CapStar Financial Holdings, Inc.

Good morning everyone and welcome to Capstar Financial Holdings second quarter 2022 earnings conference call. Hosting the call today from Capstar are Tim Scholes, President and Chief Executive Officer, Mike Fowler, Chief Financial Officer, and Chris Tietz, Chief Credit Policy Officer. Please note that today's call is being recorded. Replay of the call and earnings release and presentation materials will be available on the investor page of the company's website at capstar.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 to not place undue reliance on forward-looking statements. A more detailed description of these and other risks, uncertainties, and factors are contained in CAPSAR's public filings with the Securities and Exchange Commission, except as otherwise required by applicable law. CAPSAR 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's rights 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 and I ask you to bear with us this morning. The vendor, Victor, here, we changed our software and so this will be the first time we're using it this quarter so be patient with us as we navigate this new software challenging to adopt it on an earnings call. Today we're excited to be speaking with you from Asheville, North Carolina where it started off in the cool 60s this morning. I think it's going to be 100 in Nashville today so it's nice to be here and this is where we announced last week we'll be opening a new office. It's an outstanding and healthy growing market. It also is one we're very familiar with. It's lost 12 community banks since 2008 and is often served out of Charlotte. We feel it presents Capstar a tremendous opportunity as with Chattanooga and Knoxville investments. I'll provide some highlights to these shortly. In the second quarter, we reported 45 cents per share, pre-tax, pre-provisioned assets of 170, and a return on tangible common equity of 12.7%. I'm particularly proud of our results as they demonstrate the strengthening of the core bank, which for today's purposes I'm defining as excluding our mortgage, SBA, and tri-net businesses. Due to the headwinds I communicated for these businesses last quarter and the since rapidly changing market conditions, the second quarter net contribution of these three businesses was minimal. This is meaningful as the core bank essentially earned about $1.80 per share annualized, which I believe would be a record. This positions Capstar very well when you incorporate the underlying growth opportunity of Nashville and our community markets, the expense we have embedded in our recent Chattanooga, Knoxville, and now Asheville investments, and what our mortgage and tri-net business historically have provided in a more stabilized market environment and the potential we believe is in our SBA business. The underlying four key drivers of our company are performing very well. First, year-over-year revenue growth, excluding our specialty banking businesses and PPP, increased 13% led by a healthy increase in loans. Our net interest margin expanded 44 basis points from the prior quarter, largely due to a favorable change in earning asset mix and an increase in market rates. Third, our productivity management is outstanding, with core banking expenses down 1.5% year over year, aiding our overall efficiency ratio, which now stands at 56%. In combination with the revenue growth I mentioned previously, year-over-year core bank free tax pre-provision growth was 38%. And lastly, credit quality remains outstanding, where past dues reach their second consecutive record of 12 basis points and charge-offs remain low. Importantly, you have seen thoughtful and balanced capital allocation discipline with the announcement of three de novo expansion markets over the past two years to include Asheville and further expansion of Chattanooga this quarter. The paying of an increased dividend as well as share repurchases. Before turning it over to Mike to cover the highlights of our key trends, I'd like to discuss the progress of our recent new market investments. If you'll please turn to page five of this morning's presentation, you'll see the targets we've established for each expansion market and the early results of Chattanooga and Knoxville. This is new for us, so we're still learning and refining. Needless to say, we're pleased with our progress to date. I find slides six and seven to be the most meaningful in today's deck. It shows the transformation that is occurring at Capstar as well as the opportunity. Over the past three years, our team has significantly increased the franchise value of Capstar from a footprint and performance standpoint. We are now in four of the Southeast's most dynamic markets, have improved efficiency, profitability, and earnings, and our year-to-date one-year, three-year, and five-year total shareholder returns were greater than industry and local peer performance. I'll let you read through the commentary on Asheville and our continued Chattanooga investments and move forward to pages 13 and 14. Here, we have attempted to provide some thought of what the potential of these recent investments could be. Obviously, there are many variables that could make these results better or worse. In second quarter, our current Chattanooga and Knoxville investments contributed a positive one cent per share. On page 13, we've listed what their future incremental contribution might be under stable market conditions and if we execute at the level we aspire. Similarly, page 14 shows the same for Asheville in our newest Chattanooga investments. As we all know, de novos come with front-end startup costs but provide the opportunity for significant future accretion if successful. What is so exciting is there are many other aspects of Capstar which should also increase their contribution during these periods. Mike, if you'd please now cover the financial highlights of the quarter.

