State Bank Financial Corp (NASDAQ:STBZ)

Q1 2017 Results Earnings Conference Call

April 27, 2017, 08:00 AM ET

Executives

Joseph Evans – Chairman & CEO

Sheila Ray – CFO

David Black – Chief Credit Officer

Thomas Wiley – President

Analysts

Kevin Fitzsimmons – Hovde Group

Jennifer Demba – SunTrust

Christopher Marinac – FIG Partners

Stephen Scouten – Sandler O’Neill

Tyler Stafford – Stephens

Christopher Nolan – FBR & Co.

Steve Comery – Gabelli & Co.

Operator

Ladies and gentlemen thank you for standing by and welcome to the State Bank Financial Corporation Results of the First Quarter 2017 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Thursday, April 27, 2017.

I would now like to turn the conference over to Joe Evans, Chairman and CEO of State Bank Financial Corporation. Please go ahead sir.

Joseph Evans

Thank you, Selena. Good morning and thank you all for joining our call.

Here with me on the call today are President at least for now, Tom Wiley; Chief Financial Officer, Sheila Ray; and Chief Credit Officer, David Black.

The first quarter press release and slide presentation we will reference on this call are available on the Investors section on our website statebt.com. As usual, I need to remind you that the comments that we make on this call are subject to the cautionary note regarding forward-looking statements that you will find both in our press release and on Slide 2 of the earnings presentation. After my remarks, Sheila will go into first quarter results in more detail, David will talk about the loan portfolio and asset quality metrics, and Tom Wiley will say a few words to wrap up before we start Q&A section.

First, let me start by addressing the press release that we filed this morning regarding Tom becoming CEO of the Holding Company, in addition to his current role as CEO of the Bank on June 1, with me remain Chairman.

This is a special moment for me for a couple of reasons. First, 35 years ago when I recruited Tom to a little banking organization called Bank Corporation of Georgia that I told him, if he would just stick with me and work hard, he’ll had the opportunity for advancement. I’m pleased to be making good on that promise. Tom is an expectational banker, leader and a great friend. He is kind of friend you call when you run out of gas on the downtown connector at Atlanta on Sunday night and you absolutely know he will come. There is not a banker on this planet that are suited for this job.

Second, this is a validation of the quality of our broader management team that has the depth, breadth of skill, intelligence, experience and most importantly philosophical alignment to enable me as a founder and a significant shareholder to take a step back and just smile. This is as much if not more about how the rest of the management team in this company has stepped up over the past several years as it is about Tom and me.

From the standpoint of corporate functionality, I think you all will look this as the formulization of an organizational evolution that’s already taken place more so it’s been our precursor of change yet to come. I’ll tell many times about the $4 billion asset level being what I have pursued to be threshold of core earnings sustainability for us in post accretion world.

Equally critical to sustainability is building a management team capable of delivering continuing excellence to shareholders in a post founder world. Today I can attest to you that we’ve achieved sustainability in both counts and it feels pretty damn good to me.

By the way I just want to remind you that I’m not going anywhere. As the press release indicated I signed on for another three years intend to be a very active Chairman focused primarily on coaching government strategy and corporate development and continue to be just a shareholder advocate. I do plan on exercising a bit more flexibility in my personal scheduling and just given the same some room to grow. And as you know, I’ve got a lot of money riding on the success of State Bank.

Turning on the results on Slide 3, this fundamentally is a solid quarter with a $11.6 million in net income without any benefits from gains on pool close outs. Interest income on loans and invested funds excluding accretion was up 25% in the quarter and 36% year-over-year aided in part by our two recent deals.

We continue to make significant progress growing core interest income as accretion income continues to become a less meaningful part of our revenues. Although, we still have roughly $63 million of remaining accretion to come into income over the next few years. We had another solid quarter of loan growth as organic and purchase noncredit impaired loans increased a net $47 million in the quarter or 7% annualized.

Moving to fee income which totaled $9.5 million per quarter mortgage banking had a solid quarter despite the seasonal slowdown we typically see in the first few months of the year while payroll continues to add clients each quarter. SBA income was a bit lower in the quarter after a strong fourth quarter, but we’re seeing the pipeline build out nicely this year and look for strong results for the rest.

