CapStar Financial Holdings, Inc.

Good morning, everyone, and welcome to Capstar Financial Holdings' fourth quarter 2022 earnings conference call. Hosting the call today for Capstar are Tim Schools, President and Chief Executive Officer, Mike Fowler, Chief Financial Officer, Chris Teets, Chief Credit Policy Officer, Executive VP of Specialty Bank. Please note that today's call is being recorded. 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 the presentation, we may make comments which constitute forward-looking statements within the meaning of the federal security laws. All forward-looking statements are subject to risks 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, uncertainties, and factors are contained in CAPSTAR's filing 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.

OK, thank you, sir. Good morning and thank you for participating on our call. We appreciate your interest in Capstar. We're pleased with our results for 2022 and the quarter. We reported earnings per share of $1.77 and a return on equity of 10.7%. Strong loan growth, NIM expansion, discipline, expense control, and low credit costs each contributed. In line with our capital allocation efforts, we also returned a record $17.9 million to shareholders through dividends and share repurchases. What is significant is within the annual numbers, we had $2.7 million of loss related to mortgage and the wire loss, and TriNet was breakeven. We're in a complex operating environment, but our mortgage and tri-net divisions are outstanding businesses that have strong earnings power in the right markets. As we mentioned last quarter, we had two operational losses, of which one for $732,000 was fully recovered this quarter. We remain optimistic that we will have a recovery also related to the wire later this year. As an aside, I will mention the FBI the TBI and the Cleveland, Tennessee Police Department have identified the fraudster and have put out a national indictment, which is unusual if they typically are limited to 500 miles. The TBI also intends to add the individual to the Tennessee top 10 most wanted list. In contacting our core FIS, This individual's online credentials showed up across their operating system, attempting to penetrate other banks. He also attempted to fraud another Tennessee bank a few weeks after us. Assuredly, he is part of a larger network and is trying to impact a number of banks. In the third quarter, we reported 47 cents per share and a return on equity of 11.8%. As noted, our earnings included the recovery of $732,000 related to one of the operational errors. It is subject to appeal, but our Council feels it is more likely than not that the opinion will remain favorable to Capstar. The appeal process could continue through year end. Loan growth for the quarter remains strong at 11.1% average and 8.6% end of period linked quarter annualized when you exclude the tri-net balances that we moved this summer and are holding in loans held for investment. Our markets remain strong, although lending has begun to slow due to the impact of higher rates. As a bank, we are being cautious with the uncertain economic and funding outlook, having pulled back on CRE last summer, tightening some underwriting criteria, and maintaining our discipline on loan spreads. We have a strong loan engine in advantageous markets that continue to be in a conservative nature. Our credit metrics remain strong, which Chris Teets will cover later. We have three past dues we are addressing, two of which have been problem loans for a while. We are performing active portfolio management with higher rates to identify customers early who might become a problem now or in a slowing economy. As we communicated last summer, depositors became very aggressive in the second quarter of 2022, and that continues today. One of the biggest competitors to date has been the U.S. Treasury and Treasuries, where individuals have pulled money from banks into Treasuries. We are working hard to offer competitive rates and products to maintain and attract new depositors while not cannibalizing the portfolio. It is as challenging as I have seen it. More recently, banks have stepped up to wholesale prices on their deposits, and you face a situation that you either have to match or lose the relationship. We hope this will slow as the Fed slows, but margin pressure will likely continue in their near term through the first half of 2023. Until then, deposit rates will continue to rise. We will work hard to get as much offset as we can on the loan side. Some of the specific actions we're taking related to deposits include we're monitoring competitor bank rates in our markets and their specials. To date, it appears our betas are in line or a little lower than our local competition. We are proactively discussing each customer request that comes to the table. We're requiring the primary deposit relationship on all new loans. We are calling on all relationships where a deposit was not obtained historically. We're calling on all customers for accounts that they might have elsewhere. Lastly, we've changed our incentive plan to require a certain level of funding percentage to loans for each banker in market. Our highest paying category has always been deposits and specifically DDA. This will also ensure our great staff are outstanding bankers and not just outstanding lenders, encouraging them to call on deposit only customers as much or more as borrowers. As it relates to fees, mortgage volumes remain at historical lows nationally. We have a tremendous mortgage company and team and are monitoring local and national markets. We reduced staff in the third quarter and have an opportunity to evaluate that further. Again, we have a strong division and do not want to be short-sighted, but it is something we are discussing. Trinet was paused in third quarter 2022 due to the unusual rate environment. We will be testing a limited pool in the first half of 2023 with a different rate structure and risk protocols. We do not have a tolerance for further losses, so volumes might be lower, but we want to ensure we have a gain on sale. We're very excited about our new SBA expansion. From my experience, SBA is something you should really be committed to or not do it. Capstar has had a limited investment to date and demonstrated some success over time. In fourth quarter 2022, we were approached by a top 10 team that elected to join us. Over time, we are planning that they can generate 2 million plus of quarterly gain on sale. There are three other revenue components that Chris will discuss later, but that is the most visible component. In the past, we've cited $16.5 million as our non-interest expense range. Recently, we've been running under that, and this team adds another approximate $800,000 a quarter of non-interest expense. to include commissions that would go with their revenues. Lastly, we've worked hard to put Capstar's capital to use in a productive manner by entering new markets and growing loans, increasing our dividend, and buying back stock. We renewed our buyback this week, albeit at a lower level of $10 million. We feel that is prudent with the uncertainties with the economy at the moment and will continue to evaluate as the year progresses. Now I'll turn it over to Mike for more details on the margin and other items.

