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Howard Bancorp (HBMD)
Q2Â 2019 Earnings Call
Jul. 25, 2019, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answer
- Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to the Howard Bancorp Inc. Second Quarter 2019 Financial Results Conference. My name is Chantell, and I'll be your operator for today. [Operator Instructions]
I will now turn it over to George Coffman, Executive Vice President and Chief Financial Officer at Howard Bancorp, Inc. Mr. Coffman, please go ahead.
George C. Coffman -- Chief Financial Officer, Executive Vice President
Thank you, and good morning, everyone. I'd like to begin by thanking everybody for joining the call this morning. As she stated, my name is George Coffman, I'm the Chief Financial Officer for Howard Bancorp. Before we begin the presentation, I'd like to remind everyone that some of the comments made during the call may be considered forward-looking statements. Our Form 10-K for 2018 as well as our quarterly reports on Forms 10-Q and our current reports on Form 8-K, all identify certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning.
The company does not undertake the process to update any forward-looking statements as a result of new information or future events or recent developments. Our periodic reports are available from the company, either online on the company's website or via the SEC's website. Again, I'd like to remind everyone that while we think our prospects for continued growth and increased performance are good, it is our policy not to establish with the markets any earnings, margin or balance sheet guidance.
With that said, I'd now like to introduce Mary Ann Scully, the CEO and Chairman of Howard Bancorp.
Mary Ann Scully -- Chairman of the Board, President, Chief Executive Officer
Thank you, George. And I'll add my thanks to George's for those of you that are on the line. I'll like to also note that George and I are joined today by Rob Kunisch, our President; Randy Jones, our Chief Credit Officer. So when we open the question-and-answer session, we should be able to address any questions that you have if you drill down in to these numbers.
I'm actually going to begin with a brief reiteration of the presentation that was sent yesterday, both to provide additional time for those that may not have had an opportunity to study it but also to begin to add some commentary that may enlighten some of this.
So we began with our forward momentum, which is our view of the strategic accomplishments that these numbers reflect. Most importantly, we think that the second quarter does show significant tangible progress toward the higher growth and the higher return franchise that we have discussed repeatedly. Commercial loan growth resumed with $50 million in the second quarter of 2019, a little over 3% within the quarter. Our expense focus continues its reaping rewards and improving profitability, and as we'll discuss a little bit later, we've announced further movements to further increase the efficiency.
We're pleased to see that our asset quality continues to migrate toward more normalized set of ratios, host the turnaround numbers that we experienced in the rolling months after the First Mariner merger. We have a very strong capital position that, as everyone would remember, allowed us to announce earlier in the quarter the option of a share buyback program. And believe that we are uniquely positioned to take advantage of the waves of consolidation disruption in our market in particular with mergers and acquisitions being announced very frequently that impact our market and our customers.
The financial highlights on the fifth page of the presentation indicate that our net income was $2.1 million. Those reported earnings represented earnings per share of $0.11, which was down from the $0.22 per share in the first quarter. However, if we exclude the infrequent expenses, mostly associated with the branch optimization, second quarter core net income was $4.7 million, representing growth in the core EPS numbers to $0.25, in line with consensus estimates.
Our total noninterest expenses were also up given those infrequent expenses that are on an ongoing core basis or $15.2 million. Of the $4.3 million in infrequent expenses, the majority of that $3.6 million was related to the branch optimization changes. It was actually discussed for the last two quarters on these earnings release call.
These most recent changes, impacting five branches, are expected to lead to $2 million in annual operating savings in 2020. And most significantly provides us not only with the branch network that we believe reflects more of a behavioral preferences of our customers but that will have an average $100 million in deposits per office. So stronger than the majority of our peers.
Total loan growth during the quarter was $53.8 million with $50 million in the most important commercial loan category. Total loan originations remain strong and totaled $119 million and so while as the press release noted, we do continue to see payoff activity, especially in the very competitive commercial real estate sector. The loan origination volumes have been large enough and sustainable enough to now show significant net growth in the quarter.
The net interest margin for the second quarter was relatively stable but did reflect an increased cost of funding, largely related to a drop in transaction deposits, which in turn was largely related to the movement of some balances from one customer's account into investments in fixed assets in their own business. So not a movement to another company and not in any way a mitigation of the customer relationship, but something that did impact our cost of funds.
Excluding fair market value adjustments, which always are relatively modest even after our acquisition history, core NIM was 3.44% versus that 3.53%. And on the capital side, our book value per share increased to $15.92 at the end the quarter, tangible book value increased to $11.94 per share and we will -- it's become our practice, so the impact of some of those intangibles on our return numbers going forward.