It’s also notable that we continue to find really exciting synergies with our Patriot Capital Division. We have an active effort going on with them to add additional industry verticals and we continue to believe that we’re learning from Patriot is as valuable to us as the business threat.

Turning to core deposits and funding mix, period end deposits were down just over $20 million in the quarter. We did experience a dip in noninterest bearing demand deposit and transaction accounts which can be traced primarily to the seasonality of clients business and operating cycles as we’d expect with transaction account.

Even with the volatility average non-interest bearing deposits still makes up a healthy 28% of total businesses. And when you look at our new business relationships net of the volatility that we experienced in existing clients relationships we’re seeing a real strong growth in the penetration of new relationship particularly in the Atlanta market.

Lastly, I want to congratulate our team on the very successful integration of two new banks in the State Bank of first quarter. Going from 12/31 closings to February conversions on both National Bank of Georgia and S Bank is as fast as I have ever experienced. This quick effective integration will help lead the all expenses going forward as we continue to see efficiencies from these two deals.

Overall, I’m very pleased with solid quarterly results and as I mentioned once again I remain all end at State Bank, got a lot of money riding on the success of this team and genuinely believe the best days of State Bank are still ahead of us.

With that, turn it over to Sheila.

Sheila Ray

Thank you, Joe.

Before I begin, I want to remind you that the first quarter income statement includes the impact from our recent acquisitions that closed on December 31, 2016. So as we review our linked quarter comparisons please keep that in mind. As Joe mentioned, we had net income of $11.6 million or $0.30 per diluted share in first quarter which included $2.2 million of pre-tax merger related expenses which impacted our diluted earnings per share by approximately $0.04.

Slide 4 shows our revenue growth trends, we grew revenues 10% linked quarter and 18% excluding accretion income. Total interest income on loans and invested funds increased $8 million or 25% from the previous quarter and $10.5 million or 36% from the first quarter of 2016 which is due impart to NBG and S Bank. This quarter marks the 12th consecutive quarterly increase in traditional interest income.

Accretion income was $7.7 million in the first quarter and included $4.7 million of base accretion and $3 million of loan recovery income. This is great quarter for loan recovery income but as you know recovery income can be bumpy and our performance this quarter should not indicate an expected run rate. We did not have any loan pool gains in the first quarter and the accretive discount decline to $63 million from $69 million at the end of the fourth quarter.

Our net interest margin excluding accretion expanded just 3.95% in the quarter from 3.50% last quarter approximately half of the increase was due to deposit of impact rate hike on loan investment yields as well as the higher yielding acquired loan portfolios. The other half of the increase was due to the acceleration of the discount accretion on certain acquired loans but NBG and S Bank that are paid off during the quarter.

The pickup in accretion on newly acquired portfolios in the first quarter was related to timing of loan cash flows and should not repeat at that level in the future quarters. However, the pickup related to the rate increases should spin and continue as rates continue to rise as most economists has suggested.

Now if you’ll turn with me to Slide 5, noninterest income in the first quarter was $9.5 million compared to $9.9 million in the previous quarter and $9.4 million in the first quarter of 2016. Mortgage banking had a solid quarter as production of $115 million led to net income of $2.9 million the $116 million in production was comparable to the first quarter of 2016 and the first quarter of 2015 as the first quarter typically a little closer across the entire industry.

We did have a significant decline in SBA income to $1.2 million in the quarter as productions slowed to $12.3 million from $17.3 million in the fourth quarter. However as Joe mentioned activity is picking back up after a relatively slow at the end of February. We closed and sold a lot of loans in the fourth quarter and frankly you don’t build a pipeline in the fourth quarter. We saw an improvement in March and we expect to return to more normalized run rate in the second quarter.

Finally looking at the performance of Altera Payroll I want to point out that we have combined our payroll and interest business for reporting purposes as these units have been operating as Altera Payroll and insurance for about a year now of the data that we maintain on our payroll system and the efficiencies we have in offering group health and supplemental employee insurance products along with our payroll product it makes sense to combine these two units. Payroll and insurance income was $1.5 million in the first quarter essentially in line with the previous quarter and first quarter from 2016.

