TriState Capital Holdings, Inc.

Q2 2021 Earnings Conference Call

7/22/2021

spk08: Good morning, everyone, and welcome to the Tri-State Capital Holdings Conference call to discuss financial results for the three months ended June 30th, 2021. All participants are currently in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key, followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one on your touchtone telephones. To withdraw your questions, you may press star and two. In the interest of time, we do ask that you please limit yourselves to one question and a single follow-up. Please note that you may re-enter the question queue if you do have additional questions. Please also note today's event is being recorded. Before turning the call over to management, I would like to remind everyone that today's call may contain forward-looking statements related to Tri-State Capital that reflect Tri-State Capital's current views with respect to, among other things, future events and the company's financial performance, as well as the company's future plans, objectives, or goals. Such forward-looking statements are subject to risks and assumptions, and uncertainties that could cause actual results or outcomes to differ materially from those currently anticipated. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. You should keep in mind that any forward-looking statements made by tri-state capitals speak only as of the date on which they are made. New risks and uncertainties come up from time to time, and management cannot predict these events or how they may affect the company. Tri-State Capital has no duty to and does not intend to update or revise forward-looking statements after the date in which they are made. For further information about the factors that could affect Tri-State Capital's future results, please see the company's most recent annual and quarterly reports filed with the Securities and Exchange Commission. Please also note that annualized information referenced in this presentation is not predictive of future performance, which may differ materially from annualized information. To the extent non-GAAP financial measures are discussed in this call, they will be presented with the most comparable GAAP measures, and reconciliations of the non-GAAP measures can be found on Tri-State Capital's earnings release, which is available on its website at tristatecapitalbank.com. Representing Tri-State Capital Holdings today is Jim Goetz, Chairman. He'll be joined by David DeMis, Chief Financial Officer, and Brian Federoff, President and CEO of Tri-State Capital Bank, and Tim Riddle, Managing Partner and CEO of Chartwell Investment Partners, for the question and answer session. At this time, I would like to turn the conference call over to Mr. Goetz.
spk02: Good morning, and thank you for joining us. Tri-State Capital delivered a very strong financial result in the second quarter as each of our businesses made meaningful contributions to our top and bottom lines. We believe Tri-State Capital Bank's 35% organic loan growth annualized from the link quarter will be truly exceptional relative to peers and the industry. And our Chartwell Investment Partners business also delivered differentiating organic growth with double-digit annual growth in assets under management in the quarter to a record $11.5 billion. Collectively, our loans, deposits, and assets under management reached an all-time highs. This growth helped us to generate record levels of quarterly revenue, pre-tax, pre-provision net revenue, pre-tax income, and net income available to common stockholders. Additionally, net income available to common stockholders grew by some 78% annualized from the link quarter and 86% from the second quarter of 2020. We also delivered earnings per share of 41 cents, growing EPS even with a higher share count and preferred dividends from our December 2020 capital raise, continuing our record of efficiently and effectively putting new capital to work through the responsible and meaningful growth of this company. In addition, all this core earnings growth was achieved solely through organic means and with continued modest provision expense. What makes these results possible and what differentiates this company from competitors large and small is our people. We now have more than $23 billion in on-balance sheet assets and client assets under management. as our team's impeccable reputation for client service, expertise, and results continue to attract new business and grow existing relationships. Revenue per employee, a metric you've heard us highlight regularly, was $678,000 in the second quarter on an annualized basis. This is more than twice the level that the median $10 to $20 billion asset bank generated. based on most recent quarter data. Our agile business model combined with our culture of valuing each individual's contributions and focus on building the best team has driven our collective performance at this level. We're expanding our scalability and responsiveness through further investments in technology designed to support our people and enhance their ability to provide best-in-class service to our clients. We are investing in our client engagement experience and offerings to position us for enhanced market share and profitability, all while maintaining our operating leverage. We believe these investments will, in turn, support continued earnings growth and long-term value creation for our shareholders. Following its breakout performance in the first quarter, Chartwell has done everything but slow down. Assets under management of $11.5 billion and annual run rate revenue of $39.9 million at June 30, 2021, each reflect growth of more than 20% from one year prior. In the second quarter, our asset managers' strong performance attracted continued positive net flows. Products like Core, Core Plus, and short-duration BB-rated high yield are attracting flows from new and existing institutional and retail clients seeking enhanced yield with a