Capital Bank Financial (CBF) CEO Gene Taylor on Q1 2015 Results - Earnings Call Transcript

Capital Bank Financial (CBF) Q1 2015 Earnings Conference Call April 23, 2015 10:00 AM ET

Executives

Ken Posner - Chief of Strategic Planning and Investor Relations
Gene Taylor - Chairman and Chief Executive Officer
Chris Marshall - Chief Financial Officer
Bruce Singletary - Chief Credit Officer

Analysts

Erika Najarian - Bank of America Merrill Lynch
Peter Ruiz - Sandler O'Neill & Partners
Paul Miller - FBR Capital Markets.
Blair Brantley - BB&T Capital Markets.

Operator

Please standby, we’re about to begin.

Ken Posner

Thank you, Cecilia. Good morning. I'm Ken Posner, Chief of Strategic Planning and Investor Relations for Capital Bank Financial Corp. Welcome to our First Quarter Conference Call. Today's call is being recorded.

During the call, we’ll refer to a slide deck which you can find on the Investors page of our website, www.capitalbank-us.com. The slide deck and the press release contain a reconciliation of certain non-GAAP financial measures to GAAP results. This call contains forward-looking statements regarding expected operating and financial performance. Statements that are not of historical fact may be deemed to be forward-looking. The words believes, anticipates, plans, expects, and similar expressions are meant to identify forward-looking statements.

We caution that forward-looking statements may be affected by risk factors, including those set forth in Capital Bank's SEC filings, and actual operations and results may differ materially. The company undertakes no obligation to publicly update any forward-looking statements.

At this time, I'll turn the call over to the company's Chairman and Chief Executive Officer, Gene Taylor.

Gene Taylor

Good morning. Thanks for joining us today. In addition to Ken Posner, I'm here this morning with our Chief Financial Officer, Chris Marshall; our Chief Credit Officer, Bruce Singletary; and our Chief Accounting Officer, Jack Partagas. We'll discuss the company’s results and then take your questions.

Let's start by reviewing Slide 4, which highlights the company’s accomplishments during the quarter. The company generated 13% growth in core net income per share. New loan production was $316 million, up 25% year-over-year, with gains in each geographic market and product type. As a result, the loan portfolio grew 6.2% on an annualized basis and increased 11.7% year-over-year. We're building a diversified portfolio with high quality customer relationships and the credit metrics for the new loan portfolio remain exceptionally strong.

Historically, the first quarter has been seasonally weak, but our performance this quarter was significantly better than last year. This progress is a direct result of driving higher productivity in the sales force which we've been working on for the past five years. It's also the result of operating in terms of the country’s best growth markets such as Miami, Raleigh-Durham and Nashville, with strong population growth trends and significant business activity. As I spent time in these markets on a daily and weekly basis, I’m finding that customers and prospects are very receptive to the Capital Bank story.

Another positive, deposits increased sequentially at 8.3% annualized rate, with impressive double-digit growth in non-interest checking balances, which are the lowest cost and more stable funding for the bank. We've been working for last five years to drive a stronger sales culture in the branches and more effective sales practices and you're beginning to see more consistent deposit growth as a result.

Managing expenses is a critical part of achieving our profitability goals, especially in this persistent low-rate environment. Core net interest expense was down $400,000 sequentially and 7% year-over-year. Our special asset teams have done a great job aggressively resolving legacy loans and OREO, and as a result of their efforts legacy credit expenses are down 37% year-over-year.

Additionally, we scrutinized the cost to serve across the entire company. As you recall, in the first quarter we implemented a reduction in force, initiated plans to close nine branches and completed an early redemption of CVRs for the Southern Community transaction.

From my standpoint, the only softness in the quarter was deposit service charges. As Chris will address in a minute, if we don't get the results we need here, you should expect us to take additional actions in order to hit our profitability goals whether they’re revenue initiatives or cost related.

I'll now turn the call over to Chris Marshall, Capital Bank’s CFO.

Chris Marshall

Thanks Gene. Good morning, everyone. I'm going to start by reviewing our first quarter financials which are summarized on Slide 5.

