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Atlantic Capital Bancshares, Inc (NASDAQ:ACBI)
Q3 2018 Earnings Conference Call
Oct. 26, 2018 9:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the third-quarter 2018 earnings conference call. [Operator instructions] Thank you.

Gray Fleming, chief risk officer, you may begin your conference.

Gray Fleming -- Chief Risk Officer

Thank you, Heidi, and thank you all for joining us for our third-quarter earnings call. With me today to discuss our results are Doug Williams, chief executive officer, and Patrick Oakes, chief financial officer. As a reminder, the Atlantic Capital earnings release is available in the Investor Relations section of our website. I wish to caution you that we'll be making forward-looking statements during this call and that actual results may differ materially.

We encourage you to review the disclaimer in the earnings release dealing with forward-looking information. This disclaimer applies equally to statements made in this call. In addition, some discussions may include references to non-GAAP financial measures. Information about those measures, including reconciliation to GAAP measures, may be found in our SEC filings and in our earnings release.

And with that, I'll turn the call over to the CEO of Atlantic Capital, Doug Williams.

Doug Williams -- Chief Executive Officer

Thank you, Gray, and good morning. After the close of the market yesterday, Atlantic Capital reported net income of $6.5 million, or $0.25 per diluted share, for the third quarter of 2018, compared to net operating income of $6.9 million, or $0.26 per diluted share, in the second quarter. We had record loan and deposit growth in the third quarter. You'll recall that based on solid loan pipelines, we expected meaningful loan growth in the second half of the year, as anticipated loan sell-through investments were $104 million, or 22% annualized in the third quarter and 7% year over year.

Growth was balanced across our business units. Our corporate and business banking teams grew commercial and industrial and owner-occupied real estate loans 25% annualized and 14% year over year. Average deposits increased $118 million in the third quarter, or 22% annualized for the quarter and 6% year over year. Average transaction account balances, that is demand deposits and NOW accounts, are 48% of total deposits and were up 36% annualized in the quarter and 18% year over year, as corporate treasury management and depository client relationship growth continued to build.

Asset quality metrics remain strong during the quarter. Net nonperforming assets to assets declined 1 basis to 13 basis points, and there were no net charge-offs. Generally, credit quality improved with positive migration and a reduction in credit size and classified loan levels. Now Pat Oakes will review the financials with you, then I'll return to comment on the outlook and the focus of our fourth-quarter strategy and capital planning process proprieties. Pat?

Pat Oakes -- Chief Financial Officer

Thanks, Doug. Good morning, everyone. Our operating ROA for the third quarter was 92 basis points, compared to 1.02% in the second quarter. This decrease was mainly the result of a decline in our net interest margin, which I'll discuss in a minute, along with a higher provision expense from the third-quarter strong loan growth.

We anticipate the ROA to improve the fourth quarter from for the margin expansion, along with the full benefit from the recent loan growth. Our net interest margin declined 7 basis points 3.47% to the third quarter. The decline was primarily the result of three items: a change in asset mix toward liquid assets from the strong growth in deposits during the quarter, the increase in our cost of interest-bearing liabilities, and the impact of limited increases in one-month LIBOR in the third quarter on loan yields. With approximately 50% of our loan portfolio tied to one-month LIBOR, any changes to this index have a significant impact on our loan yield and NIM.

Earlier this year, we saw one-month LIBOR increase at a faster pace than increase in Fed funds rate, providing a nice benefit to our loan yield. During the third quarter, the spread between LIBOR and Fed funds returned to more normal levels, resulting only a 2-basis-point increase in loan yields in the third quarter. Now that we've seen a normalization in the spread between LIBOR and Fed funds, along with September's increase in the Fed Funds rate, we expect to see higher loan yields and NIM in the fourth quarter. We're still pleased with the NIM expansion over the last few years.

We have seen it increase from a 3.11% in the fourth quarter of 2016 to the 3.47% this quarter. Our deposit beta for this industry cycle has been at approximately 43%, compared to 60% for our loan portfolio. Our overall cost to deposits increased by 8 basis points to 77 basis points in the third quarter, which is less than an increase of 12 basis points in the second quarter, as a result of nice increases in non-interest-bearing deposits. The cost of interest-bearing deposits increased 15 basis points, slightly above our expectations and less than the 16-basis-point increase in the second quarter.