focus on credit quality and interest rate sensitivity. The combination of asset and revenue growth that we've achieved at Chartwell is further supported by incremental improvement in operating leverage as we continue to benefit from past initiatives to moderate Chartwell's segment expenses while continuing to invest in new products, marketing, and distribution. Year-to-date investment management fees have grown at 20% year-over-year, while expenses have grown at almost half this rate, generating significant operating leverage. We're particularly proud of the Chartwell team's ability to grow revenues at this clip in the current rate environment, with fixed income representing some 60% of total assets under management. We're thoroughly focused on continued organic growth Chartwell's new business pipeline began the third quarter with more than $65 million in unfunded institutional commitments. We are also investing in product development, including a new Chartwell short-duration high-grade bond fund. This new product leverages the talents of our fixed income team and serves as a complement to our very successful short-duration high-yield strategy, which has grown to represent more than 25% of AUM. Chartwell sees significant retail and institutional demand for this new short-duration product. We have total confidence in our fixed income team's abilities, and the sales and distribution team is motivated to bring it to market. Meanwhile, Tri-State Capital Bank grew total loans by more than 29% over last year, and nearly 9% during the quarter to $9.3 billion on June 30, 2021. That's annualized growth of 35%, lending to very high-quality clients in the differentiated and attractive markets we've served for years. This exceptional growth continues to be driven by private banking loans, which grew to some $5.7 billion, or nearly 62% of total loans, at the end of the quarter. That's because these loans, which are collateralized by marketable securities, cash value life insurance policies from select issuers, and other liquid assets, are an excellent and timely solution for many high net worth borrowers across all economic and market cycles, especially the current environment. With a referral network of 292 financial intermediaries, including independent financial advisors, trust companies, family offices, broker-dealers, regional securities firms, and insurance companies, we expect to continue dominating market share and driving formidable growth in this business moving forward. Additionally, private banking loan application volume is up 43% from the second quarter of 2020 and reached a new record level. We expect continued growth although we continue to focus our origination efforts on where we can deliver the most meaningful benefits and experience to borrowers and their advisors. Commercial loans totaled $3.6 billion at June 30, 2021, up 15% from one year prior and 2% from March 31. Commercial real estate loans grew nearly 16% annualized, while totaling just 25% of total loans as we continue to partner with what we believe are some of the highest quality and most experienced sponsors in our markets. Commercial and industrial lending was down from the link quarter as new originations and draws on lines of credit and growth in equipment finance production were offset by amortization and pay downs. This activity in the C&I book is reflective of seasonal trends, and temporary supply chain dynamics, but we are optimistic about the second half of the year. Both our CRE and CNI portfolios remain well diversified, have grown solely by organic means, and have strong pipelines. Our private banking business, which made up 61.5% of total loans at the end of the second quarter, as well as the high quality nature of our commercial banking relationships, continue to favorably impact our asset quality metrics and credit costs. Credit quality has long been a differentiator for tri-state capital, and we further improved our metrics in the second quarter. We reduced adverse-rated credits by some 33 percent compared to the linked first quarter. On our $9.3 billion book of loans, we reported just $34 million of adverse-rated credits, or 37 basis points of total loans. Non-performing assets totaled 12 basis points of total assets, and net charge-offs were just 10 basis points of average total loans. Importantly, the second quarter charge-off activity was previously reserved for in prior periods. Our significant loan growth allows for improved profitability and deployment of liquidity, which continues to be readily available and inexpensive. Our team has done a tremendous job with liquidity management. ensuring that we are managing against excess liquidity by timing our pipeline and putting our liquidity to work in high-quality assets. Deposit growth during the second quarter fully funded our loan and investment growth, with record deposits of more than $10.2 billion at quarter end, reflecting 30% growth over the last 12 months and 10% during the quarter. Treasury management deposits doubled from June 30, 2020, and now make up 22% of total deposits. We're excited about our continued addition of meaningful and long-term client relationships. These deposits support our efforts to effectively manage deposit costs, which we reduced by six basis points during the quarter. This, in turn, contributed to our third consecutive quarter of net interest margin expansion, up another four basis points from the first three months of the year. Second quarter 2021, NII grew to a record 42.9 million, up 28% over the second quarter of last year, marking Tri-State Capital's 22nd consecutive quarter of annual net interest income growth. This is the result of the high quality and robust volume we're achieving, particularly in private banking. We currently view responsible volume growth as the primary driver of net interest income expansion in 2021, as we position for favorable profitability when rates do rise. NII was complemented by record non-interest income driven by our strong investment