We reported net income of $11.4 million or $0.24 per share and core net income of $13 million or $0.27 per share. Items categorized as non-core include a $2.4 million restructuring charge related to the reduction in force completed in January, and our plans to close nine branches. We also had a small amount of amortization for our initial founder equity grants, small expense associated with the retirement of our Southern Community contingent value rights and a small securities gain. These three items netted to about $100,000 of expense, and as usual you'll find details on these adjustments in the appendix.

Now let me summarize the major items in the income statement. Net interest income was down sequentially by $1.6 million, of which, approximately $1.3 million was due to the shorter day count the first quarter. We provisioned $1.1 million for the growth in our originated loan portfolio, where our credit metrics remain excellent. We also had a $1.9 million reversal of impairment in our acquired loan portfolio, which allowed us to record a net bit $800,000 negative provision for the quarter.

Core non-interest income declined sequentially primarily due to fewer NSF fees as we continue to transition away from low balance accounts to stronger customers who overdraw less frequently.

Core non-interest expense was down $400,000 sequentially and 7.2% year-over-year. GAAP results included the $2.4 million charge I just mentioned. You may remember that during our last call we estimated a restructuring charge of approximately $3 million. Please be aware, this quarter’s charge represents the majority of our restructuring expense, but there are some additional expenses associated with the branch closure that will be recorded in the second quarter, which we estimate to be approximately $1 million.

And then finally during the quarter tangible book value per share increased by $0.21 to $19.49 per share.

Now let's go into a little more detail on the first quarter results starting with Slide 6, which covers new loan production. As we did throughout 2014, we benefited from strong consistent production in each of our markets and major product types. In total, new loans were up 25% year-over-year. And as you can see, we had year-over-year growth in every single category on this page, thanks to strong production in moderate payoffs. Loan growth came in at 6.2% annualized pace, which was stronger than our results in first quarter 2014 and the loan portfolio was up 11.7% year-over-year, which is slightly ahead of our earlier guidance.

Over the last few years, we significantly transformed and diversified the bank’s loan portfolio, which is now 43% commercial, 34% consumer and 23% CRE. New originated loans accounts for 68% of the portfolio and acquired loans of 32%. And of note, the FDIC covered portfolio is down to less than 4% of total loans.

Now turning to Slide 7, you can see the bank has generated solid growth in deposits, which was sufficient to fund the quarter’s loan growth. We’re especially pleased with the double-digit growth rate in non-interest checking, which we achieved in each of our three geographic markets with consistent products, pricing, branding and sales management. As you know, this is the lowest cost, stickiest, the most stable source of funds for the bank. Both core and total deposit costs remained flat in the quarter at 15 and 34 basis points respectively.

Now turning to Slide 8, let's take a look at the NIM, which compressed by 9 basis points to 3.96% in line with our expectations. Variable rate loans made up 58% of total production during the first quarter, which continues to pressure NIM. This high proportion of variable rate loans also keeps the bank extremely asset sensitive. To help manage our interest rate risk position, we put on $70 million of receive fixed interest rate swaps during the first quarter. And as a reminder, we expect to see continuing NIM compression of 10 to 15 basis points per quarter in total GAAP NIM convergence with the Contractual NIM or until such time as interest rates begin to rise.

Let's turn to Slide 9 and review non-interest income. In the table you can see that debit card, mortgage and wealth management income was largely stable on a year-over-year and sequential basis. Deposit service charges however declined by $700,000 sequentially. With projected deposit service charges to be seasonally weak in the quarter, the fees came in below our projections. There were a number of factors that play here but the biggest is the decline in asset fees, which reflects the attrition of legacy low balance accounts and our shift away from promoting free checking type products. We expect overall fees to increase modestly from Q1 levels, with improvements tied to better debit card penetration and increased opt-in participation from our new customers.

Slide 10 shows you the trend in non-interest expense. As was mentioned earlier, core non-interest expense declined by $400,000 sequentially. It’s down to 7.2% year-over-year. We begin to see the benefits of restructuring in the second quarter and the full effect in the third as our branch closures are planned to occur on a staggered basis through June. During the quarter, we also completed an early redemption of the CVRs issued in connection with the Southern Community acquisition. There is no gain or loss on the redemption, but it will save us approximately $300,000 per quarter in after-tax accruals going forward.