The fifth page of the presentation, there's a little bit of a drill down on the infrequent expenses that we've referenced in both of these last two slides. As noted, most of the $4.3 million was related to the branch optimization. In turn, the branch optimization was mostly lease termination payments, some lease hold improvement write offs. These were related to the three closed branches and two branches that will be consolidated into one.
Again, these branch optimization infrequent costs, which were signaled for the last two quarters, are expected to create approximately $2 million in annual pre-tax operating savings. So less than a two-year earn-back on that. And these numbers have led to the consistently improving profitability ratios that we show on Page 7.
We note the reported numbers, we note the core numbers, and we note those numbers against the first quarter reported in this chart. And especially ask everybody to again focus on the return on assets versus the return on tangible assets, again, reflecting our history as an acquirer. And then given the significant CDI expense incurred in the last merge, I ask everybody to focus on the average assets net of those CDI expenses to allow purely for more comparability with some peers.
The loan growth story, as I indicated earlier and as we've said in the press release, is one of the most positive outcome showing in this particular quarter. And most loan growth trends are put into context on Page 8, where we show not only the loan growth of $53.8 million or the 3.3%, as noted earlier, but the fact that majority of this growth was driven by the commercial loan growth, which is the element of our asset mix that differentiate us from others. It shows that the commercial loan originations were particularly strong, even in an environment where commercial real estate, in particular, is impacted by more volatile payoff activity, and that the organic loan growth is not driven by broker relationships or participated relationships that is, as it's always been, primarily focused on building long-term profitable client relationships with funding opportunities from those clients as well.
And I note from a longer-term perspective that long-term organic CAGR for Howard is over 21%. All of this allows us to capitalize on our strong capital ratios in terms of the opportunity that this capital provides us for future growth. And as noted on Page 9, again, a reference to the fact that these capital ratios, even with anticipated future growth, have allowed us to be comfortable in announcing that we now do have the ability to undertake share buybacks, should we believe that our price in the market does not reflect our value.
The margin, as we referenced, was also relatively stable. It was down 11 basis points from the first quarter and the primary driver was the funding cost due to the large outflow of transaction deposits from one large deposit relationship. That deposit relationship remains with the bank and that withdrawal of funds was invested in the company's core business, not in other liquid assets.
We took the opportunity seeing this margin compression during the second quarter to prepay some longer duration FHLB borrowings and that's also referenced in some of the infrequent-costs slide earlier. But we believe this will allow us to do, so an action already taken, is to boost the net interest margin 3 basis points for future quarters. So an action that's already been taken that will mitigate some of that net interest margin pressure.
Again, the gap between reported NIM and core NIM is always sensitive issue within a serial acquirer, continues to be very stable and relatively small. I will also note that the net interest income in absolute terms for the first six-months of 2019 was 16% over the net interest income for the first six-months of 2018.
The growth in the portfolio, as we note on Page 11, also does not come at the expense of quality. We continue to see, as we noted in the first slide, nonperforming assets decline, charge-off decline and reserves increased both as a percentage of loans and as a percentage of nonperforming loans. Our reserves are always impacted by the merger accounting that we've undertaking as the serial acquirer. And so the relative movement in those numbers from one quarter to the next is very important to note.
So I'll summarize again, the loan origination engine is regaining momentum. Two banks that came together in 2018, both with very strong commercial loan origination histories that were initially impacted not only by their short-term nature of some transitions in the merger but more significantly from some changes in the commercial real estate environment. Coming together, we've been able to offset that. But we have the $50.5 million in commercial loan net growth in the quarter.
We're still anticipating mid-to-high single-digit loan growth. So the pipeline remains very strong. But we are not indicating that we will expect to see double-digit loan growth for the remainder or the average of the year. But we do expect to perform on that mid-to-high single-digit loan growth. We're also very pleased with what the strategic optimization of the franchise, the delivering network in particular, has allowed us to do from not only in efficiency standpoint but from a relevancy and an impact standpoint.
So the closure of three additional branch locations, the consolidation of two other locations, has allowed us on a going-forward basis to have annual pre-tax operating savings of $2 million, $0.10 per share in 2020. And we are pleased to note that this gives us a 15-branch network that has an average deposit base of over $100 million per branch. And finally, I'll go back to the references on the first slide, that this differentiating positioning that the largest locally owned bank and the one that is exclusively focused on the small and middle market enterprise network in greater Baltimore, will position us especially well for the numerous consolidations and mergers that occur in our marketplace. And we're very excited about the opportunities that, that's going to provide our employees, our [Indecipherable] but also our shareholders.
So with that, I'll conclude the review of the financial presentation. And I will open it up for any questions.
Questions and Answers:
Operator
Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Your first question comes from Catherine Mealor, KBW. Go ahead, please.