All right. Thank you, Tim. And good morning, everyone. So on page five, a few quick comments on financial results for the quarter. We reported net income of 10.3 million, 47 cents a share. As Tim noted, Q4 results do include a 700,000 recovery related to one of the two third quarter operational losses. Total revenue was 31.2 million in Q4. That is up 2.4 million versus Q3. They'll recall that Q3 did include $2.1 million of realized and unrealized losses related to selling or transferring to held to investment the remaining tri-net loans which were in held for sale. Expenses were $16.3 million for the quarter. They were down $1.3 million versus the prior quarter, but again, as Tim noted, Recall that the prior quarter did include $2.2 million of operational losses, partly offset by an $800,000 voluntary executive bonus reversal. On page six, I just point out a few metrics. So we did report pre-tax, pre-provision as a percent of assets of 1.86%. We reported return on assets of 1.31 and reported return on tangible equity of 13.6%. And we will go through, Chris will review the credit metrics obviously later in the presentation. On page seven, in terms of net interest income and net interest margin, after rising materially in the second quarter, and the third quarter, where we benefited modestly from Fed hikes and remixing the assets, shifting excess cash into loans. As Tim noted, the fourth quarter net interest margin of 344 was down six basis points versus the third quarter, primarily due to two factors on the deposit side. One was a mixed shift into higher cost categories and runoff of customer funds, which we'll talk about in the next slide. And number two is additional deposit pressure from increases in customers seeking alternatives, but also from an increasingly competitive local deposit market. And I would say some of that is from local competitors, locally based competitors within our footprint. I've been surprised somewhat to see more aggressive pricing both on promotions and on an exception basis from some much larger regional players and from some very large national players. Haven't seen that until recently. Overall, our deposit data increased about 40% in Q4, and as Tim alluded to, we have seen NIM pressure late in the quarter, and that does suggest likely near-term NIM pressure in the next one to two quarters. On page eight, in terms of deposits, total deposits We're roughly flat. I would say in terms of deposit pricing, we have seen our betas. And as Tim said, we actively monitor competitor pricing through S&P. We monitor standard rates. We monitor promotional rates. And we monitor exception rates through what we're hearing from our bankers And we certainly, as we've seen in prior cycles, and as we expected, we have seen betas increase the deeper the Fed has gone into their Fed hiking cycle. In terms of balances, we did see customer balances decline this quarter by 156 million. We saw about 60 million in our correspondent banking division. as our corresponding bank clients are deploying their excess liquidity. But we also saw about $97 million in other bank customer balance decline. We offset that this quarter with $160 million in broker deposits. And from a price, from a cost standpoint, as you can see in the chart, our deposit costs rose 58 basis points to an average of 1.2%. If we look at page nine, in terms of loan growth and loan yields, we continue to have solid loan growth. The bar chart on the left is our reported loan balances. The first bullet that Tim referred to in terms of our health or investment loan growth That is excluding the TRINET transfer from, it's removing TRINET loans that we have had in-held for investment. Normally those are in-held for sale. So we did remove the TRINET impact from the 11.1 average growth and the 8.6% end of period. Without excluding those, you can do the math, but the period end is a little bit under 4% without adjusting for Trinet. We continue to see strong loan production. It is down a bit from last quarter, I believe, but we're continuing to see solid loan production, $150 million in Q4, and the pipeline remains strong across our markets. commercial pipeline of $450 million. As we've said on the last call, and I know we're hearing more of this in the industry, we are being more disciplined and somewhat limiting our loan growth, maintaining disciplined pricing, which I would say we've seen more challenges on the deposit side from a pricing standpoint. We've seen, I would say, to some respects, the The flip side of that on the loan side, middle of last year when the Fed was hiking 75 basis points every meeting, rates were going up sharply along the curve. As we mentioned on earlier calls, we were remaining disciplined but seeing more competitive pricing that hadn't caught up to where market rates have gone. I think with the Fed slowing and the yield curve flattening and inverting, We're seeing competitive pricing more in line with where the markets are, I think giving us more comfort and ability to achieve our targeted spread on the loan side. Our loan yield did increase this quarter, 41 basis points. And we did achieve, in terms of originations for the quarter, match funded spread against wholesale funding, against home loan funding, of 2.39% as of the time of funding. On page 10, related to non-interest income, mortgage revenue, as you know, has been down sharply from a year ago with the increase in mortgage rates. We do believe at this point mortgage revenue reflects limited volume in line with national trends. Margins, however, have started to rebound and are returning to what we view as more normal levels. As Tim mentioned, TriNet, which we had announced previously we had paused in third quarter, that remained paused through the fourth quarter. But as Tim said, we are now testing a limited pool in the first quarter. As he said, we have no appetite for additional losses, and these are originated to sell. We're cautiously optimistic that our testing will be successful and will lead to potentially further expansion in that business. But SBA lending revenue, as Tim said, very excited about that. Chris will talk about that more in a few minutes. You certainly see the results of a recent SBA expansion in terms of fourth quarter revenue, where fourth quarter SBA lending revenue is up a little bit under $1.5 million. up about $900,000 from last quarter. In terms of page 11 and non-interest expenses, adjusting for, well, again, we reported $16.6 million. That includes the recovery that Tim had mentioned of $700,000 operational loss from Q3. That is down from $17.9 million last quarter, but recall, as Tim mentioned, last quarter did include $2.2 million of operational losses and partially offset by $800,000 voluntary executive bonus reversal. A good part of the increase in adjusted expenses versus last quarter is the additional SBA or costs related to the additional SBA hires. which, again, are very excited about, and I will turn that over to Chris to discuss now.