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Howard Bancorp (HBMD)
Q3Â 2019 Earnings Call
Oct. 24, 2019, 10:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning and welcome to Howard Bancorp Incorporated Third Quarter 2019 Financial Results Conference Call. My name is Omar and I will be your operator for today. Please note this conference call is being recorded. There will be a question-and-answer session after the presentation. [Operator Instructions].
I will now turn it over to George Coffman, Executive Vice President and Chief Financial Officer of Howard Bancorp Incorporated. Mr. Coffman, you may begin.
George C. Coffman -- Executive Vice President and Chief Financial Officer
Thank you. I'd like to begin this morning by thanking everybody for joining the call. As he stated, my name is George Coffman, I'm the Chief Financial Officer for Howard Bancorp.
Before we begin the presentation this morning, I'd like to remind everyone that some of the comments made during this call might be considered forward-looking statements. Our Form 10-K for the fiscal year 2018, our quarterly reports on Forms 10-Q and our current reports on Forms 8-K, all identified certain factors that could cause the company's actual results to differ materially from those projected in forward-looking statements we make this morning. The company does not undertake the process to update any forward-looking statements as a result of new information or future events. Our periodic reports are available either through the company's website or via the SEC's website. I would like to remind everyone that while we think our prospects for continued growth and performance are good, it is our policy not to establish with the markets any earnings, margin or balance sheet guidance.
With that said, now I would like to introduce Mary Ann Scully, the CEO and Chairman of Howard Bancorp.
Mary Ann Scully -- Chairman and Chief Executive Officer
Good morning, everybody. I'll add my thanks and thanks of our entire executive team to everybody who's taken the time to join us on this call. You all have seen in the 8-K filing this morning the presentation that we published, which would complement the earnings release that went out last night. So I will try not to duplicate, but rather to highlight and then leave as much time as possible for questions. We will begin as always with the statement of what we believe the core strengths of the company are and you will hear this recurring theme that we think that the company is exceptionally well positioned at this point in time. We made progress toward higher growth and higher return. We're especially pleased with the net loan growth in the quarter and most especially the growth in our core segment of Commercial Banking, which showed an 11% annualized growth rate.
The funding of those loans is critically important. We've highlighted a number of times our emphasis on transaction deposits and our strategic plans to grow those as a percentage of total funding sources and the transaction deposits in that light, increased by $11 million which funded 38% of our net loan growth. So positive trends there. We did see some pressure on the net interest margin, but as will discuss in more detail later, believe that we are insulated from some of those net interest margin pressures by virtue of both our loan mix and our funding mix and the loan mix, not only in terms of residential versus commercial, but also fixed versus floating.
We continue to focus on efficiency as well as revenue growth and are right now very focused on the final execution of the branch optimization strategy that we've discussed in previous calls, most of which has not yet worked its way through the financials as those branches just closed late in the second quarter. Given the strong capital position of the company, we also have commenced the share buyback program that we announced. So as the slide will show going forward, much of our positioning is based not only on the performance, the revenue growth, the expense management that I've just highlighted, the strong capital levels, but also the unique position and because of our wave of consolidation and concurrent disruption in our market.
The financial highlights that are on page five of the presentation are that we showed net income growth and showed a core EPS after adjusting for the infrequent expense associated with a piece of litigation to $0.27, so up about 9% from the last quarter. Non-interest expenses continue to come down and again adjusting for infrequent expenses was $14.7 million in the third quarter versus $15.2 million in the second quarter. And again, most of the branch optimization efficiencies are not yet showing in this quarter given the third quarter closings of the branches.
Loan originations, as noted remained strong. From an origination standpoint, we've already highlighted the net loan growth. We had $46 million, almost $50 million in commercial loan originations in the quarter and the NIM as I noted was down slightly at 3.46% and that's despite two prime rate decreases and again is a function of both the commercial emphasis and the fixed rate nature of much of our commercial loan portfolio and our book value and tangible book value continue to increase.
What this leads to is improving metrics shown on page six. We've made this presentation more concise than we've shown in the last couple of quarters and what I would draw everyone's attention to while we show the reported is the core numbers over the last four quarters showing a consistent improvement and return on average common equity, return on average assets and the one non-GAAP adjustments that we make which is the return on average assets, net of the CDI expense, which remained significant, almost $750,000 per quarter and that's the reason for that adjustment, which shows in the third quarter after adjusting for that, a 1% adjusted ROA.
The loan growth trends that we show on page seven are over a longer period of time. I think the important thing to note here is not only the annualized loan growth of 6.7%, the commercial annualized growth of 11%, but the strong annualized loan originations, $197 million, which is 16% of the base portfolio. We've seen net loan growth of $80 million year-to-date and the organic growth always is focused on core relationships. The long-term organic CAGR for Howard since 2013 I will note is over 20%.