You should also expect us to continue to rationalize costs in a number of areas, as we remain committed in achieving efficiency of no more than 60%. I will remind you that the FDIC indemnification amortization expense associated with our acquired commercial portfolio will end in the third quarter, which will reduce our quarterly pre-tax expense by approximately $2 million.

Slide 11 summarizes our capital and liquidity positions, which remains strong. The tier-1 leverage ratio increased sequentially from 14.3% to 14.4%. During the quarter, we repurchased 961,000 shares at an average price of $26. And since the IPO, we've repurchased 16% of our shares outstanding. Our investment portfolio remains concentrated in low-risk instruments, 93% of which consist of Agency guaranteed mortgage-backed securities, CMBS, CMOs and cash. And finally, the modified duration of our investment portfolio increased slightly to 4.4 years.

So that concludes my remarks related to Q1. But before I hand over the call to Bruce to discuss credit, I'd like to share two slides with you that address questions that we've consistently gotten from investors over the last few months.

Slide 12 summarizes the company's interest rate risk profile compared to other national banks. And the data shown here is based on recent regulatory study published by the OCC. I will take you through the slide in detail, but sufficed to say Capital Bank is significantly more asset sensitive than the Median National Bank. What you see here is the impact of 100, 200 and 300 basis point parallel increase in rates, as well as the decay rates and the repricing betas for non-maturity deposits.

You can see at the bottom of the chart that our decay rates are in line with the Median assumptions and our betas are slightly more conservative but the impact on NII and our EVE [ph] is significantly more positive for our company than for the Median Bank. I will dwell on this data because we don't expect to see any of these scenarios occur in the near future. However hopefully this provides some substance to support our position that we are extremely asset sensitive.

Now, I'll wrap up my comments by discussing our path to the 1% ROA target we’re aiming for by year-end. Chart on Slide 13 shows you the road forward from first quarter to fourth quarter. As I mentioned earlier, deposit service charges came in below forecast during the first quarter and we’ve lowered our expectation for fee growth modestly for the remainder of the year. Now if we didn't take any offsetting actions, our modeling would show us coming in short of the 1% target by about 8 basis points. But to address this potential shortfall, we are reviewing several contingencies, and you should expect us to implement actions that we can talk a little bit more about next quarter. We remain very committed with financial targets. We believe they are achievable and we will take responsible actions where we can to stay on track and hit them.

So with that, I'll turn the call over to Bruce to discuss credit trends.

Bruce Singletary

Thanks Chris. Turn to Slide 14, you can see the new loan portfolio continues to exhibit strong credit metrics. Past dues were flat at 11 basis points and non-accrual rolling 22 basis points. In addition, criticized and classified loans totaled 87 basis points of the loan portfolio. This is down sequentially and year-over-year. This performance demonstrates a shared credit culture and effective partnership between our credit and loan groups. We've been carefully [indiscernible] diversify portfolio at high quality credit relationships while this is likely to be the low point in credit cycle for charge-offs, I have no concerns about any aspect of portfolio at this time.

Slide 15 provides an update on non-accruals and special asset activities. As you can see, non-performing loans declined 46% year-over-year and were 2.5% at quarter end. And I'll remind you non-performing consist almost entirely legacy acquired impaired loans which is conservatively marked. We continued to reduce special asset portfolio, which has declined 59% at year-end 2012 to $299 million at quarter end. Inflows into non-accruals status also down significantly from $27 million in first quarter last year to $12 million this quarter. As the special asset portfolio shrinks, our legacy credit expenses continue to decline and were down by 37% year-over-year. I continue to expect further declines in legacy credit expenses as these assets are reduced.

I'll now turn the call over to Ken for questions and answers.

Ken Posner

Thanks Bruce. This completes our prepared remarks. Cecilia, would you please open the call for questions.

Question-and-Answer Session

Operator

Yes sir. [Operator Instructions] And we'll go first to Erika Najarian of Bank of America.