The legacy payroll business was $1.3 million in the first quarter down $89,000 from the fourth quarter as we have changed our billing practices this year to include the costs new impacts supporting in our clients regular monthly billings instead of charging them on a current basis. This should eliminate some of the seasonality we typically see in the first quarter.

Overall we continue to add payroll clients at consistent rate each quarter which drives recurring revenue and we are optimistic that insurance will become a meaningful contributors as well as we are regularly adding new benefit clients thereby increasing our revenue per employee.

Now turning to Slide 6 on expenses and efficiency. Total noninterest expense was up $1.7 million in the first quarter as a result of additional expenses related to NBG and S Bank, seasonality and benefit expenses and merger related expenses.

During the quarter NBG and S Bank contributed approximately $2.6 million to noninterest including $1.8 million in salary expense as well as increased debt processing cost as we were essentially running three separate operating systems during the quarter. In addition, we had a $2.2 million in merger expenses and a net benefit of $1 million from OREO gains. Excluding the impact of one-time expenses we expect a $32 million quarterly expense level as roughly $1.4 million of extension dropout of the run rate next quarter.

Production volume which could result in higher commission expense can also affect our quarterly run rate that obviously there will be more than offset by increased revenue. The additional expenses related to the acquisition acted as headwind are not efficiency and burden ratios however excluding the merger expenses the burden ratio was 2.22% which is an eight basis point improvement from 2016 full year level and we expect to continue to trend towards our stated target of 2%.

Lastly I want to talk about core deposit funding on Slide 7 and 8. We continue to focus on growing our low cost core deposit funding and increase in transaction deposit accounts. As you can see from the percentages at the bottom of Slide 7 we have 28% noninterest bearing deposit and 46% transaction deposits with the mix slightly less favorable that at the end of 2016 due to the deposit composition of NBG and S Bank. This slide use average balances so they highlight the affect of the two banks which were added on the last day of 2016.

Slide 8 shows deposits in all five regions we continue to strengthen our number one market share in Middle Georgia and have top 10 market shares in the Augusta and Athens but believe that Atlanta where we have less than 1% market share in a $150 billion market and our new market of Savannah where our management team has significant experience will continue to provide the most growth opportunities for us going forward.

This concludes my remarks and I will now turn the discussion over to David.

David Black

Thank you, Sheila, and good morning, everyone.

Turning on Slide 9, we just laid the three year trend of total loan portfolio by accounting classification. New loan fundings and advances on existing commitments were roughly $420 million in the first quarter a level very consistent with prior quarters. The spot balance total loan growth number was slightly off the recent trend line due to move by paydowns that are different production.

Now turning to the bottom of the page shows our period and loan growth by asset class as organic and PNCI loans grew $46.7 million comprised of organic growth of $82 million which was all set by $35 million of contraction in the PNCI portfolio. Total loans increased $40.2 million or 6% annualized in the first quarter which is a net of $6.5 million decrease in purchase credit impaired loans.

The mix of organic and PNCI portfolio remains relatively consistent with prior quarters with one notable exception the AD&C bucket contracted $89 million largely due to the conversion of completed commercial construction projects which fueled part of the growth and other CRE.

Slide 10 provides a breakout of the CRE and AD&C portfolios highlighting the diversification across major sub categories. During the quarter, our current CRE concentrations as a percent of risk-based capital at the bank level declined to 96% for AD&C and 323% for total CRE compared to 1.16 and 3.25 in the fourth quarter. We remain comfortable with these concentration levels largely due to the mix and underlying diversity and supported by thorough underwriting and portfolio risk management practices.

We continue to see positive fundamental economic trends throughout our Georgia markets and are optimistic about what we see in terms of population growth, job creation and real estate absorption and the future earnings asset growth these trends could represent even in a very competitive lending environment.

I’ll wrap on Slide 11 where we highlight another quarter of sound credit metrics. 30 day plus organic loans, pass due represented just eight basis points of organic loans. Organic nonperforming loans were $6.1 million, representing 28 basis points of total loans, down two basis points from the prior quarter.

We recorded a $1.3 million provision on organic loans primarily due to 82 million of organic loan growth during the first quarter resulting in an allowance as a percentage of organic loans remain unchanged at 1.01% covering organic NPAs by over three times.