I've highlighted the strong capital ratios on page eight. And again would simply note here that given the strength of these ratios, we did commence our share buyback program in the third quarter. Much of the focus I know is going to be in the questions on our net interest margin. So the margin was 3.46% for the third quarter, down from 3.53%. The primary driver was the impact of decreases in prime rate. But again there is a certain installation because of the mix of fixed-rate loan assets, almost 70% of the commercial loan portfolio. It does provide us with some protection. Now as some of those loans prepay, it puts a certain amount of pressure on that fixed rate portfolio, but that mix is the reason why we're seeing a smaller compression in the net interest margin along with the focus on transaction deposits.
If you look at asset quality on page 10, this continues to come down. Contextually, I will note again that at the time of the merger with First Mariner, we had a higher than normal NPA as a result of the legacy, pre-recapitalization loan portfolio of First Mariner. That have worked down dramatically and we see that in terms of the NPAs to total assets of 1.04% in the third quarter. I've referenced the loan mix, but I think it's important to highlight that again the strong emphasis on commercial, constituting about 69% or 68% of the total portfolio.
I would also note that from a portfolio perspective, while we do maintain a residential mortgage origination division, that the majority of our mortgage portfolio was related to the serial acquisition activity of the bank, FDIC transactions, whole bank acquisitions and the merger with First Mariner. The funding mix also continues to be very strong. Our overall cost of deposits was 0.96% for the third quarter, one of the lowest in our regions and the funding mix should improve more over-time given the experience level and the well-known nature of our commercial team, the very competitive treasury management product set that we have, the reconfigured branch network that has allowed us to decrease the number of branches in our system, 46% since the date of the merger in 2018, giving us an average branch size of over $100 million, but still allowing us to fully cover our footprint.
Page 13 is a slide that I've used to quantify the repeated references that we've made over the last couple of quarters to end market deposit disruption. And what this shows is that starting in the fall of 2018, we have had a series of acquisitions of local banks acquired by out of state banks and in-market banks or banks that are either owned by out of state banks that are now merging as in the case of SunTrust and BB&T and the in-market consolidation of Revere and Old Line. If you look at the acceleration of that line from May of 2019, I think that all of us familiar with the industry would recognize that this sort of disruption, the attended changes in branch structures and in systems conversions provide us with a huge opportunity. But over and above the opportunity, I would remind everybody, we are the largest locally headquartered bank in the Greater Baltimore area. We're now at number 7 in deposit market share, all six banks above us are out of state banks. And upon the completion of the Old Line and Revere Bank acquisitions, we will actually be the third largest local bank in Maryland behind Sandy Spring and Eagle.
We have a commercially focused loan origination engine that is performing well and shows continued momentum. We're continuing to optimize our franchise both with acknowledged different customer behaviors and also to provide us with a more efficient platform that allows us to leverage the scale we have achieved with the First Mariner merger. And once again a word that I think cannot normally be used in a banking industry context, we're not just well positioned, but we're uniquely positioned as the largest locally headquartered bank.
With that, I'll turn it over to you for questions.
Questions and Answers:
Operator
Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions]. Our first question is from William Wallace at Raymond James. Please proceed with your question.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Thanks. Good morning.
George C. Coffman -- Executive Vice President and Chief Financial Officer
Good morning.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Mary Ann, maybe just we'll start with the expense, the branch rationalization efforts that you completed in the third quarter. Are we going to see a full run rate of all the efforts that you've taken in the fourth quarter or will we not see that until the first quarter?
Mary Ann Scully -- Chairman and Chief Executive Officer
We won't see it until the first quarter, Wally. You will see a significant percentage of it in the fourth quarter. But part of the branch optimization was closing two branches and consolidating them into one new branch in the northern area of our footprint. That new branch is not scheduled to open until the fourth quarter. And as a result, we're going to keep those other two branches open and my colleagues are reminding me it's probably very late in the fourth quarter or early in the first quarter. But given that we will have two of those branches still open for most of the fourth quarter, you won't see the full effect until the first quarter.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Okay. And so if I look at $15 million as a baseline of expense, when I back out the legal accrual and the benefit for the FDIC reimbursement, can you remind us how much of expense should be coming out and so that we can kind of gauge what we'll see in the first quarter as a run rate?
George C. Coffman -- Executive Vice President and Chief Financial Officer
Hey Wally, this is George. When we talked about this before, again, we were closing five locations, three of them, as Mary Ann mentioned closed in September, the other two will close late this year, early next year. All-in, we expected between $1.8 million and $2 million in overall cost savings. We're starting to see -- for the three that have already closed, starting to see those reductions, but we'll see the rest of them starting in January.
