CSTR (2020 - Q4)

Good morning, ladies and gentlemen, and welcome to CapStar Financial Holdings Fourth Quarter 2020 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 Officer. Please note that today's call is being recorded and will be made available for replay on CapStar's website. Please note that CapStar's earnings release, the presentation materials that will be referred to in this call and the Form 8-K that CapStar filed with the SEC are available on the SEC's website at www.sec.gov and the Investor Relations page of CapStar's website at www.ir.capstarbank.com. Timothy

Okay. Thank you, Ludy. Good morning and thank you for participating on our call. We are pleased with our fourth quarter and 2020 results, and we appreciate the opportunity to review them with you. Each of our lives involves the participation in groups and teams starting in school, caring through sports and other activities in life. There is no team I participated in that I am more proud of in the 2020 CapStar team. Looking back, as we enter 2020, we were still integrating our first large merger and like many in the industry, anticipated a modest decline in our net interest margin and an increase in provision expense having had little to no losses in the prior year. In short, we thought it would be somewhat challenging year and we are focused on strategies and initiatives that could overcome this.

Thank you, Tim, and good morning, everyone. On Slide 7 of our earnings presentation, you'll see our net interest income of $22.3 million for the quarter reflects a continued increase over the past three quarters. The net interest margin was 3.12% for the quarter and was relatively stable at 3.41% on an adjusted basis. The adjusted NIM includes the impact of excess deposits on our balance sheet, which adversely impacted the margin by 37 basis points. PPP loans contributed 8 basis points favorably to the margin in the fourth quarter. Also driving an improvement was a shift of earning assets from cash into investments totaling about $178 million in the fourth quarter.

Thank you, Denis. Turning to Page 14. Let me start by saying, again, we are encouraged by the resiliency we have observed in our communities, our customers, and our CapStar team as we have all confronted the effects of the pandemic. We have fared well over the course of 2020 as this pandemic has evolved. To think of the uncertainty that we face less than a year-ago and to compare it to the focus we are gaining, while looking to the future is heartening in many ways.

Okay. Thank you, Chris. Operator, we are now happy to answer questions.

And our first question comes from the line of Graham Dick from Piper Sandler. Your line is open.

Hey guys. Good morning.

Good morning, Graham.

I guess, just starting on credit. Can you talk about what drove the increase in loans 90 days past due? I think it's just over – a little over $4 million now. Was this just matured loans that were pending renewal kind of like you mentioned in the deck or was there any actual credit migration of note here?

Yes. Generally, it falls in the category that had to do with the – our maturing loans pending renewal.

Okay. Great. And then looking at SBA, they're obviously a great contributor to the fee income again this quarter of about $400,000. I know this division is still pretty new, but can you give me an idea of kind of what's driving growth here and where you might think the run rate might shake out in 2021? You think it might be closer to that 3Q level of – think about $500,000?

Sure. We actually think it's closer to the fourth quarter level and can do even more. The challenge is – and this isn't really a challenge because we're glad to help. Is its PPP3, so that team is now fully focused on executing PPP, which takes their game off of their normal SBA business. But if you think long-term, it's a very talented team that came over maybe two years ago. And it takes some time to get set up their processes, their centers of influence referrals and was really proud.

That's great color. And then I know you guys took a lot of that excess cash this quarter and put into the securities book. It looks like you still have a fair amount of liquidity on balance sheet. You think there could be any incremental additions to the investment portfolio. And how are you thinking about balancing that with future loan growth opportunities that might be a little further down the road?

Well, obviously everybody would love to put it on with loans, right? And we don't want to be imprudent and put on bad loans. And so it's a really balanced approach and I'll let Denis add to that. But we're looking at five or six different things and certainly we could go buy a ton of securities like anybody today, and you may earn 50, 70 basis points. We don't want to hurt our interest rate risk. And so we're really trying to look at the return on capital of investments and we've done some securities. We've actually tried to run some deposits off that were non-core. And Denis, do you want to add other strategies?

I would just say, Tim, we're monitoring it. We're doing a number of things. We've bought a lot of sub-debt, a lot of investment securities in the fourth quarter. We may be able to do some more. We obviously have other things that we're looking at. And of course, we are monitoring our capital position as well. And so we have a lot of things in the pipeline. The liquidity ratio was close to 23%. So plenty of liquidity, a lot of excess deposits, and we'll continue to be aggressive in pricing those deposits downward as we move into 2021.

Okay. Thanks for that. That's all for me guys. Congrats on a good quarter.

