CSTR (2021 - Q2)

Good morning, everyone. And welcome to CapStar Financial Holdings Second Quarter 2021 Earnings Conference Call. Hosting the call today from CapStar are Tim Schools, President and Chief Executive Officer; Denis Duncan, Chief Financial Officer; and Chris Tietz, Chief Credit Policy Officer. Please note that today’s call is being recorded. Replay of the call and the earnings release and presentation materials will be available on the Investor Relations page of the company’s website at capstarbank.com. During the presentation, we may make comments which constitute forward-looking statements within the meaning of the federal securities laws. All forward-looking statements are subject to risks and uncertainties, and other factors that may cause the actual results and the performance or achievements of CapStar to differ materially from those expressed or implied by such forward-looking statements. Listeners are cautioned not to place undue reliance on forward-looking statements. Tim Scho

Okay. Thank you. Good morning and thank you for participating on our call. We appreciate the opportunity to review our results with you. In the second quarter, we saw the beginning of positive economic trends and continued favorable developments from the hard work of our associates. We reported earnings per share of $0.54 and annualized return on average equity of 13.5%. Year-to-date, we have earned $1.04 per share and our return on average equity was 13.13%. We continue to benefit from PPP in mortgage related revenues, which will not continue with the level they have. In this quarter benefited from a release of our reserves related to potential credit losses due to improved credit trends. I am very proud of our team and the results they are producing in this highly unusual environment. While some of this year’s earnings are not sustainable, CapStar’s competitiveness and performance is strengthening. As a company, we are focused on four strategic initiatives, enhancing profitability and earnings consistency, accelerating organic growth, maintaining sound risk management practices, and executing disciplined capital allocation. As we illustrate on slide three, we achieved many new milestones across our company that support the above mentioned initiatives and our risk management during this cycle has been strong. It is hard to highlight one achievement over the other as everyone is chipping in and doing a great job. With that, I will turn it over to Denis to cover our financial results for the quarter.

Thank you. Thank you, Tim, and good morning. On slide eight, net interest income was $23 million for the quarter, up $800,000 from the first quarter due to the increase in the net interest margin and an additional day in the quarter. Our net interest margin was 3.26% for the quarter, up about 13 basis points. Our adjusted NIM for the first quarter was up 1 basis point for the first quarter. Our adjusted NIM includes the impact of excess deposits which adversely impacted the net interest margin by 28 basis points for the quarter and PPP loan forgiveness favorably impacted our NIM by 7 basis points. Net interest income benefited in the second quarter from a shift of our earning assets into additional investments, as well as very strong loan growth as you saw.

Great. Thank you, Denis. Turning to page 14, let me start by saying that the good news is that a year ago in the midst of the pandemic my prepared notes were several pages long and today they are only two, some points of emphasis.

Thank you, Chris. As you can see our employees are improving our operational and financial results, and we see many growth opportunities among our current team from Tennessee as a state and from industry consolidation where in the last 12 months four Tennessee-based banks over $1 billion in assets have been acquired. Operator, we are now happy to answer questions.

Thank you. Our first question comes from the line of Graham Dick with Piper Sandler. Your line is now open.

Hey. Good morning, guys.

Good morning.

Good morning.

So, Tim, I was wondering if there are any other markets that you are maybe looking to expand your lending operations in kind of similar to what we saw you guys do in Nashville and the success you have had there, and then, particularly if there’s anything out-of-state that you might be looking at?

Nothing in particular, I mean, I guess, I would respond that something that would make logical to manage to Nashville and really not focusing on markets, but rather the quality of bankers. And so it’s more opportunistic. We were fortunate that a group in Knoxville was looking to make a change and was excited about us. And so we just -- we are keeping our ears open and we did hire one of the top -- we are also looking in market by the way, but we hired one of the top mortgage originators by volume in the Metro Nashville area this quarter. So I would put it more around looking for talent and you are not sure when that will pop up.

Okay. Great. And then, I guess, just maybe more generally to loan growth, obviously, another good quarter for you guys, great production and the pipeline looks good as well. Has your outlook changed maybe since we talked last? I think it was, I think, we coined like a 6% to 8% range longer term. Do you think it might be maybe get closer to 10% over the next few quarters as this pent-up demand continues to I guess come through to you guys.

Well, it seemed every bank that I saw had pretty good loan growth. So I am real happy what we had. But it seems like everybody’s doing a great job out there and it seems like the economy’s coming back. I guess on our side, as I don’t want to hype or mislead people, we -- to me we are transforming our company and we did a fair amount of participations in share credits before and we have some new bankers. So I just don’t want to everybody get ahead of it. But our pipeline does look great. It’s largely in Tennessee. So knock on wood, maybe the last two quarters we have had good growth. I hope that will continue. But we would really like to see three or four quarters of that to know that it’s sustainable. But I think -- I certainly think we have the right activities and we are heading in the right direction.