management fees and solid swap fees during the quarter. Excluding securities gains and losses, NII and non-interest income combined to generate record quarterly total revenue of $57.7 million. This reflects an increase of 10% from the link quarter, or 41% annualized, which we believe will further differentiate Tri-State Capital's latest results from similar size peers and industry overall. Looking ahead, we remain focused on measuring our performance through operating leverage and growing revenue at a faster clip than operating expenses. Our expenses were in line with our expectations and reflective of investments we're making in people, technology, clients, and the products. Against the backdrop of the challenging economic environment, we showed what our company is capable of. Loans, deposits, and total assets each cross significant thresholds during the quarter, surpassing $9 billion, $10 billion, and $11 billion, respectively. We are enhancing net income consequentially in a low-interest rate environment driven by our penetration of niche markets, our well-positioned distribution capabilities, and high-quality client service delivered by motivated professionals who are focused on effective execution. This company has reached critical mass, providing it with the flexibility to continue investing meaningfully for the future and providing impactful earnings to the bottom line on a consistent basis. We enter the second half of the year with strong confidence and healthy pipelines across all three of our business lines. For year 2021, we remain keenly focused on growing each of total revenue loans and deposits at 15% to 20% rate over 2020, managing annual expense growth to a low double-digit rate continuing to generate positive net asset inflows and expand segment profit margins at Chartwell, and continuing to grow net interest income dollars, all while maintaining our hallmark superior asset quality. That concludes my prepared remarks. I now ask the operator to open the lines for Q&A.
spk08: Ladies and gentlemen, at this point, we will begin the question and answer session. Once again, in order to ask a question, please press star and then one using a touch-tone telephone. To withdraw your questions, you may press star and two. In the interest of time, we once again do ask that you please limit yourselves to one question and a single follow-up. Please note that you may re-enter the question queue if you have additional questions. Once again, that is star and then one to join the queue. And our first question today comes from Michael Pareto from KBW. Please go ahead with your question.
spk05: Hey, everybody. Good morning. Morning, Mike. I wanted to start with kind of a high-level question, Jim. You know, the deposit growth and really improvement over the last few years has been really notable. And I guess, Mike, my question is you know as we look ahead i mean obviously the the rate environment is hard to predict but i mean i think you know consensus outlook seem to be factoring some you know rate hikes at some point in the next 24-ish months and i'm curious if you guys just have any high-level thoughts on on how the deposit portfolio might um perform in that type of environment relative to to your performance in the past i mean it seems like the relationships are a little bit stronger over the last few years with some of the hiring efforts that you've made. Obviously, the banking environment as a whole is a bit more digital now than it was four or five years ago. I'm just curious if you guys have any high-level thoughts or expectations about how that might perform if we do get into some type of rate-increasing environment.
spk02: Michael, let me make a couple general comments, and then I'm going to turn it over to Brian Federoff, who's the CEO of our bank. What you're seeing is the results of some 15 years of really focusing on each aspect of this business. And it's been coming to fruition slowly over the period of the years. And what you want to keep in mind, as I mention almost in every single one of these reports, that we've put highly experienced, sophisticated individuals in place. And they've, for us, on the liquidity side, built a very sophisticated funding mechanism. And it's working. And we can control the flows that come in place through the relationships we have in place. And if you were to look at the turnover that we have of our relationship managers, it's almost nonexistent in that regard. And these are people that had a great deal of experience in their prior life, and we're leveraging off that and seeing the results today in these numbers. So I would suggest to you the better times are yet to come. Brian?
spk07: Yeah, thanks, Jim. Tough to follow that last statement there, but I would agree with Jim's characterization that we're looking forward very optimistically. As Jim mentioned, we've built it over 15 years. You can look at the last two years in particular to see the diversification of that growth Treasury management, obviously, as we pointed out, has doubled in the last year. And that's just one segment. But obviously, service-based deposits being a key piece of our forward strategy, relationship deposits being the broadest piece. And as Jim indicated, the people that we've brought in have those key relationships. And again, keep in mind that this is a national deposit gathering capability. So We think that that provides us a huge scale. But we're super focused right now on being there meaningfully for existing clients to grow with them, and we are seeing our existing clients grow, and attracting new clients as well. And with the technology investments we're making, again, we look at this as very timeless technology investments. The obsolescence is low. which allows us to continue to build better and better service capabilities and products for clients. So we're attracting new clients at the fastest rate we ever had. But to your point, we are building for two years from now in our deposit pipeline and portfolio.