In the purchase credit impaired portfolio, PCI loans totaled $154 million at the end of the first quarter as this portfolio was relatively mature the rate of contraction has slowed and the overall asset quality has improved with 89% of our PCI loans currently performing as agreed. Other real estate owned declined a favorable 66% in the quarter to just $3.8 million a start contrast versus our peak OREO balance of over $172 million back in 2010.

Our dispositions in the first quarter resulted in net OREO gains after loan collection expenses of just over $1 million even though low remain OREO balance we will not expect to see the same level net OREO benefit going forward. Overall from a credit perspective we’re very pleased with the results of the quarter.

I’ll now turn the discussion over to Tom.

Thomas Wiley

Thank you, David.

First of all I would just like to say that I am deeply honored to have the opportunity to not only to lead an incredibly talented team of bankers the State Bank and also to succeed Joe Evans my partner, mentor and my friend. I’ve known Joe and worked with Joe over three decades. I think we all know that Joe is a vision in the Georgia banking community and has and the better part of 40 years. He is in personal take responsible for the success of 100s of bankers and investors. I happen to be the beneficiary of that experience.

However, his most recent achievement in State Bank might be his greatest by possessing in State Bank with a management team which is superior to any we have been part of in the past. I know and I think well and that Joe will continue as leadership and vision and – will contribute to State Bank going forward as we continue to execute on our strategy and build upon the strong foundation he helped create.

With that our operator we can open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Kevin Fitzsimmons of Company Hovde Group. Please proceed with your question.

Kevin Fitzsimmons

Hi, it’s Hovde Group. Good morning, everyone. Just want to say, first off, congratulations Tom. Happy to see the announcement. And I guess my — and just let me know if this assumption is correct, I’m assuming that with you having been President and Vice Chairman and CEO at the bank level, I’m assuming most of the operating direct reports were coming to you Tom. So, I’m assuming there is not going to be that much of a change in the day to day, is that correct?

Thomas Wiley

That’s correct – this organizational structure in place for the better part as for 18 months or so.

Joseph Evans

I think this is more of a validation of what we’ve already done as opposed to what we’re going to do?

Kevin Fitzsimmons

Right. That’s what I was assuming. Great. Can I just — as I always do, can I talk through the margin with you a little bit here? So the 3.95% margin excluding accretion income, we pull out maybe 23 basis points or 22 basis points of the 45% linked quarter change that’s coming from the accelerated discounts. So then we get it down to, call it like 3.72% ex accretion and other stuff. I guess looking forward, a big part of that benefit came from rates. How much of the benefit was just the December rate hike and not necessarily the March rate hike? Trying to get a sense for how much more is coming even without further rate hike assumed. Thanks.

Sheila Ray

Sure so our loans are mostly and a lot of securities as well are actually are tied to LIBOR which typically leaned a little bit so we got I would say the majority of it was from rate hike that occurred prior to the end of 2016 as LIBOR will add a little bit but if rates continue to increase we expect to see similar improvements and I would expect to see another a little bit of rate improvement based on the March increase in the second quarter. But yeah I agree with your number I assume with 73 and 75 would be adjusted after the day two issues.

Kevin Fitzsimmons

Okay. But maybe it’s kind of gradual improvement, but not the same kind of magnitude we saw in this quarter just because of — that’s when we saw the big uptick in LIBOR, unless we see another continued uptick to that magnitude, right?

Sheila Ray

Agreed and one other thing I would remind you Kevin in the fourth quarter our margin without accretion was down a little bit of the holding so much cash. We had been running in the 360s before that so we hold more cash in the fourth quarter because so many municipalities spend of accounts and that’s kind of on average basis. So given all of that I would say yeah it’s certainly not another 20 to 25 basis points up.

Kevin Fitzsimmons

Right. And then based on your comments about accretion income. So there’s a 64 basis point difference between reported and margin, excluding accretion and base accretion kind of is what it is, it will gradually decline I guess, but it seemed like based on your comments, the amount of recoveries was higher than you would have thought and we shouldn’t assume that same kind of pace going forward.

Sheila Ray

I think that recovery income is going to be bumpy and we running the last two quarters of 2016 at about 4 million and now we went down to 3 million and we just had a really good quarter and did not want people to anticipate as they project forward that we’re going to hit $3 million a quarter going forward. We frankly don’t know what it’s going to be because it depends on what borrowers are going to do and we are certainly working hard to recover as much as we can.