The provision for loan loss was $845,000 in the third quarter, compared to negative $173,000 in the second quarter. This increase was attributable to the strong loan growth in the quarter, offset by improved credit quality. Noninterest income for the third quarter totaled $3.1 million, compared to $5.3 million last quarter, which included a gain of $1.7 million on the sale of Southeastern Trust Company and the remaining $507,000 in trust income. SBA income in the second quarter totaled $882,000, a decrease of $115,000 from the second quarter, mainly due to lower SBA premiums and the bank's decision to retain the government-guaranteed portion of some loans.

Year to date, SBA production as of September 30 was $73 million, an increase of 34% compared to year-to-date 2017. Noninterest expense totaled $16.6 million in the third quarter, which is a decrease of $766,000 from the second quarter. This included a decrease of personnel expense of $769,000, primarily from the remaining savings associated with the sale of the trust company, lower equity incentive expense, and lower payroll taxes. Turning to deposits in the third quarter increased $313 million, and quarterly average deposits increased $118 million compared to the second quarter.

We benefited in the quarter from solid growth in our core businesses, including some large short-term deposits from most clients that we anticipate to leave the bank over the next few quarters. Our focus on growing treasury management clients generates significant levels of transactions accounts, which also carry a greater level of volatility than our peers. The third quarter was a good example, with average non-interest-bearing deposits increasing $65 million and accounting for 31% of average deposits, an increase from 29.6% of average deposits in the second quarter. Now I'll turn it back over to Doug.

Doug Williams -- Chief Executive Officer

Thanks. Thank you, Pat. With record loan and deposit growth in the third quarter and a strong economic outlook over the next several quarters, Atlanta Capital is well-positioned to build up a average revenue growth, further improvement in profitability and superior through-the-cycle credit quality. Based on a three-year track record of solid double-digit-percentage compound average growth rates and loans and deposits in our commercial banking and corporate specialty finance businesses, a continued healthy economic outlook in all of our markets and merger-induced market turmoil in Atlanta, we anticipate an exceptional opportunity to sustain and build strong revenue growth in these high-performance businesses next quarter and over the next couple of years.

While higher levels of balance sheet liquidity increased deposit cost and later increases in one-month LIBOR during the third quarter interrupted our trend of net interest margin expansion, we expect the positive trend to resume with future rate increases beginning in the fourth quarter. Net interest margin expansion, disciplined expense management, and a shift in business mix to our growing and more profitable businesses should result in improved levels of profitability going forward. Through the global financial crisis of 2008 and '09, the ensuing recession, subsequent recovery and current expansion, Atlantic Capital's maintained credit quality among the best in banking. Strong credit underwriting and management are a core competency in our company and provide confidence that we've sustained superior through this cycle credit quality.

Accordingly, our priorities as we look to 2019 and beyond our, one, to invest to build on our solid record of growth in our commercial banking and corporate specialty businesses; No. 2, to improve profitability and efficiency metrics to those approaching business model levels or better; and three, to maintain a fortress balance sheet with superior credit quality reliable core client deposit funding and capital levels calibrated for expected growth through-the-cycle risk and shareholder return objectives. As we complete our planning work this quarter, we'll have more specific objectives and initiatives to share with you. Now we'll be pleased to attempt to answer your questions.

Questions and Answers:

Operator

[Operator instructions] Your first question comes the line of Brady Gailey from KBW. Please go ahead.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

Hey, good morning, guys.

Doug Williams -- Chief Executive Officer

Good morning, Brady.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

So Atlantic Capital clearly has excess capital here. And if you look at the stock, it's trading around 1.3 times tangible. I thought we might see a buyback announcement from you all this quarter, but we didn't get that. So just maybe an update on how you're thinking about potentially buying the stock back here?

Doug Williams -- Chief Executive Officer

Yeah. We do have healthy capital ratios today, and we expect improvements in profitability. So we anticipate generating excess capital levels over the next several quarters. Our capital plan for 2019 and beyond will balance expected growth through-the-cycle risk and shareholder return objectives.

We're calibrating those parameters now and communicate them and our capital management plan later this quarter or early next quarter.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

OK. So it sounds like it's something you'll all consider at some point later on in this quarter?

Pat Oakes -- Chief Financial Officer

Certainly.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

OK. All right. And then, Doug, maybe just an update on Tennessee. I know you had issues there.

Has it not been that profitable and had been growing very much. But maybe just an update on kind of how you're thinking about the Tennessee franchise right now?

Doug Williams -- Chief Executive Officer

Yeah. We think Dalton, Chattanooga and the whole Knoxville region are attractive markets. Our people there are working hard and making progress. We have good loan and deposit pipelines and they continue to strengthen.

