growth is not driven by broker relationships or pretty good relationships that is as it's always been primarily focused on building long term profitable client relationships with funding opportunities from those clients as well.
And I note from a longer term perspective that long term organic CAGR for Howard is over 21%.
All of this allows us to capitalize on our strong capital ratios in terms of the opportunity that this capital provides us for future growth and as noted on page nine again, a reference to the fact that these capital ratios, even with anticipated future growth have allowed us to be comfortable announcing that we now do have the ability to undertake share buybacks should we believe that our price in the market does not reflect our value.
The margin as we've referenced was also relatively stable. It was down 11 basis points from the first quarter and the primary driver was the funding costs due to the large outflow of transaction deposits from one large deposit relationship that deposit relationship remains with the bank and that withdrawal of funds was invested in the company's core business not in other liquid assets.
We took the opportunity seeing this margin compression during the second quarter to prepay some longer duration FHLB borrowings.
And that's also referenced in some of the infrequent costs flight earlier, but what we believe this will allow us to do so in action already taken is to boost the net interest margin three basis points for future quarters. So an action that's already been taken that will mitigate some of that net interest margin pressure.
Again, the gap between reported NIM and core NIM always a sensitive issue within a serial acquirer continues to be very stable and relatively small.
I will also note that the net interest income in absolute terms for the first six months of 2019 was 16% over the net interest income for the first six months of 2018.
The growth in the portfolio as we note on page 11 also does not come at the expense of quality. We've continued to see as we noted in the first slide nonperforming assets declined.
Charge offs declined.
Claim reserve increase both as a percentage of loans and as a percentage of nonperforming loans. Our reserves are always impacted by the merger accounting that we've undertaken as a serial acquirer and show that relative movement in those numbers from one quarter. The next is very important to note.
So I'll summarize again the loan origination engine is regaining momentum to banks that came together in 2018, both with very strong commercial loan origination histories.
That were initially impacted not only by the short term nature of some transitions in the merger, but more significantly from some changes in the commercial real estate environment coming together, we've been able to offset that so we have the $50.5 million in commercial loan net growth in the quarter.
We're still anticipating mid to high single digit loan growth. So the pipeline remains very strong, but we are not indicating that we will expect to see double digit loan growth for the remainder or the average of the year, but we do expect to perform on that mid to high single digit loan growth.
We're also very pleased with what the strategic optimization of the franchise. The delivery network. In particular has allowed us to do from not only an efficiency standpoint, but from a relevancy and an impact standpoint.
So the closure of three additional branch locations. The consolidation of two other locations has allowed us on a going forward basis to have annual pre tax operating savings of $2 million.10 per share in 2020 and we're.
Pleased to note that this gives us a 15 branch network and has an average deposit base of over $100 million per branch.
And finally I will go back to the references on the first slide that this differentiated positioning as the largest locally owned bank and the one that is exclusively focused on the small and middle market Enterprise network in greater Baltimore will position us, especially well for the numerous consolidations and mergers that occur in our marketplace and we're very excited about the opportunities that thats going to provide our employees our clients, but also our shareholders.
So with that I'll conclude the review of the financial presentation and I'll open it up for any questions.
Thank you Jane.
We will now be conducting a question and answer session. If you're trying to ask a question. Please press Star then one on your telephone keypad.
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One moment Folly poll for questions.
Thank you. Your first question comes from Kathryn.
Mellow Kate Spade W. Baird go ahead. Please.
Thanks, Good morning.
Okay.
[noise] I would first start with the margin and maybe and I appreciate your.
Commentary on how the prepayment of the FHLB will add three that's to the margin that then outside of that how are you thinking about your margin outlook. If the fed cuts later this month and then perhaps thinking later in the year. Thanks.
Good afternoon. This is George I'll take that.
Thanks, as we noted in the release there were actually a couple of things we did in the second quarter.
Obviously on the negative side, we had that outflow transaction deposits, which maryann talked about we had to replace those with higher cost Cds and FHLB advances that was the biggest driver of the margin compression and that happened early in the quarter.
Knowing that that had happened towards the end of the quarter, what we did.
Is we had about $85 million of FHLB advances long term advances that were typically higher.
We see those.
Dropped the cost of funds by about 40 to 45 basis points and by doing so.
And then we were able to cover that prepayment penalty of the 650000 by selling off about $35 million of securities generating a gain taking advantage of the market position on that so the net pre tax impact of the sale of the securities versus the FHLB turned out to be about a $5000 net impact.
But we also then use that reduction in securities and you'll notice a similar offset or increase in the loans. So we not only do we reduce the cost of the FHLB, but we redeploy those funds into higher yielding loans versus securities.
So both of those things, we expect are probably going to mitigate about half if not slightly more than half of the compression that we saw during the quarter and again that is excellent actions already taken.
Now to your question about the impact of any rate cuts.
We run some modeling.
And we anticipate that for every 25 basis point cut in rates or change in prime I should say.
That would impact our margin on an annual basis about 3%.
So depending on the timing of prime rate reductions on annualized basis, Thats kind of what we're factoring into our modeling.
And as you think about that 3% Harry how quickly do you think you'll be able to lower.
Funding costs, if the fed cuts.
The way, we've positioned our borrowings portfolios to keep it relatively short in anticipation over over move.
So the book the bulk of the borrowings benefit all of US all of the FHLB advances, we have or short term and would reprice within three to six months.
It takes a longer time to feel the impact of that on term deposits.