Thank you very much, Graham.

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

Thank you. Good morning. One of your peers sold some hotel loans this quarter. Just wondering if you would be willing to consider if the pricing were favorable in that?

Jennifer, your question broke up. Could you repeat it please?

Sure. One of your Southeast peers sold some hotel loans during the fourth quarter. Just wondering if that's something CapStar would consider if the pricing were favorable in that?

Well, Jennifer, as we mentioned earlier, 87% of our hotels are pass rated. We have got – we would typically look at something like that as in offensive step to avoid losses. Right now, we think that our assessment on a transaction by transaction basis of those borrowers is favorable, their capital structure and liquidity is good. And our pre-pandemic valuations are strong because we still adhered to a high cash equity underwriting model on the front-end. So I would say we would consider anything, but favorable for us would have to be par, but they're good customers to us.

Okay. And the revenue growth environment is going to still continue to be pretty – in this year. What kind of expense growth did CapStar envision this year?

I don't think we want to give any guidance. We're still coming out of the FCB, which added expense and we're taking our estimated cost saves out. So we're getting to our normalized base. I would say we're focused on discipline management. I don't see a lot of capital investments or – so I would think it would be hopefully pretty close to the fourth quarter run rate. And you're right, revenue – economy is uncertain. So revenue and loan growth is tepid. We're certainly looking for strong loan growth and we're looking for additional bankers to hire. And then, I'm hopeful as is Denis that our margin is near stabilizing. So I think this is going to be a year. We're still excited about our fee businesses. We're going to try and get the balance sheet going again and try and be very disciplined on the expense side.

Hi, Jennifer. This is Denis. I think that we're finished with – pretty well finished with the conversions and the integration of our acquisition. So we'll have some savings that'll be coming in from – that will be fully realized going into 2021. We also see with some upside opportunity in our net interest income and our net interest margin, especially if the yield curve continues to steepen a little bit as the economy begins to open up. And then we've got really a tight focus on our regular ongoing general operating expenses. So I'm really optimistic that we've got a pretty stable situation from a revenue and an expense standpoint.

Do we still have you?

Yes. Thank you.

Okay. Thank you, Jennifer.

Thanks, Jennifer.

And our next question comes from the line of Catherine Mealor from KBW. Your line is open.

Thanks. Good morning.

Hey, Catherine.

Good morning, Catherine.

Hey. I know we've talked about capital management a lot, and just want to get your updated thoughts on buybacks, and what signs on the economy you're looking for to where you think you'd be comfortable starting to buy back stock?

Yes, good question. And I'll just – let's go back a little bit. I'll say when I joined 18 months ago, one of the pieces of feedback – and you will get feedback from everybody, right? Everybody has thoughts and you try and digest it all. But one of the feedbacks I got maybe in the summer of 2019 was that CapStar had run on excess capital and buyback opportunity or increasing the dividend. People even talked about a one-time dividend. So I think we took that input and we talked about it a lot and we actually chose to do the FCB deal. If you remember, part stock, part cash too because, obviously, you'd like to find profitable investments to use that cash is priority one. And if you can't find a loan growth or an acquisition, then do something. So we changed that to that mix and we're going to use our internal cash, which would have lowered some of our ratios and put it to use, and then COVID hit. And just one of the things I think that's great about CapStar is we are very focused on risk management. And so rightly or wrongly, we wanted to be conservative this time last year and elected to raise sub-debt. And so we just never wanted a situation not knowing how deep it would get. We would ever be in a position that we had bought back stock at $15 and then needed to issue at lower later because it was just a horrible event. In hindsight, it looks like things are not going to be as bad as maybe we all thought it could have been last second quarter. So Monday-morning quarterback, maybe there were some periods , we could have bought some stock. So we've studied it since August and we've run a burndown analysis between myself and Denis and Chris Tietz and Steve Groom and Mike Fowler. And we've probably met three or four times to monitor what we think the maximum loss could be. What do we think our earnings potential would be. What price we would buy at. It got discussion this week at our Board meeting. So I would say it's under discussion. We really just wanted to make sure it was clear and that our shareholders were protected. And I can't say much more than that, but we do think our stock price is an attractive price. But we don't want to jeopardize the bank or our capital base.

As you look at it, do you feel like it's more likely that you'll see reserve released before you buyback stock. Do you kind of look at the – I guess there's two kind of ways of capital management or kind of indication that you're comfortable with the credit. Maybe in that sense, how do you think about how early we could see reserve release coming out as we move to next year?