We're making slow progress there.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

All right. And then, Pat, you guided under $17 million of expenses this quarter, which you did plus some. Your efficiency ratio is now down to the 65% mark, which, I, think is the hurdle you all throwing out there as far as under that 65% market. Maybe just an update on, if you think expenses will continue to decline here and if continue to see improvement in that efficiency ratio?

Pat Oakes -- Chief Financial Officer

Well, you're not going to see a probably expense decline from here. We're starting to do some of the hiring we talked about before with bankers here and some of our specialty businesses Atlanta. So that's going to help expenses kind of tick up from here. But I hope you're going to see that offset by hopefully a lot faster revenue growth in the expense growth.

So now you're right. We hit that 65% efficiency ratio, we want to drive return from there definitely.

Doug Williams -- Chief Executive Officer

And just as I talked about capital planning in terms of performance objectives, we'll be recalibrating those, and we do expect improved profitability and efficiency metrics going forward.

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

All right. Got it. Thanks, guys.

Operator

Your next question comes the line of Stephen Scouten from Sandler O'Neill. Please go ahead.

Stephen Scouten -- Sandler O'Neill and Partners -- Analyst

Hey, guys, good morning.

Doug Williams -- Chief Executive Officer

Good morning, Stephen.

Stephen Scouten -- Sandler O'Neill and Partners -- Analyst

Hey, I wanted to think about on your comments about the credit quality portfolio. Obviously, I don't personally think we're really anywhere near credit cycle, but there seems to be a lot of fear out there today. Do you -- are there any -- is there anything specific about the way you guys do underwriting or about your loan portfolio that makes you have that confidence? And how you performed through the cycle? I mean, obviously, everybody's metrics looks to today, but everybody's deposit metrics look good two years ago. So, like, where is the real differentiation within your book versus maybe someone else?

Doug Williams -- Chief Executive Officer

I'll let Gray Fleming, our chief risk officer, take that one. Gray?

Gray Fleming -- Chief Risk Officer

Stephen, I think that is a good question. Because like you say, a lot of metrics look good. And we feel we have very good underwriting on the front in all of our business lines, and everybody does say that. I would say one of our real differentiators is our portfolio management approach.

We pride ourselves in identifying potential problems early and identifying credits that we think are better fit, for example, in an ABL shop. And a lot of our reduction in the last couple of quarters in our criticized loan balances have been via refinance. And so it hasn't been by way of charge-off or moved to OREO, but by refinance in full by another lender. And that's really, throughout our history, have been our primary method for working through problem credits.

And I think identifying those problems early and being able to work through that is really how we think we can continue to manage our credit book very well and in a timely manner.

Stephen Scouten -- Sandler O'Neill and Partners -- Analyst

OK. Very helpful. And then, Doug, you mentioned profitability goals in line with peers and like business models. In your mind, what is something that would be a more acceptable level of profitability? Or how are you guys thinking about what those targets would be for the franchise?

Doug Williams -- Chief Executive Officer

Yeah. Our objective was to get in the neighborhood of a 1% return on assets. And with the tax rate reduction, that sort of number becomes the 115-, 120-range number. And I would anticipate we move in that direction.

We understand the math what's required to get there, and we're making plans accordingly.

Stephen Scouten -- Sandler O'Neill and Partners -- Analyst

OK. OK. Fair enough. And then maybe lastly just on the funding side.

Can you give any color in terms of what do you think the dollar amount that will flow out in that late 4Q, early 1Q? And then as you look to fill or continue to fund the balance sheet, I presume that will come from CDs over time. And can you talk about what sort of CD rates you're having to offer today on new money?

Pat Oakes -- Chief Financial Officer

So based on our deposit base, there is a lot of volatility with our deposits. So it's hard to predict what the deposits are going to do. So what I would tell you is, kind of how we're thinking about the fourth quarter is, we've already seen significant amount of runoff and deposits from that quarter-end balance. But as we get closer to year-end, we expect that to pick back up.

Our best guess at this point is if you look at average deposits third quarter versus fourth quarter, I think, they'll be relatively flat at this point. And then as we head into first quarter, we'll see another runoff and we'll replace that. And then your second question. I mean, our focus here is to grow operating accounts.

That involves transaction account, DDA and NOW, right? And that's our core business. We have to offset that with growing money market in CDs. is not a major part of our business. It's a pretty small percentage of our deposits.

So it's pretty competitive out there now for the CD market. So we've offered some promotions there, but we haven't as aggressive as some other banks.

Doug Williams -- Chief Executive Officer

We don't think CDs are going to become a prominent part of our funding profile.