Okay. And then, I guess, the last question for me is kind of on the buyback, at the current valuation, it’s not as much of a -- as a no brainer as it might have been a year ago or several months ago, but probably still somewhat appealing given how much capital you guys have your disposal. How are you thinking about utilizing this going forward, while also making sure you have got enough capital set aside for organic needs that would actually build franchise value more so than buying back the stock would?

I will let Denis pitch in also. I guess my thought is, we are still solving that. We are still -- we talk about it a lot. We are still trying to crack it and people think about buybacks in different ways. We try and think about it as an internal rate of return, which you need to have a pretty good forecast, you can discount back and it’s uncertain times right now. So I’d say we are trying to balance that with some of the exciting growth opportunities. We feel our pipeline is looking pretty good and we are having some conversations in other markets. So it’s not a real black and white thing, and Denis, I don’t know if you have anything you want to add to that on your thoughts.

No. No, Graham. I -- Graham I would say, if you look at our capital ratios in general, I mean, we have got roughly in terms of excess capital. We have got probably $40-odd million of excess capital that we could put to use. We would like to put it to the highest and best use obviously and buying the stock back is obviously something that we now have in place and we are ready to go on that. But bank stocks in general have rallied pretty well over the last three, four kinds of months. So it’s tough -- it’s difficult to like you said justify using that to buy your own stock back, if you have the organic in your market type of opportunities to deploy that capital. So we are continuing to look at it. There’s a -- there -- we look at the levels of kind of internal returns. We could get on buying the stock back versus using it in within our businesses and so great for us to be able to have that flexibility to be nimble and use that excess capital to the highest of best use.

Okay. Great. And then if I could just sneak one more in here just quickly, it looks like the loan coupon held pretty steady, but loan fees were up a little bit quarter-to-quarter. Do you think those loan fees will normalized back to more historical levels going forward here?

I think it bounces…

Yes.

…down, it’s…

Yeah.

…hard to predict. But the loan yield surprisingly have been pretty good and so it’s been fairly stable.

Okay. Great. Thanks, guys.

Thank you.

Thank you. Our next question comes from the line of Jennifer Demba with Truist Securities. Your line is now open.

Hey. This is Brandon King on for Jennifer. How are you doing today?

Hey. Good morning, Brandon.

Good morning. Good morning. So I would like just to update on the hires you made in the quarter. And if there are any plans to get more aggressive hiring especially in Nashville with the acquisition that was announced most recently from a competitive bank?

I don’t want to comment too much on that. Reliant is outstanding bank and United Community Bank is outstanding bank. That’s an exciting transaction. But I would just say for us, I don’t know. I am trying to think back. I don’t know we hired one of the top mortgage originators this quarter. In first quarter, near the end of first quarter we hired a banker in Knoxville who had had a $100 million plus portfolio. So I would say those are our two recent hires. There had been some that were hired earlier in the first quarter also that it’s exciting when we look at our pipeline. They have got growing pipelines and this week or maybe was last Monday, they now have several million dollars of balances. So I don’t think there was really substantial hires this quarter, really looking for the ones and first quarter to see their exciting contribution. We are always looking and always talking and always having discussions both in-market and in other markets. And I would say, there’s good activity, CapStar has a good reputation. And I would say that the four questions get people thinking. So whether it would be those banks or other banks, it has led to good conversations and I will leave it at that.

Okay. And the positive growth in DDA balances is pretty good. I know the focus for the bank going forward. I wanted to know where is that growth coming from, is it coming from more existing customers, is increasing their own liquidity or are you seeing market share gains?

I’d say more existing customers. I mean it’s a good problem and a bad problem, right? I mean 18 months ago, CapStar is a bank that’s young and had more ease in finding loans and deposits. So at times was scratching and clawing for deposits and now we have more deposits like everybody that we can use. So we had started a higher emphasis on deposits across our bankers before the crisis and there was actually good traction in the first quarter or two and then the crisis came. So you sort of hate to tell everybody, hey, wait a minute, we tricked you stop. So we wanted to still be an emphasis and it’s a dilemma, because it’s hard to put it to work. But to be honest, I would say, the vast majority is just existing customers and all the excess liquidity and stimulus money that’s in the economy, to be honest.

Okay. And just lastly, I know last quarter you mentioned that the company was reviewing the technology investments for more efficiency opportunities. I want you to update on that and see if there’s anything to know from the review so far?