Catherine Mealor -- , Keefe, Bruyette, & Woods, Inc. -- Analyst
Good morning. We're going to first start with the margin. And Mary Ann, I appreciate your commentary on how the prepayment of FHLB will add 3 bps to the margin. But then outside of that, how are you thinking about your margin outlook if the Fed cut later this month and then perhaps again later in the year? Thanks.
George C. Coffman -- Chief Financial Officer, Executive Vice President
Catherine, this is, George. I'll take that.
Catherine Mealor -- , Keefe, Bruyette, & Woods, Inc. -- Analyst
Thanks, George.
George C. Coffman -- Chief Financial Officer, Executive Vice President
As we've noted in the release, there are actually a couple of things we did in the second quarter. Obviously, on the negative side, we had that outflow of transaction deposits, which Mary Ann talked about, and we had to replace those with higher cost CDs and FHLB advances. That was the biggest driver of the margin compression and that happened earlier in the quarter. Knowing that, that had happened, toward the end of the quarter what we did is, we had about $85 million of FHLB advances, long-term advances that were relatively higher rate [Phonetic].
We repaid those, dropped the cost of funds by about 445 basis points, by doing so. And then we were able to cover that prepayment penalty of $650,000 by selling off about $35 million of securities, generating a gain taking advantage of the market position on that. So the net pre-tax impact of the sale of the securities versus FHLB turned out to be about $5,000 net impact. But we also then used that reduction in securities, and you'll notice a similar offset or increase in the loans. So we -- not only did we reduce the cost of the FHLB but we deployed those funds in the higher-yielding loans versus securities. So, both of those things, we expect, are probably going to mitigate about half, if not slightly more than half, of the compression that we saw during the quarter. And again, that is excellent actions already taken.
Now to your question about the impact of any rate cuts. We run some modeling, and we anticipate that for every 25 basis point cut in rates or change in prime, I should say, that, that would impact our margin on an annual basis about 3%. So depending on the timing of primary reductions on an annualized basis, that's kind of what we're factoring into our modeling.
Catherine Mealor -- , Keefe, Bruyette, & Woods, Inc. -- Analyst
And as you think about that 3%, how are you -- how quickly do you think you'll be able to lower funding costs if the Fed cuts?
George C. Coffman -- Chief Financial Officer, Executive Vice President
The way we've positioned our borrowings portfolio is to keep it relatively short in anticipation of a move. So -- but the bulk of the borrowings, matter of fact, all of the FHLB advances we have are short term and we're going to reprice within three to six months. It takes a longer time to feel the impact of that on term deposits. So we would take probably more of a lag on that one. And then on the transaction accounts, we don't expect to see much of a difference there.
Catherine Mealor -- , Keefe, Bruyette, & Woods, Inc. -- Analyst
Okay. And then on the asset side, can you give us a little bit of color as to have much of your loan portfolio is variable versus fixed? And then as you're seeing the new production this quarter, what -- on average, where would you say the average yield is of that new production versus where the current portfolio is yielding? Are you seeing that still coming in higher? Or is it still ---- or that's still going to be added pressure?
George C. Coffman -- Chief Financial Officer, Executive Vice President
There's definitely pressure. Mary Ann mentioned $119 million of new originations. The weighted average yield on those originations were about 4.6% versus if you look at the loan yields from the margin tables in the earnings release, we were at 5%. So the new originations are coming in slightly lower than the portfolio yields. The mix of -- on our current portfolio, the mix of fixed to adjustable loans, about 35% of our portfolio loans are adjustable. So we would definitely see the impacts of any rate moves on those. Does that cover your question?
Catherine Mealor -- , Keefe, Bruyette, & Woods, Inc. -- Analyst
It does it's all very, very helpful. Thank you.
Operator
Thank you. Your next question comes from Joe Gladue, Alden Securities. Go ahead, please.
Joseph Gladue -- Alden Securities -- Analyst
Yeah, hi. Good morning.
Mary Ann Scully -- Chairman of the Board, President, Chief Executive Officer
Good morning, Joe.
George C. Coffman -- Chief Financial Officer, Executive Vice President
Hi, Joe.
Joseph Gladue -- Alden Securities -- Analyst
I guess just in terms of the loan growth, I noticed the loan-to-deposit ratio is getting up, brushing up along 100%. Just wondering, are you comfortable going above there? Or could that act as a constraint on loan growth going forward?
Mary Ann Scully -- Chairman of the Board, President, Chief Executive Officer
Joe, we've always assumed, you know as well, have run a high loan-to-deposit ratio. And that's tended to be intentional to put a lot of a focus on the asset side of the balance sheet in the loans and to fund it as efficiently as possible. And we'd seen that historically go at higher to 104%, 105%. So I think we'd comfortable with a modest continuation of that higher loan-to-deposit ratio.