spk05: Got it. Helpful. And then this is my follow-up question, maybe a question for Jim or Tim, just on Chartwell. you know, revenues are up nicely quarter-to-quarter, year-on-year. I mean, if the market cooperates, is it fair to think of this business as kind of a, you know, a high single-digit, you know, revenue growth-type business at this point with all the investments you made? And can you just remind us also, you know, what the M&A landscape and appetite is in the AUM business at this point as well?
spk02: Michael, let me – comment with regard to your question generally, and then I'll turn it over to Tim. I take you back to March of 2020, and the condition of the market drove Chartwell's assets down to $7.7 billion. We determined at that time, Tim and myself and a lot of others, that we were going to solely focus on bringing Chartwell back from that level. And now, as you can see today, it has $11.5 billion. We've been hugely successful. And I would see us at some point as we go into the new year being much more aggressive in that market. There's a lot of opportunities that are available there, but we wanted to get our own captive infrastructure back in shape and breathing strongly. And I think you can see by the flows the net income it's delivering, the revenue growth, that it's having an impact. Tim?
spk01: Yeah, Michael, first of all, good morning. We're certainly captive to the market environment, as you well know, but we would certainly expect with the exceptional results that we've been able to achieve, particularly on the fixed income side, and with the unique type of products that we have available to both the institutional and the retail market, that, again, revenue growth is, as you had indicated, is certainly something that we believe is achievable, not only in the second half of the year, but going forward as well. And as Jim indicated, we're solely focused on organic growth of the franchise. and we'll continue to look, but obviously in this environment there could be an opportunity that presents itself. We would be open to that, but we're certainly not leading with our chin. Our job is to grow Char-Well organically.
spk05: Got it. Thanks, Tim, and thank you guys for taking my question.
spk08: Our next question comes from Daniel Tomeo from Raymond James. Please go ahead with your question.
spk00: Good morning, guys. Good morning, Danny. Good morning, Danny. Just wanted to follow up on your balance sheet growth commentary. I think you reiterated what you've said in the past, about 15% to 20% growth for loans and deposits this year, if I heard that correctly. It looks like loan growth already about 13% and deposit growth already 20% for the year. Is that just conservative commentary, or you think that you're expecting a slowdown in the second half there?
spk07: Yeah, this is Brian. Hey, Danny. I would say, I mean, obviously, year over year, our third and fourth quarters last year were pretty impressive quarters as well, so we'll probably look at it from an average balance perspective and a spot, but Overall, we remain optimistic on the second half. The second quarter and the fourth quarter, more seasonally, historically, those have been sort of our strongest quarters. So we're not surprised that second quarter performed so well. But I think we indicated even the last quarter that we would expect to be at the higher end of that 15% to 20% range. And that looks like that's where we're going to be able to pull through. continue to be optimistic on the private bank side. We're seeing sort of very strong market acceptance and sort of our distribution and our internal client engagement efforts continue to grow that. So we don't see any slowdown there and the commercial side we think will pick up a bit as we indicated between the supply chain. Loosening on the equipment finance and some funds finance aspect. So still think 15 to 20 is a right place to direct us, but at the top end of that would be the right place.
spk00: Okay. And then maybe for Dave, you know, you talked in the past about the NIM expansion getting up to the mid to high 160s by the end of the year. You know, we've seen obviously some pressure on the 10-year Just wanted to see if that's still how you're thinking about it in the current rate environment or if you need rates to rise from here to get back to that mid to high 160s.
spk03: No, Danny, we still believe that. As we've long said, we're more focused on net interest income growth through sort of reasonable and risk-managed growth in loans and investments, building durable relationships, and matching liquidity with the needs as we build the franchise. We were pleased that we were able to expand NIM in the quarter, and we see that expansion continuing for the rest of the year. It will primarily be driven by deposit cost reductions as we manage deposit balances in line with the opportunities for deploying that liquidity. We believe that we'll be able to achieve further cost reductions in that category as we continue to grow deposits And as we've shared with you at the beginning of the year, we would, again, expect that the NIM will be somewhere in the mid to high 160s by year end. That's great.
spk07: You know, it might be a good place to add real quickly just from a 10-year perspective. Certainly, it's a metric that we watch, but we think that, again, if you roll it over to the swap revenue opportunity, we've demonstrated we can um work with the swap market um in all markets and all rate curves um you know flat um steepening and inverted but um you know we're pretty happy with it where the tenure is right now uh gives us a lot of opportunities our clients are super engaged at these levels so you know we think that we um you know in some respects you know the stock sometimes trades obviously with you know, the industry and around the tenure because of everybody's exposure to that, you know, we would say we have more opportunities, you know, in that kind of environment. So, you know, obviously that's separate from the NIM question, but from a revenue perspective, we're happy where we are. And obviously it's, you know, good for Charwell as well.