No. There’s not. We just -- I just -- I think I mentioned that is in each of the banks I have been -- that’s been a -- interestingly it’s ended up being a pretty sizable opportunity from at least two frames or two angles. One is, it’s just interesting, software sales folks are very good and banks tend to get software that either doesn’t do or maybe it was marketed to do or maybe it was a not a good fit. And so there is opportunity to sort of evaluate to have what you need, number one. And automate more processes, so that’s all one big project. And then number two, just getting the contracts coterminous and negotiating and bidding pricing. And so, that’s a longer term project. It doesn’t happen quickly. But I suspect there will be some level of opportunity there. And then outside of that, in our -- think we noted in our slides, in second quarter from memory about $250,000 is in our run rate related to PPP software processing that it should go away at some point. But we are just at the infancy of really studying our whole IT and software strategy.

Okay. Thanks for the answers.

Sure.

Thank you. Our next question comes from the line of Catherine Mealor with KBW. Your line is now open.

Thanks. Good morning.

Hey, good morning Catherine.

Good morning, Catherine.

I wanted to see if you could -- good morning. I wanted to see if you could give us your thoughts on the updated view of the core margin. I know there’s a lot of moving part, it seems like you have put a lot of excess liquidity to work this quarter, which is great and so just how are you kind of thinking about with the core margin moving pieces of the core margin over the next couple of quarters? Thanks.

Would you like to address that, Denis?

Sure. Sure, Tim. Catherine, we have been diligently working on that with our new partner called Arling who is a specialist in this business. But we have got several initiatives going on with the margin. One, obviously, that you have seen that has paid off substantially is really just in the overall deposit pricing strategy that we have been deploying. So we are down to 21 basis points of deposit costs. We can take that down a little bit more and we will be doing that very shortly. And then longer term, deploying investments in the shorter term that we have been doing very, very conservative mortgage backs sub-debt kinds of investments. So we have got some investment capacity that we will be deploying. And then, just generally, positioning ourselves for as interest rates rise being able to take advantage of within our loan portfolio, just the rising rates and re-pricing within our own loan portfolio. I would say, at 3.30 -- at 3.36%, our goal is to get it back up over 3.50%, closer to 3.60%. If you look at our goals and our strategies, we want the margin -- we want the net interest margin to be back up into the north of 3.50%, close to 3.60% kind of range and it will take several things to be able to do that. But we are definitely Catherine moving in the right direction on that as you saw this quarter.

You say that goal is still requires higher rate, right, or you could get there in this late...

No. No. Totally. Totally. And what I would say…

Okay. Okay.

… again, I just want to command, really it’s been managed great across, I think, that the community banks we partnered with brought stronger funding. I think that…

Right.

… Denis and the finance team has done a great job on really instilling deposit pricing discipline. There was not a monthly pricing committee at CapStar, which is something we have started and over a year ago and that’s just gone well on learning and talking and discipline. That’s done great. We talk a lot about the spreads. We have walked from loans. I think I shared -- didn’t share the customer name, but I think it was two quarters ago that, we really talk a lot on the spreads we want and let’s be disciplined and walk if we have to. So I think we are doing a great job to stabilize it and get as strong as we can, but obviously not just the steepness of the curve, but the level of the curve. Your DDA is worth very little today. If the whole curve shifts up, your DDA doesn’t go up in price and so that DDA becomes more valuable. So we are trying to take a lot of the interest rate sensitivity out, but we would benefit from an absolute rise of the curve, which is what it will take to get it towards our goal.

Right. And on loan pricing too that seems to be holding in, where would you take an average new productions coming on versus your -- is your current yield about 2 or 420-ish?

Well, I will tell you how we think about it and it’s hard, because we have a different product mix now, right? We have got three community banks that have more business banking and consumer products. So they tend to come at higher yields. They also have higher delinquencies and little bit higher charge-offs. On the commercial side, we target a spread to the matched FHLB theoretical funding rate. So, on each loan we go out to the FHLB website and look at what our theoretical cost of funds would be. That’s sort of our cost of goods sold. And then we put a spread over that based on sort of the commercial risk rating of the loan. And so, Chris, I don’t know if you want to comment what you are seeing coming through.

Yeah. Generally speaking, Catherine, on a monthly basis we monitor the new and renewed yields or really coupons, I should say. And they have been holding out on the commercial -- this addresses the largest transactions in the portfolio. And generally, they are holding out in the high 3s or low 4 kind of range right now.

Great.

And that’s on a weighted average basis.

Okay. Makes sense. Great. Thank you very much.

Thank you. There are no further questions. I would now turn the call back to Tim Schools for closing remarks.

Okay. That’s it. That concludes the call. We appreciate everybody taking the time to call in and we appreciate you following CapStar. Thank you so much.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.