CapStar Financial Holdings, Inc.

Good morning, everyone, and welcome to Capstar Financial Holdings First Quarter 2022 Earnings Conference Call. Hosting the call today from Capstar are Tim Schools, President and Chief Executive Officer, Mike Fowler, Chief Financial Officer, and Chris Teets, Chief Credit Policy Officer. Please note that today's call is being recorded. A replay of the call and the earnings release and presentation materials will be available on the Investor Relations page of the company's website at capstarbank.com. During this presentation, we may make comments which constitute forward-looking statements within the meaning of the federal securities laws. All forward-looking statements are subject to risk and uncertainties and other factors that may cause the actual results and the performance or achievements of Capstar to differ materially from those expressed or implied by such forward-looking statements. Listeners are cautioned not to place undue reliance on forward-looking statements. A more detailed description of these and other risks and uncertainties and factors are contained in CAPSTAR's public filings with the Securities and Exchange Commission. Except as otherwise required by applicable law, CAPSTAR disclaims any obligation to update or revise any forward-looking statements made during this presentation. We would also refer you to page two of the presentation slides for disclaimers regarding forward-looking statements, non-GAAP financial measures, and other information. With that, I will now turn the presentation over to Tim Schools, CAPSTAR's president and chief executive officer.

Good morning, and thank you for participating on our call. We appreciate your interest in CAPSTAR. Our first quarter results reflect the focused strategic plan and disciplined execution we put in place three years ago. At that time, we established four strategic objectives, enhance profitability and earnings consistency, accelerate organic growth, maintain sound risk management, and execute disciplined capital allocation. This quarter, our loan growth, excluding PPP, exceeded $100 million for the second consecutive quarter, leading to 31% annualized growth. Our past dues were a record low 17 basis points, and we increased our dividends 67% as part of our balanced capital allocation strategy. As you know, this is a transition quarter with the industry coming off two historical outlying years. Specifically, mortgage volumes and PPP income will not recur at those levels, and in many occasions, provisions increased significantly and then have been decreasing. As we return to more normalcy, I'm excited at what I see. Our markets are healthy. We have improved organic growth engine. with additional teams inquiring about joining. Over 20 banks have sold in our state, with our state's largest bank, First Horizon, having sold this quarter. And we have significant excess liquidity in capital. Three items I'd like to point out in reviewing our first quarter results are a BOLI death benefit, expenses related to severance slash retirement, and deferred loan costs from prior periods. They net out, but particularly the deferred loan cost true-up is important to understand as it impacted the reported NIM for the quarter. Excluding this, PPP, and adjusting for excess liquidity, we estimate our NIM to be 3.32%, down eight basis points. Mike will expand in his comments, but some of that is related to some one-year specials we've offered in Chattanooga as they attract new customers. So we will not expect that to be ongoing. There are always near-term challenges when you're running a business, and they change over time. We've migrated from the potential pandemic-led credit risk to supply chain, inflation, and interest rate risk. For our core bank, We feel these risks are manageable. We remain optimistic growth will continue, and we recently updated our deposit data assumptions and asset sensitivity results, which show we are favorably positioned in both a traditional rate shock situation as well as a flattening of the curve, which might be a more likely scenario. As it relates to our tri-net and mortgage fee businesses, They are each coming off of record years and face some near-term headwinds as a result of rising rates. Trinet volumes remain strong. However, spreads are lower at the moment as we work through our inventory of loans held for sale in the recently increasing rate environment. Generally, we expect this business to return to levels slightly above the pre-pandemic 2019 level. We had a great first quarter as we worked through volume from last year, but again, with the recent rise in rates, spreads will be challenged for a quarter or two. I am hopeful TriNet can produce 750,000 to one million of fees a quarter over the long run. We have an outstanding mortgage division. I do not think it would be a long shot to say the absolute best in Nashville. It is built on purchase money transactions where in a non-refinanced market, 80% has historically been purchase money. It also is coming off of a record year and we feel can return to slightly above the pre-pandemic 2019 level. However, the industry faces several near-term challenges in that refinance volume is declining with the increase in rates, spreads have tightened as competitors fight for less volume, and there is a shortage of inventory. We feel this is temporary and that Capstar is in a position of strength. Historically, this situation causes smaller refinance-oriented competitors, who are often the ones offering lower spreads, to exit the market. And we have a long list of customers. There are just a limited supply of houses for sale at the moment. I'm hopeful mortgage can produce $2 million to $2.5 million of fees a quarter over the long run, but this business can have more variability than most with changes in rates and in different seasons of the year. Chris will expand on each of these in his comments. We are equally excited about our SBA division. It has had two light quarters. but we feel has tremendous potential as demonstrated by a few quarters close to $1 million. It is not as impacted by rates. It is more that we are working on our business development capabilities as we have in the core bank. We feel this can eventually be a $1 million a quarter revenue business, which in the near term could help as tri-net and mortgage normalize. As I turn it over to Mike, I want to take a minute to thank Dennis Duncan, who served as CFO over the past year as Mike faced a family emergency soon after taking on the CFO role at Capstar. We are grateful to Dennis for stepping out of retirement. He did a great job in advancing many of our initiatives. Sadly, Mike's situation did not work out as we hoped, but we are thankful he had time to spend with his wife and are excited to have him back. Thank you, Chris. Oh, no, sorry, to you, Mike.