Mary Ann Scully -- Chairman and Chief Executive Officer
And the other thing that I would note Wally and I think we noted this in the press release itself is that we've recently renegotiated our core processing contract and in addition to it allowing us to provide some enhancements to some of our cash management products, it also provides us with some significant savings, about $700,000 a year and you will start to see those roll through in the fourth quarter and essentially, you will see the full effect of those on a quarterly basis roll through the fourth quarter.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Okay. Are there other opportunities on the cost side?
Mary Ann Scully -- Chairman and Chief Executive Officer
I think the big opportunity is probably the one that we've referenced before and that's not just a non-interest expense savings, but is an opportunity to just deliver a more focused franchise and that is the fact that we continue to look at the mortgage operation and what we want to do with the mortgage operation. It's an operation that we've determined and publicly stated on a number of occasions, we don't want to see significantly grow. If we reach some sort of final resolution on that, it will obviously affect, if nothing else, the efficiency ratio given the higher efficiency ratio associated with any mortgage operation. We've seen improvement in the profitability levels there, but it continues to be an area of non-focus and for that reason we're still evaluating a variety of alternatives on the mortgage company. But that would affect the non-interest expense level on the overall efficiency ratios.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Okay. And then I would like to maybe just ask about net interest margin. So we obviously had the September cut, which will impact the fourth quarter. Can you give us a sense as to what you anticipate the impacts from the September cut and assuming we get another cut next week, what the margin should look like?
George C. Coffman -- Executive Vice President and Chief Financial Officer
Wally, this is George. I'll answer that as best as I can. When you look at -- and I'm going to start talking about the loan portfolio, Mary Ann mentioned that earlier. If you look at the percentage of our loan portfolio that is subject to changes in rates, either prime or LIBOR, about 28% of our portfolio is subject to changing rates, as I just mentioned. So just taking that what I would say is after prime changes the immediate impact is about a 7 basis point impact on our overall loan yields and therefore our margins, just from a drop in prime. However, if you look at the composition of our funding and I'll just use September numbers, we had $273 million of FHLB advances, the vast majority of those repriced within 90 days and then you look at the CDs that are scheduled to mature within 90 days and where the day one impact of a prime rate is about 7 basis points within 90 days, it's down to only 1 or 2 basis points because of the ability to shift the funding mix around. So overall, the way we're looking at this given the composition of both our loan portfolio and funding mix at the end of September is that within 90 days, we would expect there will be a 1 or 2 basis point impact per 25 basis point change in prime.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Okay. And then with the new loans that you're putting on the balance sheet today, how are they coming in on average versus the portfolio yield?
George C. Coffman -- Executive Vice President and Chief Financial Officer
Unfortunately, lower. The market is competitive. The rate environment in order to achieve the goal is driving some of the new loan yields lower than what we're seeing. For example in the third quarter, the weighted average yield of loans that we originated was 4.45%. That's down from where we were even in the second quarter and the payoffs that we're achieving because most of them have been on the books for a little while, the weighted average rates of what paid-off in that third quarter was around 5%. So we're seeing some churn in the differential between the new [Indecipherable] versus what's being paid down.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
So presumably that adds additional pressure to net interest margin or do you feel like you've got enough room on the deposit costs to fight that?
George C. Coffman -- Executive Vice President and Chief Financial Officer
I don't know that we are going to fully offset it. We're expecting another basis point or two. Just because of the churn in the loan yields, we could offset most of that through lower funding, but unfortunately we have to -- most of it is dependent on the timing of the maturities of our CDs in our FHLB. As I mentioned, FHLB is relatively short, but we have to look at the timing of the maturities on the CD portfolio to fully mitigate the loan reductions.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Okay. So putting it all together, it sounds like we're probably seeing 2 basis points to 3 basis points of pressure every time the Fed cuts?
George C. Coffman -- Executive Vice President and Chief Financial Officer
Yes. I would say 1 basis point to 2 basis points because of a Fed cut and 1 basis point to 2 basis points because of the current market rates on loans.
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Okay. I'll hop out and let somebody else ask questions. Thank you.
Mary Ann Scully -- Chairman and Chief Executive Officer
Thanks, Wally.
Operator
Our next question is from Catherine Mealor, KBW. Please proceed with your question.
Catherine Mealor -- Keefe, Bruyette & Woods, Inc. -- Analyst
Thanks. Good morning.
Mary Ann Scully -- Chairman and Chief Executive Officer
Good morning. Catherine.
Catherine Mealor -- Keefe, Bruyette & Woods, Inc. -- Analyst
I want to ask about loan growth. It feel like we came out of First Mariner acquisition and we're pretty positive for kind of at a double-digit loan growth and then we pulled that back, just given the competition and what I think Mary Ann you called some silly pricing and silly structure in the market, but this quarter had really great growth and it feels like your outlook for growth feels better just given some of the market dislocation. So can you just kind of put that all together and give us an outlook for what you think loan growth should be as we move into next year? Thanks.