Thomas Wiley

While I do think – it’s fair to say that we charge-offs through the assimilation of failed banks – that was something like $1 billion approval of charge-offs out there.

Sheila Ray

Yes.

Thomas Wiley

To be worked – so expect that to be as you said spread but there still recoveries out there if you worked.

Sheila Ray

Agreed.

Kevin Fitzsimmons

Can I ask just one quick follow-on on the loan growth. David, I understand the movement between the C&D and CRE and how that flowed. C&I was kind of flattish linked quarter. Was that where the paydowns were really focused and that’s what kept growth from transpiring there?

David Black

Yes Kevin the C&I was relatively flat despite some activity and we had some real originations and we had some payoffs I wouldn’t point to any one particularly asset classes the reason why loan growth wasn’t as robust as it may have been in the past. But – an organic number of 82 million is a pretty strong number relative to what we’re seeing from other banks that are now playing. So I don’t want to be too apologetic about even net of some PNCI contraction of 7% annualized number in this 2% GDP world we’re living in.

Kevin Fitzsimmons

That $82 million is the whole…

Thomas Wiley

Yes, Kevin I think problem just couple of other things that we just working early – for the fast integration of the two banks that we bought that was you don’t do acquisitions without some diversion or otherwise organically focused attention. So – can’t quantify it but the distraction of acquisition integration will slow otherwise organic growth both from a standpoint of the last franchise as well as the folks in the acquired banks that are having to adopt to a new world and secondly as third quarter is just typical seasonally a bit sledge so we’re pretty optimistic about the outlook.

Kevin Fitzsimmons

Yes. And I’m not trying to criticize it and saying it’s slower than what other people are seeing. I guess I was asking the question more from the standpoint that I had the impression over the last few quarters that you were not so much de-emphasized in commercial real estate, but you are trying to focus more the growth in C&I, and I’m assuming C&I is where most of the Patriot type stuff shows up. So that’s why I was just a little surprised to see it flattish. Okay all right thanks very much guys.

Operator

Thank you. Our next question comes from the line of Jennifer Demba of SunTrust. Please proceed with your question.

Jennifer Demba

Good morning. Congratulations, Tom. Question on Patriot, you mentioned Joe, that you’re contemplating expanding into other industry verticals there. Can you give us some color on that?

Thomas Wiley

Sure I’ll start at and again we are in beginning stages of that in particular but we have probably customer in our of different type of equipment et cetera in the current pipeline we think that growth up and barely significant cliff and it’s fanned from beyond just our Patriot type petroleum driven equipment – to essential equipment or whether it be [indiscernible] et cetera.

Jennifer Demba

Okay. Thank you very much. And I guess, I’ll go to my standard question on M&A. We obviously saw a big deal announced this morning over in the Carolinas. Can you just talk about the level of discussion activity and what the potential sellers are thinking these days?

David Black

I don’t know that in our world it’s materially different than the way we talked about it last quarter that the list of possibilities that are both that are strategically interesting to us from an acquisition standpoint or it’s a fairly short list, but there is some significant opportunities on that list.

And I have not noticed that from a standpoint of expectations that – in our day-to-day world there anything is materially different today than we talked about it four weeks still have interesting things to look at. And because we focus on things that are much more relationship driven we don’t change bid deals that the points under discussion primarily are about cultural fit of how well we align and post acquisition integration more so the price.

Jennifer Demba

Thank you so much Dave.

Operator

Thank you. Our next question comes from the line Christopher Marinac of FIG Partners. Please proceed with your question.

Christopher Marinac

Thanks, good morning everyone. Wanted to drill down on the payroll and insurance income and also mortgage for the same question, which is what do you see as the trajectory at growth for these? Are these businesses kind of slow and steady growing or would you think that they could be more significant in terms of where they may be several quarters out?

Sheila Ray

I’ll start with payroll and insurance and I’ll let Tom address mortgage. Payroll and insurance I would say we have historically had probably somewhere between to 8% to 15% growth in revenues. We would expect to get back to that we’ve got some bumpiness from quarter-to-quarter that we talked about in the past, but if you look at our client growth what happens is, there is kind of steady incline quarter-to-quarter then a steep incline from the third quarter to fourth quarter when we add a lot of clients who are getting prepared for the new year.