All right, thank you, Tim, and good morning, everyone. So, on slide seven of the deck, net interest income was 21 million for the quarter. That was down 1.9 million from the fourth quarter. and that decline was driven by a number of factors. We had a 700,000 favorable impact of the strong loan growth that Tim described. That was more than offset by a 1.2 million decline in PPP interest and fees, the 500,000 deferred cost loan origination expenses related to prior periods, 400,000 impact of two fewer days in the quarter and a $200,000 decline in interest related to loans held for sale. The margin of 2.97 for the quarter, as Tim noted, is down 17 basis points versus Q4, excluding the deferred cost adjustment, PPP, and excess liquidity The adjusted NIM was 3.32%, which was down eight basis points versus Q4. There are a number of factors that contributed to that, none of them very large. We had about a two basis point drop in non-PPP loan fees. We had about a one basis point decline in the impact of purchase accounting. and we have about a little less than three basis point impact from the near-term specials that Tim mentioned us offering in Chattanooga to attract new customers to that new market. The improvement in the loan-to-deposit ratio driven by strong loan growth, we expect... We expect net interest income and NEM to improve going forward due to a number of factors. The strong loan pipeline and production obviously provide tremendous opportunity to continue remixing our balance sheet and redeploying excess liquidity into loans. Number two, loan pricing tailwinds. As competitors respond to the dramatic recent market rate increases we've seen, especially since year end, we remain asset sensitive and expect to benefit throughout the aggressive series of Fed rate hikes that has now started and expected to continue over the next one to two years. On page eight, I want to talk a minute about our interest rate risk sensitivity, which Tim touched on. So as Tim noted, we recently refreshed our deposit repricing beta assumptions. And the net result is a little bit lower beta assumptions. We remain asset sensitive. And as you see in the charts, Our model shows that we will have a 4.1% year one net interest income increase for an immediate 100 basis point parallel yield curve increase. Obviously, the Fed is broadly expected to aggressively raise short-term rates, though following this significant yield curve steepening in recent months, as Tim noted, we believe And I think the market believes a yield curve flattening scenario is very likely. So in a scenario where Fed funds rises 200 basis points gradually over the next year and five-year rates move up by a more modest 45 basis points, we estimate that net interest income over that year will rise by about 1.7%. On page nine, Average deposits of $2.7 billion remain near record levels, and we continue to be focused at Capstar on building core responsibly priced deposit relationships. We want relationships certainly to cover both sides of the balance sheet, loans and deposits as well as fee income, et cetera. Deposit costs have held flat for the quarter. at 19 basis points. We will be very focused on disciplined deposit pricing as the Fed raises short-term rates. We will be focused on optimizing profitability while remaining competitive to ensure that we can be effective in retaining and attracting core profitable relationships. We are committed to a deposit-first culture. which will ensure strong core funding and stronger profitability and more balanced profitability as we move forward. On slide 10, total health or investment loan growth excluding PPP of 31.1 percent on average or 21.3 percent based on end-of-period balances. And you can see we have only $6 million of remaining PPP loans. The remaining fees related to those are about $170,000. So the headwind, if you will, related to PPP loan forgiveness is essentially done. Our Q1 production of $186 million in health or investment loans annually, that equates to $755 million. And you can see from the last few years' numbers that demonstrates continued momentum in growing our loan origination in the last few years. The loan pipeline, the commercial loan pipeline exceeds $500 million with strong contributions across our markets. Our loan yield in Q1 declined significantly 50 basis points. 24 basis points of that is due to lower PPP fee recognition. 11 basis points is due to the deferred cost adjustment for prior periods. The remaining 15 basis points is due to a number of factors, loan coupon, other loan fees, purchase accounting accretion, all items I noted in the explaining the difference on adjusted NIM. We had disciplined pricing in Q1. We had match-funded spreads of about 211 basis points, though, as Tim noted, in Chattanooga and very selectively elsewhere where appropriate, we have had some originations at lower than targeted spreads given lag competitor responses to market rate increases, where we are seeing recent movement, which we're obviously very pleased to see. On slide 11, solid non-interest income for the quarter. Thanks to our unique fee businesses, our non-interest income has exceeded 30% of revenue over the past eight quarters. As Tim touched on, with large market rate increases and very sudden interest rate increases, mortgage income is normalizing, coming off record highs in prior quarters. And Trinet had a very solid quarter, though down from the record $4 million quarter in Q4. As Tim noted, we also had one-time BOLI income of $858,000. On slide 12, related to expenses, our total expenses were $17.7 million for the quarter. We continue to focus on maintaining strong expense discipline with the adoption of a productivity mindset across the organization. Excluding $385,000 of severance retirement expense in the quarter, non-interest expenses declined $1.3 million from the fourth quarter. A number of factors driving that, but primarily lower incentive accruals coming off of record revenue period and reduced recruiting expenses. On page 13, actually, I will turn it over to Chris to talk about our risk management and credit.