Erika Najarian

Good morning.

Gene Taylor

Good morning, Erika.

Erika Najarian

My first question is on how you're thinking about loan production trends for the rest of the year. I think slide 6 is great in that, it shows the seasonality and it shows the improvement year-over-year. Based on your pipeline today, should we expect the pace of new loan production up 25% year-over-year to be replicated for the remainder of the balance of 2015?

Chris Marshall

Erika, it’s Chris. Good morning. We gave you guidance last quarter to expect loan growth of approximately 10% year-over-year for the full-year and that's guidance – we would reiterate that guidance. So you should expect loan growth to pickup over the balance of the year, but I wouldn't expect 25% year-over-year for each quarter.

Erika Najarian

Okay. And also in terms of the expense trajectory, you did $50 million in core, and you noted that by the third quarter we’ll start to see the full impact of some of the cost savings initiative that you're taking the charges for. And you also mentioned that $2 million FDIC related expense that's going to come out. So is the best way to start thinking about the third quarter, should we start with $48 million, and – yes, how should we think about how the cost savings initiatives can impact that $48 million run rate, plus how we should overlay the credit related costs are going to track by then?

Chris Marshall

Well, I'll give you three numbers. First of all, the FDIC indemnification just for clarity runs through the third quarter. So we won't see that fall off until the fourth quarter. So that's number one. With regard to credit expenses, we expect the balances of our special asset portfolio to be down 35% year-over-year and our expenses to come down in line with that. That's roughly the same experience we had last year. And so you can – you should expect to see that same result this year.

And then finally, there are two parts of the cost savings that we just executed. We had there ref [ph] in the first quarter, and we’ll start to see that benefit in Q2. And that should be somewhere approximating $1 million a quarter. And then we'll have additional expenses from the facility closures, the branch closures that we won't see starting to show up until the third quarter. And you should think of our expense reductions to be roughly the same as the restructuring charge in the balance of the year.

Erika Najarian

Understood. And one question if I could slip in one more. Gene, we’re starting to see credit creep throughout the industry and not just related to energy portfolios. I'm wondering if the normalization of credit for the industry – and clearly the interest rate environment remains challenging. Could that change the tenor of the conversation that you're having today with future partners?

Gene Taylor

That's a good question, Erika, and the answer is yes. We always had to be very cognizant of anyone’s credit quality. I’ll let Bruce speak to ours, because as you know better than anyone, he is the individual we rely on to maintain the credit standards that we aspire to for the company, include the results we produced in the past and in the past quarter speak to that.

Bruce Singletary

Yes Erika, this is Bruce. So we've been very dismal around pricing and credit, and it has serviced well and it’s our intention to maintain that discipline going forward. And we feel that we’ll be able to continue to grow the portfolio at that 10% rate that was mentioned earlier.

Erika Najarian

I guess my question was less about your credit quality and more in that we’re starting to see within your peers worsening credit quality from pretty pristine levels, and I'm just wondering if that could change the tenor of the conversations that you're having in terms of potential strategic partners?

Gene Taylor

Yes. Hi Erika, it’s Gene. I understood your question. As Chris and I are out talking to people and you guys know we’ve talked to everybody, every transaction you see that happens where their capital deployment, we had our board meetings or the bank board meetings, local board meeting on Tuesday, Wednesday. Capital deportment remains the top priority for the company. And the directors obviously are asking what's happening in the companies, and they ask the same question you did. Will it affect pricing ultimately or how we think about who we would partner with, and the answer is yes.

Erika Najarian

Got it.

Gene Taylor

I mean, it factors in. And while it was a tough environment to figure out how you do a transaction without significant dilution or dilution becomes somewhat harder. Not impossible, harder.

Erika Najarian

Got it. Thank you.

Operator

We’ll take our next question from Stephen Scouten of Sandler O'Neill.

Peter Ruiz

Hi guys, this is actually Peter Ruiz on behalf of Stephen. Most of our questions have really have been answered but I was just wondering if you could maybe comment on, sort of, your thoughts about where maybe the loan loss reserve is kind of headed here in terms of organic loan growth? Are we kind of reaching an inflection point here, or is there additional room to go?