We thought that last year we’ll start reaping the benefits of that and what we’re finding during the current year is that it’s not as much about adding new payroll clients as it is adding revenue per employee in those clients, but we expect continue to add new payroll clients as well. One of the interesting things that happen Chris we talked a lot about how there are synergy between this and our banking business.

We have seen more and more bank customers come in as payroll clients now the positive of that is it really solidifies a strong relationship with that client. If there is a negative to it is that some of their fees are offset by analysis – if revenue growth is strong it gets offset into the analysis income.

Thomas Wiley

And Chris as far as mortgage and our attention to the mortgage blocks and our typically it can count on about 80% of our locks converting to natural mortgage loans. And I have seen a significant tick up – actually in the month of March and has continued into April our locks are actually up about 50% from what they were in January. So wow I think everybody is paying attention at our mortgage rates compete with 10-year where it is I don’t have really noticed any decline I do see and some seasonality to the current – the fourth quarter we have a little improvement in the first quarter and I think that’s going to continue in the second quarter.

Christopher Marinac

Correct, that’s very helpful thank you. And just a follow-up question perhaps for you, Tom, or even for David. Outside of what you’re showing us on the credit trends this quarter, what else are you seeing out there in the market in general? Are you seeing anything that bothersome, whether there’s an Atlanta or other parts of the State Bank franchise?

Thomas Wiley

I’ll start because my sense is David is going to be more bothered on some of this. As I participate in loan committee some structure easing some pricing has gotten crazy. I think we don’t know that, but generally the segments that we operate in I don’t see any real disturbing trends I think multi-families are on everybody checklist, I think retail is on everybody checklist beyond that we pay such close attention to those segments I don’t see anything it give me great heartburns I’m going to turn it over to the heartburn guy.

David Black

I think Tom description that the probably is a some degree of heartburn as any risk person might feel when we look at activity and then – the focus on the real estate sector of this just because there is well exposure is. When we see the amount of supply coming on the market and in particular new – activity in specific submarkets relative to absorption and just – some degree of economic speculation that absorption is going to continue.

Although the macro picture remains relatively solid and we give a lot of scrutiny to specific transactions and stress testing and underwriting to pretty adverse scenarios and are getting comfortable enough to continue to put earnings assets on the book. And so that’s the net conclusion to come to it is that we still despite what might give us some heartburn and choose us to pass on various deals in the pipeline we still net-net are relatively bullish on the outlook for growth.

Christopher Marinac

Sounds, great. Thank you for all the color much appreciate it.

Operator

Thank you. Our next question comes from the line of Stephen Scouten of Sandler O’Neill. Please proceed with your question.

Stephen Scouten

Hi guys. Thanks and congrats Tom, and obviously congrats, Joe, on what you guys have been able to build to allow you to transition to Tom, nicely done. Curious and I apologize, I had some phone issues earlier, so if I may have missed this, I apologize for redundancy, but how much of the benefit from the March rate hike would you guys expect to see in the core NIM next quarter? And can you give a little bit of detail about how many of your loans are still at any floors that would inhibit the immediate benefit of rate hikes?

Sheila Ray

So we think as I said earlier that about half of the non-accretion the NIM ex accretion will stick which was I think somewhere between 20 to 25 basis points I think you’ll see some modest pickup again not at the same rate because fourth quarter was kind of low net interest margins without accretion just because of the amount of cash that had kind of been brought during the quarter.

So we do expect another pick up though and although the other thing that affect that as I mentioned earlier is that most of our loans and our investments are linked to LIBOR which kind of lead so we break that benefit unless we start seeing more rate increases which we are hopeful for. And so I think that the answer there we’re going to see some modest increase continuing throughout the year that we expect to stick with it. Did you have a second question I’m sorry.

Stephen Scouten

Kind of how many loans are still at their floors or how close are they to crossing through?

Sheila Ray

We still have some floors but it’s much smaller than it was so it is not going to have an appreciable impact going forward.