So we would take probably more of a lag on that one and then on the transaction accounts, we don't expect to see much of a difference there.
Okay.
And then on the asset side.
And can you give us a little bit of color as to how much of your loan portfolio is variable versus fixed and then as you are seeing the new production this quarter, what kind of on average where would you say the average yield is of that new production versus where the though the current portfolio is yielding or are you seeing thats still coming in higher or is it still or is that still going to get ahead of pressure.
Yes, there's definitely pressure Maryann mentioned 119 million of new originations the weighted average yield on Boeing those originations were about 4.6% versus if you look at the loan yields from the margin tables in the earnings release, we were at 5%. So the new originations are coming in slightly lower than the portfolio yields.
The mix of our on our current portfolio the mix of fixed to adjustable loans of about 35% of our portfolio loans are adjustable.
So you will definitely see the impact of any rate moves on those.
Does that cover your question. It does it's all very very helpful. Thank you.
Thank you. Your next question comes from Jay Kludgy.
Alden Securities go ahead please.
Yes, hi, good morning.
Hi, Joe.
Yes.
I guess.
Just in terms of the loan growth I notice the yen that loan to deposit ratio is getting up.
Pressuring up along 100%.
Just wondering are you comfortable going above there could that active.
Constrain on on loan growth going forward.
So we have always as you know you know us well have Ron.
Hi loan to deposit ratio and thats tended to be intentional on the put a lot of focus on the asset side of the balance sheet in the loans enter into funded as efficiently as possible.
And we've seen that historically go as high as 100, 405%.
So I think we'd be comfortable with.
A modest.
Continuation of that high loan to deposit ratio.
Okay and.
John I would add part of the reason why we're comfortable at those levels is the level of off balance sheet or contingent funding that we have.
Even with the borrowings that we have we're using less than 50% of our FHLB availability. So we have plenty of sources of funding to bring onto the balance sheet as soon as needed.
Okay and.
Just on the asset side it looks like there is a little bit of.
Build up on the cash side is that just a temporary blip or.
Any.
Any.
Need to.
Worry about deployment of that.
Keep up margins.
It was temporary and it was really driven by two things partially the sale of securities that happened late in the quarter.
We mentioned that we sold $35 million. So just the cash receipts on that one.
And then we did have.
Actually on the last business day, we had a loan paid off that we didnt anticipate so that brought in more cash than than what we planned to have for the quarter.
Joe I'll I'll talk a little bit more about that at least is actually one loan. It was $16 million. So you can see that that would account for a significant percentage of that cash and we actually had anticipated and in fact had requested.
But the but the borrower find another source of funding I was one of our watch credits, but it had been led to believe that they might have more difficulty.
And that it would happen in the third quarter. So we were we were surprised I think pleasantly surprised that surprised by that pay off.
But it did mean that since it happened late in the day on the last day of the quarter that it just naturally have a cash position larger than what we had projected.
Okay.
And.
You talked a little bit about the consolidation and then the.
Local banking market.
Just wondering if you could.
Touch on your.
Attitudes towards.
Further M&A and what the market looks like these days.
Sure Let me, let me touch on it from both perspectives in terms of the market perspective, just to remind everybody that.
One of the single greatest strategic advantages that we believe that we have is the fact that we are the largest locally owned bank in a marketplace.
It's dominated by small and medium sized businesses the businesses that tend to be.
Most at least initially adversely impacted by consolidation because they're not necessarily very transparent balance sheet, they're very relationship driven and so the fact that were large enough to service the needs of about 95% of the businesses in the greater Baltimore area and that those businesses do tend to appreciate stability and local credit making decisions has always positioned us well, what we see from a competitive standpoint is increasingly a market that is dominated by out of state banking institutions. So we've seen.
Just in the most recent two quarters.
The closing of a.
Purchase of a Baltimore bank by Pennsylvania banks, the closing Nava.
Frederick County Bank, which has a contiguous market through our Howard County market by a Pennsylvania Bang on the announcement two days ago of a local competitor by West Virginia Bank and then the anticipated.
Consolidation noise and integration noise associated with the BMT and Sun Trust merger. So there's a there's an enormous amount of disruption in the marketplace and we think that that will bode very well for us which is not to say that any of those mergers and consolidations.
Are you are not beneficial to shareholders, but disruption always provides you with an opportunity, especially with small business customers, who are looking at integration activities and one up one of those will involve.
Group of local customers that will have to go through the second conversion in less than 12 months.
So it's just an opportunity.
It also doesn't mean from the position of a serial acquirer that you are looking at other people, who may be considering consolidation, but I would say as I've said for the last couple of quarters right. Now we're very focused on seizing the residual opportunities in our organic growth portfolio. We're very focused on this integration in this consolidation we continue to always talk to people, but we don't have any present plans ourselves, but we also don't believe that the that the market is going to remain quiet. We think it's going to continue to be a market with lots of opportunities both from an organic standpoint and in the long term from an acquisition standpoint.
Does that answer your question.
Yes. It does thank you.
And that's it for me.
Thank you I will take the opportunity to remind everyone that it is star then one to register for a question on your telephone.
Well just to give everyone a brief moment.
Oh, Okay. There are no further questions at this time I would now like to hand back to US because go ahead. Please.
Right well I just like to again, thank everybody. Thank you for taking the time to read the press release and to read the earnings presentation. Thank you for being on the line and and note that the management team here is always available and accessible for any of you that as you go through the numbers have additional questions, but thanks for your participation.