I'm not going to really comment on that. I mean that really – I think all banks, we all comply with GAAP, we want to, and we all are required to. I think this past year, the qualitative measures which came much more important and there's still a lot of uncertainty with stimulus coming out and is that propping the economy up, second waves of the virus, third waves of the virus. So we're going to let the model tell us based on our credit. But we do have a healthy reserve based on what we felt the potential risk could be. And so we're monitoring to ensure the appropriate levels there. But at the same time, we've got great profitability in our capitals building up. So I view them together and I don't view them together. And I would just say that at our capital levels, we do feel we have more capital than we really need to run the bank long-term, we agree on that. But we just would never do any – want to do anything to jeopardize the shareholder. So I view them a little different Catherine, and I think that we will be looking at share buybacks in the appropriate time and the appropriate pricing this spring.

Great. That's helpful. Maybe just one follow-up on credit for you, Chris. Can you talk a little bit about the – I mean, very minor, but just the minor increase in NPLs and what those credits were?

Yes. Well, first of all, in terms of NPLs, there was an increase that came through the mergers that occurred in general. And – but it was not outsized by our view. Then again, the other point I noticed that the – over 90-day delinquent credits would include some of the impact of the pending maturities that were – or pending – the maturities pending renewal at year-end.

Okay. So the linked quarter increase in non-performing loans was that – would you view that as pandemic-related or more acquisition-related?

No. That was the – in terms of specifically to non-accruals, that was acquisition-related.

And what type of credits?

Well, it's a general bull. They have a large base of consumer credits there, and we manage those under the retail consumer credit reporting rules and so on. And so we put those into doubtful categories pending their resolution with their delinquencies and so on. So there's no one credit that's driving that if that's what your concern is.

Yes. Largely what we experience Catherine is, these were two privately held banks and very well run, very good ratings and they were private. And so they didn't have, I think the same discipline at quarter-end of getting all loans – matured loans renewed. And we did the conversions on these in October and November to push them out. Interestingly, we announced this deal last January. We thought it would be more conservative to push it out, thinking COVID would be really bad in the summer and that it would get better. And so what happened is that happened actually as COVID was increasing. And so just a lapse internally getting them to our public company quarterly discipline, but it was not – it was just an array of loans that matured across those banks.

Got it. That makes sense. Great. Thank you.

Sure.

And our next question comes from the line of Bill Dezellem from Tieton Capital. Your line is open.

Thank you. My question is around the mortgage business. What do you view as a normal level of origination activity and I'm thinking in terms of a gain-on-sale?

That's hard to answer. I don't know that mortgage – even if we had our mortgage person here, I'm not sure that's such a cyclical industry, number one. Number two, Nashville is such a hot market. It is unbelievable how many people you meet here are moving here from California, Chicago and New York. I mean, it's just – it's phenomenal. So I want to give you an answer, but I don't want to give you a wrong answer. I guess what I would say and I wish our mortgage person was here, I'm going to be off a little bit Bill. But I think for us a normal year would be, I don't know, $400 million to $500 million of annual production. And this year, I don't have the exact number in front of me, but I think we’re up, maybe $700 million or $800 million in production. And so just a phenomenal year, but does that get you in the right direction?

It does. That's quite helpful. And then I'd like to take this a step further and another, I guess some semi unanswerable sort of question. At what level of interest rates do you think that you'll see the mortgage, one, mortgage refi slowdown? And two, the purchase activity where it actually starts to hurt real buyers?

That maybe better for us. And I hate for everyone to not get the answer, but that maybe better for us to do a follow-up one-on-one because I don't want to speculate. And it really would be better for us to get that information from our mortgage head, Hart Weatherford. But certainly all of us across the country are benefiting on this refi boom. And you hear this in every cycle, even a couple of years ago, you heard, gosh, every loan is kind of been refi. So there's not going to be any refi opportunity. I think people move and change houses so much. I'm finding that there's always an opportunity. But certainly you would think though it's going to run out. One of the things that I think is great about CapStar is if you look at this page, we have upright here. And I don't know, are they seeing the same page.

Its Page 11, Bill in your earning deck gives you a little bit more about the trend and the – trend in the revenues and how the third quarter was a record quarter.