Stephen Scouten

Okay, that’s great. Maybe one more clarifying question on your expense guidance, Sheila, with the run rate you gave at $32 million and the $1.4 million quarter-over-quarter reduction you’re talking about, what number is that comparable to? Because I was getting kind of core interest expense — I mean, core expenses like $32.3 million this quarter, if I take out the non-recurring, so is that $32 million comparable to the $32.3 million or was it comparable to the $34.6 million, I guess?

Sheila Ray

I think it’s comparable to the $34.6 that we think will fall down to about $32 million now you take out when I say $32 million we don’t include the OREO positive benefit. We don’t include merger expenses which we still haven’t seen merger expenses this upcoming quarter, but it won’t be anything like the first quarter because obviously we ran hard and that was done. And we’ll have some benefit of some other pickup from efficiency gains we think like data processing and some staffing.

Stephen Scouten

Okay, perfect. Thanks for the help there.

Sheila Ray

Sure.

Stephen Scouten

Great. And just maybe a more general question and this is probably more to the credit side of the house, and maybe thinking about Middle Georgia in particular, but obviously we’re seeing some early signs of strip center weakness and maybe retail weakness especially in more rural areas. Is there any sizable exposure that you guys might have in any of those markets or anything on the retail CRE side of things that gives you pause at all?

David Black

Yes, Stephen retail we fully knowledge that’s a sector that has probably some generational headwinds and try to think of every deal with that it’s overarching, underlying risk. Our retail portfolio is of significant component of sub CRE categories that I would make note of a couple differential specifics that bucket is one of our most geographically diverse 65% of that portfolio is within Georgia.

So 35% outside the state which is part of our prices of people that we have long histories with in the retail sector that we will travel throughout the country with projects that they do. From a mix standpoint of what that bucket looks like over two-thirds of our retail exposure is anchored, so it’s not just non-strip or strip centers and over half of the anchors are grocery anchor. And so while – drones may be delivering goods to your doorstep it may be a challenge for the drone to pick up your groceries to drop this all.

And so we’re kind of net bullish on grocery anchor component to overall retail and pay a lot of attention to both geographic diversity to your point about any particularly submarket that maybe we’ll see softness, but we also pay attention to primary tenant exposure and no single tenant across different projects across different sponsors represents more than 10% of our overall retail exposure. And just I think class performed extremely well for us from overall – [indiscernible] is at seven basis points and only of overall retail only two basis points of that retail is NPL.

Stephen Scouten

Okay, great. That’s really helpful thanks. And then maybe one last one for me, just, it looks like there was this $22 million loan purchase, maybe part of Patriots efforts here. Any other color there, is that kind of standard practice for you guys and will it continue to be opportunistic loan purchases from here?

David Black

We’ve always had some role with looking at portfolio purchases this was unique given the asset class that was in and the sheer size of it. This is overall part of our strategy and increasing the diversity of our loan book and as we look to buy some non-CRE exposure we were selling some CRE exposure as we originate new CRE opportunities and we’ll create dropout of our existing relationships.

The one transaction that you referenced as what we think is significant structural enhancements relative to just standard consumer runs at your paper from a seasoning standpoint from a minimum FICO average FICO up in the 780s and max DTI of 35%.So this is really prime plus consumer unsecured paper purchased at a relative to par that provides us significant comfort and we think a good risk award for the bank.

Stephen Scouten

Okay, that’s fantastic. Thanks again for the color and congrats Tom really nice quarter.

Operator

Our next question comes from the line of Tyler Stafford of Stephens. Please proceed with your question.

Tyler Stafford

Good morning, guys. Tom, also congratulations as well from me. Just one question from me, the rest of been asked and answered. Just on your GAAP reserves, that was flat at 93 bps or so from NBG and S Bank last quarter. Are we at a floor now, and should start kind of, I guess, maybe stabilizing and expanding that margin or how should we think about the reserve? Thanks.

David Black

Yes, Tyler maybe not surprising – hasn’t give any outlook as to what the ALLL looks like it did remain flat at 1.01 the reserve methodology on organic is separate from that of how we measure and calculate the purchase credit impaired and the non purchase credit impaired so it’s really three separate distinct calculations. And from an organic standpoint the ASE is specifically we use a relatively small piece just because of our small TDR and NPL portfolio and then the pool loans is somewhat impacted by what is at we had low historical loss factors.