Chris Marshall

Hi, Peter. I think – this is Chris. I think we would say we’re very comfortable with our loan loss reserve and we don't see any near-term change in its levels.

Peter Ruiz

Okay. That's it for me.

Operator

We'll go next to Paul Miller of FBR Capital Markets.

Paul Miller

Yes, talking about your geography a little bit, a lot of your competitors are talking about the Florida market is picking way up. Can you just talk about the three geographies? And are you seeing a big pickup in the Florida markets at all?

Gene Taylor

Paul, good morning. This is Gene. Yes, obviously there is more activity there. One of the things that you see in our charts and as we talk with you individually and collectively, I always try to remind everyone the reason we're in three different distinct geographies or we would be in another geography is to find the best clients in those markets. And so I don't get carried away with it, but when people look at the names and that examiners look at our names and our investors look at our names of the clients that we've attracted from what were seven banks that couldn’t have banked those economies. It's bode well for us. It really does reflect trying to build a real company that is not only survives but prosperous.

And so in Florida, there is – I was reading the other companies reports and Florida, it continues to never – it never ceases to amaze me having been associated with the Florida banking all my career that you get this ebb and flows that occurs that. The Carolinas are much more stable, predictable, reliable. They don't get as frothy. They don't get the boom and bust cycles. Tennessee has turned out to be very much that way for us. So in Florida we’re achieving growth, but we’re being as you would expect me to say, incredibly selective.

Paul Miller

Okay. Thank you very much guys.

Operator

And we'll go next to Blair Brantley of BB&T Capital Markets.

Blair Brantley

Good morning everyone.

Gene Taylor

Good morning Blair.

Blair Brantley

I had a couple of questions. With the margins, should we expect to see more swaps being put on, Chris, [indiscernible]?

Chris Marshall

I think we have plenty of opportunity to monetize some of the excess asset sensitivity that we have. But I don't want to give you a number to build into your model. I think that the way you should think about it, as we've said in the past, our variable rate loan production has been much higher than we would like and we don't want our asset sensitivity to increase from what is already I think in excess of position. So we will consider adding swaps over the balance of the year to moderate the effect of that excess variable rate production, but we'll do it in a very measured way. At the end of the day, we want to remain conservatively asset sensitive, so don't expect us to do anything significantly different than we've done in the past.

Blair Brantley

Okay. And then when you're looking at potential future cost savings measures, what are your thoughts about using some of the savings for reinvestment, or is there a need for some of the savings to be reinvested into the franchise in terms of infrastructure or something like that?

Chris Marshall

We absolutely do not need any material investment and infrastructure for the company. We've built out a very robust infrastructure. We made very significant investments in our back-offices and they are performing very well. So no, we don't need investment there. But obviously we look at a number of revenue initiatives on an ongoing basis. And should we find those that we think produce long-term results for the company then those would become priorities for us. So that's not a very specific answer, but that's the best answer I could give you.

Blair Brantley

Okay. Well, speaking about on the revenue side, can you give us an update on any new hires in the loan production area, any turnover, anything like that? Just an update there would be helpful.

Gene Taylor

Blair, Gene. We don't have any turnover to report, and you heard me make a comment, I'm really pleased with our productivity increases. And so we've been able to grow our portfolio with the base we had. As you can imagine, we monitor every day, every week, every month, every quarter people's production, and we have people below the margins, the median [ph]. Obviously I'm trying to get everybody to make the median be a higher number. And so we don't, as I’ve said before, go out and add two, three, four people at a time. It's a cultural thing with me and I don't do it and we haven't done it. We’re very selective in our target hiring. And we had a couple of hires in the first quarter but nothing significant.

Blair Brantley

Okay. Thank you.

Operator

And with no further questions in queue, I'd like to turn the conference back over to Gene Taylor for any additional or closing remarks.

Gene Taylor

Well, I think I've said enough. So I thank everyone for being with us today and your questions, and we look forward to chatting with you about any of these matters at any time. Thank you.

Operator

This does conclude today's conference. We appreciate everyone's participation.