Joseph Gladue -- Alden Securities -- Analyst
Okay. And --
George C. Coffman -- Chief Financial Officer, Executive Vice President
Joe, I would add further reason that why we are comfortable with those levels is the level of off balance sheet or contingent funding that we have, even with the borrowings that we have, we're using less than 50% of our FHLB availability. So we have plenty of sources of funding to bring on to the balance sheet as soon as needed.
Joseph Gladue -- Alden Securities -- Analyst
Okay. And just on the asset side, it looks like there's a little bit of a buildup on the cash side, is that just a temporary blip? Or any need to worry about deployment of that to keep up margins?
George C. Coffman -- Chief Financial Officer, Executive Vice President
It was temporary, and it was really driven by two things, partially the sale of the securities that happened late in the quarter. We mentioned that we sold $35 million of just the cash receipts on that one. And then we did have actually on the last business day, we had a loan paid off that we didn't anticipate, so that brought in more cash than what we had planned to have at the quarter end.
Mary Ann Scully -- Chairman of the Board, President, Chief Executive Officer
Joe, I'll talk a little bit more about that. It was actually one loan, it was $16 million. So you can see that, that would account for a significant percentage of that cash. And we actually had anticipated and in fact had requested that the borrower find another source of funding, it was one of our watch credits. But it had been led to believe that they might have more difficulty and that it would happen in the third quarter. So we were surprised, I'd say, pleasantly surprised, but surprised by that payoff. But it did mean that since it happened late in the day on the last day of the quarter that it just meant we had a cash position larger than what we had projected.
Joseph Gladue -- Alden Securities -- Analyst
Okay. And you talked a little bit about the consolidation in the local banking market, just wondering if you could touch on your attitude toward further M&A? And what the market looks like these days?
Mary Ann Scully -- Chairman of the Board, President, Chief Executive Officer
Sure. Let me touch on it from both perspectives. In terms of the market perspective, just to remind everybody that one of the single greatest strategic advantages that we believe that we have is the fact that we are the largest locally owned bank in a marketplace that's dominated by small and medium-sized businesses. The businesses that tend to be most, at least initially, adversely impacted by consolidation because they're not necessarily very transparent balance sheet, they are very relationship driven. And so the fact that we're large enough to service the needs of about 95% of the businesses in the greater Baltimore area, and if those businesses do tend to appreciate stability and local credit making decisions has always positioned us well. What we see from a competitive standpoint is increasingly a market that is dominated by out-of-state banking institutions. So we've seen, just in the most recent two quarters, the closing of a -- purchase of a Baltimore bank by a Pennsylvania Bank, the closing of Frederick County Bank, which is a contiguous market to our Howard County market, by a Pennsylvania bank. The announcement two days ago, of a local competitor by a West Virginia Bank. And then the anticipated consolidation, new ways of integration, new ways associated with the BB&T and SunTrust merger. So there is an enormous amount of disruption in the marketplace. And we think that will bode very well for us, which is not to say that any of those mergers and consolidations are not beneficial to shareholders, but disruption always provides you with an opportunity, especially with small business customers who are working at integration activities. And one of those will involve a group of local customers that will have to go through those second conversion in less than 12-months. So it's just an opportunity. It also doesn't mean from the position of a serial acquirer that you're looking at other people who maybe considering consolidation. But I would say, as I've said for the last couple of quarters, right now, we are very focused on seizing the residual opportunities in our organic growth portfolio. We're very focused on this integration and this consolidation. We continue to always talk to people, but we don't have any present plans ourselves, but we also don't believe that the market is going to remain quiet. We think it's going to continue to be a market with lots of opportunities both from an organic standpoint, and in the long term, from an acquisition standpoint. Does that answer your question?
Joseph Gladue -- Alden Securities -- Analyst
Yes, it does. Thank you. And that's it for me.
Operator
Thank you. [Operator Instructions] Okay, there are no further questions at this time. I would now like to hand back to your speakers. Go ahead, please.
Mary Ann Scully -- Chairman of the Board, President, Chief Executive Officer
Well, I'd just like to again thank everybody. Thank you for taking the time to read the press release and to read the earnings presentation. Thank you for being on the line. And note that the management team here is always available and accessible for any of you as you go through the numbers have additional questions. But thanks for your participation.
Duration: 28 minutes
Call participants:
George C. Coffman -- Chief Financial Officer, Executive Vice President
Mary Ann Scully -- Chairman of the Board, President, Chief Executive Officer
Catherine Mealor -- , Keefe, Bruyette, & Woods, Inc. -- Analyst
Joseph Gladue -- Alden Securities -- Analyst
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