And so it is relatively qualitative in nature and our bias is going to be somewhat skewed towards the sort of side of thing it just how we’re oriented, but I don’t have any kind of forward looking predictions about what the net of those three buckets are going to be.

Tyler Stafford

That’s fine, thanks.

Operator

Thank you. Our next question comes from the line of Christopher Nolan of FBR & Co. Please proceed with your question.

Christopher Nolan

Hi thank you for taking my question, David the CRE concentration numbers that you mentioned, can you go through them again, didn’t quite get them?

David Black

Sure I’ll be glad Chris, so at the end of first quarter – these are all relative to bank level risk based capital which is how we get measured how the regulator measure but we were at 96% on acquisition development construction and we were at 323% for total CRE.

Christopher Nolan

And I know in past calls, you mentioned that regulators are okay with you guys having a 400% internal limit. Is that still the case?

David Black

That’s our internal policy yes and that’s still the case and the regulators were consulted prior to changing internal policy to 400.

Christopher Nolan

Okay. So that’s still the case. And then Sheila, I guess going forward, how should we look at capital ratios? I mean, should we expect capital continue to grow for the holding company?

Sheila Ray

Well I think we keep growing but not many I would expect it to continue to grow now we do believe that we have healthy dividend which we plan on maintaining. We evaluate our dividend quarterly and we are also looking obviously as Joe mentioned at other potential acquisitions so we are still interested in further leveraging our capital growing more to provide the return, but certainly don’t see a contraction capital.

Christopher Nolan

Okay. So assuming no acquisitions, capital continue to grow, will that be fair?

Sheila Ray

Yes Chris, let’s be honest back or forth.

Christopher Nolan

And then based on the comments you made earlier in terms of our second quarter operating expenses, it looks like that you might reach your target, at least what you have on page 6 of the deck, by second quarter, is that fair in terms of the efficiency ratios, is that fair?

Sheila Ray

I would think that’s a little aggressive – but I am hopeful for the end of the year maybe but not second quarter.

Christopher Nolan

And I guess just generally, given news talking about potentially changing bank regulations and so forth, how have the regulators sort of — how has their body language change in terms of companies or banks reserving or using — building up reserves as a way to help capital? I mean any sort of change in terms of how the regulators are approaching small banks like State Bank?

Thomas Wiley

We did not notice any change in either dialogue or body language or anything regarding anything we do it’s the regulatory relationships have been pretty darn consistent for pretty long period of time with us.

Christopher Nolan

Okay, great. Thank you for the color, okay thanks for taking my questions.

Operator

Thank you. Our next question comes from the line of Steve Comery of Gabelli & Co. Please proceed with your question.

Steve Comery

Hi everyone. Thanks for taking my question. I just wanted to ask maybe for a little more color on the OREO balance. I mean that came down pretty substantially. Were there a small number of credits there or was that sort of a general improvement across the board?

David Black

Yes Steve, this is David we had two assets that were of material size that came through one of the acquisitions that we were able to execute this along in the quarters so majority of that delta there. There were ample of other properties that were also that we announced a 3.8 number but it was primarily two large assets.

Steve Comery

Okay. Thank you for that. And then just finally, I was wondering if you guys give kind of an update on the overall organic loan pipeline. I know you guys talked about the pipeline in SBA being strong, but just the overall organic pipeline.

Thomas Wiley

I don’t know you’ve heard of seasonal multiple times its called – but reality as it is a pipeline in Middle Georgia, East Georgia, Gainesville, Athens, and Savannah are what I would say is results and two three quarters and all of this is happening. We do a number of our strand of actions and they also occur just based on I see in the pipeline I’m really optimistic that it will continue a relatively strong organic growth trajectory.

Steve Comery

Okay. Thank you very much and again congratulations, Tom.

Operator

Thank you. And that was our last question. Please continue with your presentation or closing remarks.

Joseph Evans

Right Selena, thank you for coordinating this and thank you all for being on the call with us. And I would just like to add my congratulations to Tom Wiley.

Thomas Wiley

Thank you.

Joseph Evans

Hell of a banker and hell of friend. Thank you and we look forward to continuing the dialogue. Good bye.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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