Stephen Scouten -- Sandler O'Neill and Partners -- Analyst

OK But I guess, it looks like they went from 1.04% to 1.41% on cost. I mean, is it fair to assume those are -- out there 1.85%, 2% something like that?

Doug Williams -- Chief Executive Officer

Yeah, yeah.

Pat Oakes -- Chief Financial Officer

Low 2s probably a good estimate.

Stephen Scouten -- Sandler O'Neill and Partners -- Analyst

OK. Perfect. Thanks, guys. I appreciate the answers.

Doug Williams -- Chief Executive Officer

Certainly.

Operator

Your next question comes from the line of Jennifer Demba from SunTrust. Please go ahead.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thank you. Good morning. You mentioned your loan growth this quarter was pretty broad-based. Just wondered if you could give us more color, and how many SBA loans you ended up [Inaudible] held in the balance sheet? And kind of what's the low growth outlook over the next few quarters for you?

Doug Williams -- Chief Executive Officer

Pat -- I've Pat take the last part of that question in terms of outlook and you can provide the detailed on the dispersion of loan growth across the company. I think we'll have solid loan growth in the fourth quarter. And based on the pipelines that we have now and even the first part of the year looks pretty good too at this point. A month into the quarter, we've had very solid loan growth and sort of the pace that we saw in the third quarter has continued.

We still do have some prospect of some significant repayments in the quarter, but also very nice funding profile. So our calendar -- so I think, will have followed loan growth in the end and 2018 in the high single digits range in terms of annual loan growth. In terms of next year, we would expect that a little bit better. So we think with the opportunities a very good we think we're really hating stride particularly in the Atlanta market and in our specialty businesses and we have a track record now of solid mid-teens percentage loan growth in those businesses are over three years, and we see that sustainable over the next several quarters.

Pat, you want to talk about the quarter, in particular?

Pat Oakes -- Chief Financial Officer

Yes. So it was pretty spread between most of us commercial businesses and specialty businesses, U.S. specifically about SBA. SBA portfolio grew about $15 million, that's probably higher than the $8 million to $10 million-ish when we don't hold any.

So we didn't hold the significant amount, as you can see, but that did help boost that number little bit was a significant number of loan growth.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thanks so much.

Operator

Your next question comes from the line of Nancy Bush from NAV Research. Please go ahead.

Nancy Bush -- NAV Research -- Analyst

Would you just talk about this issue of significant repayments in the fourth quarter? Are these -- as you looking at right now are these desired repayments, not desired repayments and what was -- sorry, if I missed it -- what was the repayment activity the third quarter, because this seems to be a problem industrywide that everybody expected to go away at some point and it hasn't gone away?

Doug Williams -- Chief Executive Officer

Yes. I think, what's underlying all this, Nancy, is a lot of liquidity out there and higher-grade credit. Our commercial real estate business has a lot of refinancing churn these -- there's a deep capital -- permanent capital market, deep pool of permanent capital available and we see assets being sold we see assets being refinanced by permanent lenders. The large corporate business is a lot of Capital Markets liquidity and the refinancing there.

And our customers tend to have a lot of liquidity. So there is -- we've averaged around $100 million of repayments per quarter. Ultimately, all of that is desirable. We make loans to be repaid some of it is unanticipated, some of it is scheduled.

It was a little bit lighter in the third quarter than it has been in the prior quarters. I think fourth quarter's probably going to be sort of around the average, but we've had very, very strong production in the last couple of quarters behind that.

Nancy Bush -- NAV Research -- Analyst

OK. Can you just give us your impressions? I mean, we've gotten into really extreme market volatility here and everybody is talking about a slowdown in 2020 and all that stuff. But as we know, Atlanta marches to its own drummer, so...

Doug Williams -- Chief Executive Officer

Right.

Nancy Bush -- NAV Research -- Analyst

So what are you -- are you hearing anything different from your clients in light of what's Capital Markets than you were hearing, let's say, two months ago?

Doug Williams -- Chief Executive Officer

No, we are not. And in fact, there's quite a disparity between what we've seen in the Capital Markets Day, equity markets, in particular, and what we heard from our clients. I think we've got several quarters of expansion certainly in the local economic -- local economies we are involved in ahead of us and we are quite optimistic. There's been this concept of this feeling of banks are reporting peak earnings I don't think that's the -- that's true in our case.

I think peak earnings are in front of us. And we see strong revenue growth opportunities. We see the opportunities to improve our profitability and we think our credit quality will continue to be quite strong. So we have a very optimistic view of our business over the next several quarters, compared to what the market generally seem to be anticipating.