Mary Ann Scully -- Chairman and Chief Executive Officer
Catherine, what we're still on committing to ourselves and when we look at the budget for next year is barring any sort of unusual activity that we still think that will average out something in the high-single digits rather than the low-double digits. This was a good quarter and the second quarter was an amazingly good quarter. And the pipeline looks good right now, but it's is a little softer frankly than it was in the last quarter. So I think what we're feeling very comfortable with is that high single-digit and in part because of what I want to call irrational pricing and irrational structure, especially on the commercial real estate side.
Now when we talk about the disruption in the market, again we believe that this disruption in the market in the short-term leads to customer activity and that customer activity factored into those pipeline numbers, factored into those growth projections, but at some point it will begin to translate to personnel opportunities and we are in discussions with a couple of people who could bring teams on board and that would clearly have a very different effect because then when you acquire people, you're acquiring whole portfolios and it's not one customer at a time, but three or four customers at a time, but barring that since we don't have any of that in place right now, I'd say that we are right now budgeting for high single-digits.
Catherine Mealor -- Keefe, Bruyette & Woods, Inc. -- Analyst
Okay, that's helpful. And then on CECL, if I'm right, you are a smaller reporting company. So are you eligible for the CECL delay and do you plan to take that?
George C. Coffman -- Executive Vice President and Chief Financial Officer
We are eligible for the deferral and we are very happy about that.
Catherine Mealor -- Keefe, Bruyette & Woods, Inc. -- Analyst
Okay, that's great. Thank you very much.
Operator
[Operator Instructions]. Our next question is from Joe Gladue, Alden Securities. Please proceed with your question.
Joseph Gladue -- Alden Securities -- Analyst
Hi, good morning.
Mary Ann Scully -- Chairman and Chief Executive Officer
Hi Joe.
Joseph Gladue -- Alden Securities -- Analyst
I just wondered if you could touch on the buyback program sort of what's your criteria for when you'll be active and and when you hold back?
Mary Ann Scully -- Chairman and Chief Executive Officer
So we are presently active in the market. As you can imagine, we don't want to disclose the target price. Although we've recently adjusted the target price to ensure ourselves the ability to do a pick-up there, but we are presently albeit to-date modestly active in the market. So the buyback program is active.
Joseph Gladue -- Alden Securities -- Analyst
Okay, all right. And just a question on the new core system. Can you give us little color on I guess when is that conversion or when was it and was there some expected additional costs associated with that?
Mary Ann Scully -- Chairman and Chief Executive Officer
All right. So it's a renegotiation of a contract with our existing core provider, Joe. So very fortuitously no need at all to go through any sort of conversion with any of our customers. A chart that I focused on earlier which show we might be the only bank in the market not going for a systems conversion, but we will not be going through a systems conversion and we expect it to be savings. If you assume present volumes right now, we expected there to be savings, as we grow the cost increase will be much less than it would have been otherwise. So it's pretty much a win-win-win and that we will not have a systems conversion need. We will have decreased costs rather than increased costs. Again, it has been negotiated. It's been signed. You will start to see that in the fourth quarter and there will be some product enhancements to some of our commercial TM products set, so I am all positive.
Joseph Gladue -- Alden Securities -- Analyst
Okay, all right. That was it from me. Thank you.
Operator
We have reached the end of the question-and-answer session. I will now turn the call back over to Mary Ann Scully for closing remarks.
Mary Ann Scully -- Chairman and Chief Executive Officer
So I'll thank everybody again for being on the call. Thank you everybody for the quality of their questions. Remind everybody that we are always here, George and I in particular to answer any more detailed questions you might have as you look at modelling or you think about valuations. As I think you could probably gather from the tone of the call, we're very optimistic, we don't see necessarily a rapidly growing economy. We also don't see any imminent signs in our marketplace of a recession, but we are very confident about our ability to grow our market share, because of the focus that we have on small and medium-sized businesses who tend to be very well served by banks that can make all the decisions, including policy decisions in their local marketplace.
So thanks everybody for your support. And if you have other questions, please do not hesitate to reach out and we'll walk you through any more details that you might need.
Operator
[Operator Closing Remarks]
Duration: 27 minutes
Call participants:
George C. Coffman -- Executive Vice President and Chief Financial Officer
Mary Ann Scully -- Chairman and Chief Executive Officer
William Wallace -- Raymond James & Associates, Inc. -- Analyst
Catherine Mealor -- Keefe, Bruyette & Woods, Inc. -- Analyst
Joseph Gladue -- Alden Securities -- Analyst
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