spk00: That's great, Keller. I appreciate it. Thanks, guys.
spk08: Our next question comes from Matt Olney from Stevens. Please go ahead with your question.
spk04: Thanks. Good morning. I want to go back to the discussion around deposits. And as you mentioned, the banks made tremendous progress lowering deposit costs and really growing the treasury management business. And I expect we'll see more of the benefits of that with higher rates. But I guess given the floating rate nature of tri-state assets, I'm curious what the appetite is at this point to start considering locking in some longer-term funding on the liability side. Thanks.
spk03: Matt, good morning. We certainly talk about that regularly. It's something we're looking at evaluating, but we've not done anything at scale yet. You know, we continue to be quite pleased with the Treasury management growth. Those balances are 20% of our total deposits now, which, you know, we just started that business four or five years ago. So we'll certainly continue to look at that in an effort to drive, you know, a total return to the shareholder. And, you know, we'll update you with any strategy we employ on a go-forward basis.
spk07: Yeah, I think I would just add to that, you know, obviously we – we look at the deposit portfolio as an opportunity. I mean, it's obviously a way to fund the lending part of our business, but again, just take a brief outtake for relationship building, right? And so some of our time deposits might be what clients are expecting. Some of it will be what we'd like to do. So it's a bit of, at this point, it's a market where Our clients are not requesting that, so that puts us in a spot where we get to design the product mix. And at this point, as David mentioned, we think we have the right product mix at this point, but we're watching it consistently and putting our own forecast together on what we think would happen and what would make sense.
spk04: Okay. That's helpful. Any update on the loan floors? I think the press release mentioned that 94% of the loans are floating at index for 30 days. Just remind us how active the floors are currently and any commentary you can provide on how many Fed Fund hikes we'd have to see to get above those floors. Thanks.
spk07: Yeah, great. Yeah, it's less than two. So there's a bit of a difference on the floor levels across the different loan product types. in two Fed rate moves, we would be through the floors on average, fundamentally. So it's been a significant contributor to the business over the last 12 months, but as we continue to adapt new loan originations and how we're approaching spreads and floors going forward, it would be about two rate moves if you look at the whole loan portfolio.
spk04: Thank you.
spk08: Our next question comes from Steve Moss from B. Riley FBR. Please go ahead with your question.
spk06: Good morning.
spk02: Good morning, Steve. Good morning, Steve.
spk06: Maybe just starting off with the loan mix here. You crossed over 60% this quarter for private banking loans. Just kind of curious, you know, where are you thinking that mix ends up by year end here?
spk07: Sorry, just to clarify, do you mean as a portion of growth or just overall portfolio?
spk06: The overall portfolio, and definitely any color on growth would be good, too, just because obviously momentum seems very strong here.
spk07: Yeah, great. So, yeah, we continue to grow into the mid-60s from a portfolio composition perspective. I mean, as you're seeing, when we say 15% to 20%, we're talking about The private bank, obviously a larger base, and then growing at not quite double, but a premium, a multiple of the commercial side. That will continue to grow. I think this second quarter is probably a bigger difference between the rates of growth. I think the third quarter will probably be a bit more reflective. Um, but I think what we were talking about, the commercial side grew on 12% and the private bank were on 25%. So that's for the 10 to 12.
spk06: Okay, great. That's helpful. And then in terms of just, you know, loan pricing these days, just wondering, uh, if you can give any update on where spreads are, um, for commercial loans, commercial real estate, and also the private banking loans.
spk07: Yeah. So, um, I think. From our guidance perspective from last time, we were on our, I think we were probably still in the same place. Our CRE loans, from a yield perspective, sort of that 3 to 3.75 range. CNI loans, sort of the 2.5 to 3.25 range. And private bank loans, probably a 2 to 3% range. So those are from a yield perspective where we are seeing things come in now.
spk06: Okay, great. Thank you very much. Appreciate that.
spk07: Yeah, great.
spk08: And our next question comes from Russell Gunther from DA Davidson. Please go ahead with your question. Hey, good morning, guys.
spk09: Good morning, Russell. Good morning, Russell. Just a quick follow-up on the CNI expectations for the back half of the year. I appreciate your comments and the prepared remarks and the Q&A. But just if you could give some color on what's driving the optimism in the back half. I know equipment finance is seasonally strong in 4Q, but any other color in terms of, you know, order of magnitude for growth and what the drivers are there?