Nancy Bush -- NAV Research -- Analyst

OK. Thank you.

Operator

[Operator instructions] And your next question comes from the line of Steven Comery from G. Research. Please go ahead.

Steven Comery -- G. Research -- Analyst

Hey, guys, good morning.

Doug Williams -- Chief Executive Officer

Good morning, Steve.

Steven Comery -- G. Research -- Analyst

Most of my questions have been asked and answered. I just wanted to ask about the multi-family portfolio. You guys grew that this quarter first time in a little while we've seen any material growth there. Has anything kind of changed in that portfolio or are there lower paydowns in the quarter?

Gray Fleming -- Chief Risk Officer

Steve, this is Gary, nothing has really changed. I think that's largely a function of pay downs in the prior quarters and the timing of refinance. We had some good growth but nothing has changed fundamentally in terms of the pay down or the origination side. It's -- it's still a market that we're watching closely particularly in certain markets, and so we're being selective and focusing on top-quality developers and largely, niche products, but not a change to that strategy.

Doug Williams -- Chief Executive Officer

Steve, what I think you'll see not necessarily quarter to quarter but year to year. As you'll see low- to mid-single digit growth in the commercial real estate business generally at Atlanta Capital. That would include the multi-family property type. You may see a quarter here or quarter there where we are either down or up more than that, but generally, I think on a year on year you'll see low- to mid-single digit growth.

That's what we -- that's what we planned for in that business and certainly at this point in the cycle that's what we would like to see.

Steven Comery -- G. Research -- Analyst

OK. Very, very good. That's helpful. And then, on the margin, as you guys mentioned, you guys had some headwinds in the margin that you expect them to expand in the fourth quarter.

I just kind of wondered if you could give any feel for the magnitude of that? Like, should we expect Q4 NIM to be above Q2, or should it go back toward that level? Just kind of, wanted to get your feel there.

Pat Oakes -- Chief Financial Officer

Yeah. I don't think -- I don't know if we can get back to that level, but I'm hoping that we can make significant ground back to the second-quarter level. So we'll have to see how that shakes out.

Steven Comery -- G. Research -- Analyst

OK. And that's -- and in the fourth-quarter rate hike wouldn't affect that at all, right? Because we've come too late. Is that right?

Pat Oakes -- Chief Financial Officer

Yeah. It did. [Inaudible] from LIBOR, but it wouldn't be significant.

Doug Williams -- Chief Executive Officer

Yeah. Half of our loan portfolios indexed to one-month LIBOR. Those rates are generally reset on the first and the 15th of the month.

Pat Oakes -- Chief Financial Officer

Right.

Doug Williams -- Chief Executive Officer

So rate increase after that is likely to have minimal effect, although we will see the benefit of that in the first quarter.

Steven Comery -- G. Research -- Analyst

OK. And then just finally, on the -- on the funding side, I mean, you guys had a really good growth in non-interest deposits, you mentioned that some of that could be seasonal and go away. I mean, how is kind of the growth in the C&I business affecting your non-interest deposit gathering capabilities? Just kind of want some general commentary there.

Doug Williams -- Chief Executive Officer

Yeah. It's very good. And we have high level of demand deposit funding associated with our C&I loan growth. Our penetration of C&I borrowers with treasury management depository services is in excess of 90%.

We have very competitive corporate treasury management capabilities and we have a number of commercial clients who are not borrowers. So we think -- and that -- you sort of work through all the volatility that we talk about, which is customer deposits, by the way, these are not wholesale purchase deposits or anything. That operating business continues to grow at a nice pace. And we think that we'll continue.

We think we have competitive advantages. We think we are very rigorous in our business development activities and we think will continue to win new business and those exist in the existing relationships continue to expand.

Steven Comery -- G. Research -- Analyst

All right. Very good. Thanks, guys.

Operator

And there are no further questions in the queue. I back over to the presenters.

Doug Williams -- Chief Executive Officer

All right. We thank you, everyone, for dialing in this morning. We appreciate the questions. If there are any more questions feel free to call us today or next week.

Thank you very much.

Operator

[Operator signoff]

Duration: 28 minutes

Call Participants:

Gray Fleming -- Chief Risk Officer

Doug Williams -- Chief Executive Officer

Pat Oakes -- Chief Financial Officer

Brady Gailey -- Keefe, Bruyette & Woods -- Analyst

Stephen Scouten -- Sandler O'Neill and Partners -- Analyst

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Nancy Bush -- NAV Research -- Analyst

Steven Comery -- G. Research -- Analyst

More ACBI analysis

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