Yes. So what I was going to say is that the refi, for us the refi is 60% roughly in these quarters. But historically for CapStar, the beauty of CapStar’s mortgage shop is it's been a purchase money shop. So absent this last 12 months, I'd say the $400 million to $500 million range with probably 80% purchase money. And with the size of Nashville and the growth of Nashville, I think there's a very good core mortgage business here that's benefiting by the excess right now.

Great. Thank you. And I do want to pick up on your point that you have people moving from Nashville from – it sounds like around the country. Is that different in some way or is it simply a continuation of a trend? No acceleration, it's just – it’s that just normal Nashville?

I'd say it's an acceleration. So what's different is, for instance, I moved here say 18 months ago. And I'm going to forget – I think it was Mitsubishi's. Two that come to mind – well, three, three that come to mind, and I know other cities are experiencing this. But this is one of the five or so cities that are really experiencing it. Right after I came, I think it was Mitsubishi. That's moving their North American headquarters from California to here. So that was way pre-COVID. There was AllianceBernstein, and then there was Amazon that's built a big building Downtown. So there is several of that, that already was occurring pre-COVID. What's happening now is – I'll give you a couple examples just quickly. It's non-company related. There are people that are quitting their jobs and just packing up and moving. So we unfortunately lost an outstanding banker as happens at the beginning of the year. And we hated to see that person leave and we've already replaced them with somebody that's going to start Monday with the same background sort of national healthcare lending. It's the person's background. And they just moved here from California and they've been here two weeks. And when you ask them why they came here, their daughters in school at Indiana University, which is just right up the road and just all that's going on in California. So that had nothing to do with the company, that person just wanted to change. I had lunch this week with a gentleman that grew up at Goldman Sachs, started his own fund and advisory business and moved here last summer due to COVID. No taxes in Tennessee. Manhattan is tough right now. And brought three girls and his wife here, has 14 employees, manages $400 million and took an office space right next to ours and went to lunch with him. And so I went to the dentist recently and they told me I’m going to be off a little bit. I said, are you all back to full staffing? They said, absolutely, full reservations and everything. They said – this is one dentist office. They said they're getting five new calls a month of people saying, are you taking new patients? And they said that they're all coming from California, Chicago and New York. So I would say the change, Bill, has gone from companies saying, why we want a lower cost place, better climate, better place to live for employees to where there's individuals that are just saying, unfortunately it's time to leave a larger city and I want a new place. And I'm sure there is other places like Charlotte or Austin, Texas. But Nashville is getting their share. And I think it's the climate, the excitement, I think it's the no state income tax, a lot of reasons.

Great. Thanks for all the perspective.

Sure.

And we have a follow-up question from Graham Dick from Piper Sandler. Your line is open.

Hey guys. Just a quick housekeeping thing here. I was wondering if you could share with me the level of PPP fee income this quarter.

Denis would you – you mean the PPP accretion?

Yes.

We may have to look that up. Let's follow-up on that. I don't know that we have that number exactly right here on the sheet. But Graham, we could follow-up if anybody else wants that. But certainly there's PPP accretion coming in as the loans…

Graham, it accreted $0.09 or $0.08 of PPP accretion into the margin. So if you want to do that…

8 basis points.

8 basis points. I'm sorry. 8 basis points into the margin. So if you want to do that math, you could do it or I'll be happy to get that for you later.

Okay, great. That’s helpful.

8 basis points on the margin would give you the amount of PPP accretion that came in the quarter.

And then – all right. That's great. We can follow-up after the call on, I guess, other PPP details.

That was about $20 million I think of PPP loans that were forgiven and then are reduced or whatever. And so we have still remaining at the end of the year, $182 million of PPP loans that will ultimately here very soon be – being forgiven or paid or whatnot. Now you're also going to have – we're in the middle of the next round of PPP. So we're going to have some more of this coming in, so…

Okay. Great. That's helpful.

Does that answer – okay, great. Thanks.

And I'm showing no further questions at this time. I will now turn the call over to Tim Schools, President and CEO for the closing remarks.

Okay. Well, I just want to thank everybody for calling in and I want to thank our employees. CapStar had a wonderful year and we've had a lot going on for awhile. Unfortunately, we had our Chief Operating Officer passed away at the end of 2018. CEO transition, and Athens was acquired. And so to accomplish all we did last year, it's just phenomenal. And I think it speaks highly to what we can continue to do. So we just appreciate you all following us. It's going to be another interesting year. We're going to continue to work hard for our employees and our communities and our shareholders. And we look forward to updating you after first quarter. So everybody stay healthy and we'll talk to you at that time. Thank you.

And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Have a wonderful day.