All right, thank you, Tim. Good morning, everyone. On page 17, a few highlights. As Tim noticed, we feel we had a very strong performance in our core banking markets, offsetting near-term headwinds in our specialty fee businesses. Our net interest margin of 341 in the second quarter was up 44 basis points from the first quarter. Our efficiency ratio of 56.3%. is an improvement of 2.4% versus last quarter. Our pre-tax pre-provision of 1.7% of assets is also an improvement of nine basis points versus last quarter. In terms of growth categories, our assets, and we'll talk more about this in discussing the margin in a minute, but despite very, very strong loan growth again this quarter, Our assets are effectively unchanged as this was a continuation of deploying our excess liquidity into higher yielding loans. Tangible book value per share is down 2% from last year. However, an issue discussed throughout the industry, if you exclude the OCI impact of higher unrealized securities losses, Due to the general increase in market interest rates, tangible book value per share is up 2.1% versus last quarter and is up 13.1% versus last year, reflecting ongoing solid profitability. And as Tim noted, credit metrics remain very strong and capital remains very strong. We continue to have capital above our peers. On page 18, you can see the drivers of the 44 basis point increase in net interest margin for the quarter. Essentially, as I noted a second ago, remixing the balance sheet, deploying excess liquidity into loans, and number two, the benefit of the Fed's rate hikes to date, 150 basis points since March. Net interest income was 24.4 million. an increase of 3.3 million versus last quarter, again, with no increase in earning assets. Our cash declined from 11.2% of assets last quarter and 14% a year ago to 3.7% on average for the current quarter. In terms of the NIM and the NINUSHIS income outlook, We have seen as expected and consistent with past cycles of rising rates, as the Fed moves deeper into rate hiking cycle, deposit betas or pricing rates are increasing. And we have seen that to some extent in the last month. But a strong long pipeline continues. And our production provides opportunity for continued interest income growth. Another thing you hear in the industry, we do expect some loan pricing tailwind as competitive pricing responds to the dramatic increases we had seen earlier this year when some of our competitors have lagged their increases in response to market rate increases. We've seen some evidence of that, of some catching up. and we do expect some tailwind on that front going forward. From an interest rate risk perspective, as we've said in the past, we are targeting to be positioned fairly risk neutral. Our net interest margin could continue to benefit and we expect it will modestly from further rate hikes. However, a potential modest decline could occur in a flattening scenario, which is certainly not unlikely. On page 19, regarding deposit costs, our deposits declined $40 million during the quarter, driven primarily by correspondent bank activity. Not surprisingly, as our bank customers are deploying their excess liquidity into loans as well, and they could be facing some deposit outflows. So not surprising to us that we've seen some modest decline in our correspondent bank balances. Outside of correspondent banking, we certainly have seen some instances of deposits leaving, but in total, our other deposits have been, in the aggregate, fairly stable. The deposit costs for this quarter was an average of 23 basis points or four basis points increase versus last quarter. As many of our peers are doing, we're striving in this rate environment to maintain discipline pricing on both sides of the balance sheet. But in terms of this slide, discipline pricing on the deposit side, as the Fed continues to raise short-term rates, We certainly focus on optimizing profitability while ensuring we remain competitive through a combination of specials and new products and competitive pricing on our standard products designed to retain and attract core profitable relationships.