spk07: Yeah. I think we're, I mean, if you look at our, you know, again, rate of growth expectations or our goals for the commercial side, probably, you know, slightly lower than we've had in past years. So that, you know, a 12% growth rate is probably optimistic for a lot of people. It's probably, you know, middle of the road for us. So pleased but not satisfied with that, just from a point of perspective. But yeah, the first half of the year, we're continuing to see good production on the commercial real estate side. I mean, I would say that we've actually seen a little bit from an unanticipated idiosyncratic payoff perspective on commercial real estate where some of our clients not looking to sell were offered some pretty significant opportunities. We've lost that balance in the short term, but those are clients that we work with very significantly, and we see them redeploying that capital into new opportunities. So we'll be there with them to grow that piece back. But overall, commercial real estate, we're confident in our ability to continue to grow that in a positive sense with our clients. And then the fund finance, if we look at it, We're only about $200 million borrowed against about $600 million in commitments. So we see a significant opportunity for that to pick up in the second half of the year. So we continue to grow that business very nicely, and we like who we're working with. But we see more opportunities and just timing of where they're going to put capital to work in the second half. So that'll be positive. And then, as we indicated, second half is usually better for equipment finance anyway. But if supply chains ease and things of that nature, deals that we've already won that we'll fund in the third and fourth quarter, it will be positive. So those are the fundamental aspects. I mean, nothing really, I think we're, nothing exceptional, pretty consistent themes that we've had over the year just coming to play in the second half of the year. But overall, we're very optimistic about how our clients and prospects are performing. Again, we obviously provided deferral activity, but as of today, we're down to two loans that are still in a deferral program of less than $20 million. Again, the way that our clients have managed through this and are growing actually through the 21-22 timeframe is very strong. We're optimistic about our ability to grow with our existing clients as well as track new ones.
spk09: I appreciate the call, Brian. Thank you. And then just switching gears for the last question, too, expenses. You guys reiterated the 10% to 12% expectation. For this year, as you continue to plan for the future and continue franchise investment and items like travel and entertainment might begin to normalize, Is that a range that you expect to be able to maintain over a longer term, or are there near-term plans for the businesses that could push that range higher going forward?
spk02: This is Jim Goetz. Let me comment first, and this is probably one of the only times in this type of call that you'll hear this. This expense growth has always been by design. And our expenses clearly reflect our continual investment in our people, our infrastructure, our technology, and our clients while moving toward the future. And we're doing this, as you notice in this quarter's numbers, while our profit margins are expanding. So that's what I meant in the end of my presentation when we talked about critical masks. We've reached that critical mass level that we're going to be able to continue to do that and invest in the future while we're providing a profitable franchise to our shareholders. David?
spk03: Yeah, Russell, let me just add some color commentary to that. So year over year, we've grown a revenue at 16%. The balance sheet's grown at 26%, and expenses, as you note, are growing at about 14.5%. This supports our overall goal of positive operating leverage. Importantly, the overall efficiency ratio for the bank has slightly improved when comparing the year-to-date results over the prior year, as has the non-interest expense to average asset ratio. The efficiency ratio stands at 51% year-to-date, and non-interest expense is about 126. Our ROE, our return on equity, has steadily and substantially improved in each of the last four quarters, It now stands at 1037 on a spot basis as of the most recent quarter, as we've put the capital that we've raised in two different raises last year to work. We believe we can continue to drive ROE improvements in the quarters ahead. What this tells us is that the investments we're making, that Jim pointed out, are driving better execution and making our business more efficient and effective. It tells us that we're making good investments. Let me give you some color on the primary drivers of expense growth. One is people. Compensation cost is up 20% year over year, and technology and data services is up 44% year over year. The growth rate on these two expenses should moderate somewhat in the second half of the year. Hiring was minimized last year's second quarter in light of the early stages of the pandemic, whereas this year we have front-loaded that hiring to the beginning of the year coupled with strong financial results driving incentive accrual increases. But that hiring pace should moderate somewhat in the second half. In the area of technology and data, we delayed our innovation and development spend through the second quarter of 2020, again in light of the pandemic, but began implementing more robust development in the second half of last year, and that continues into 2021. For technology and data on a full year basis, I would say the year-over-year comparison should be somewhere in the low to mid-20% range, down from 44%, what you're seeing right now. Other expenses is also something that grew very modestly in the quarter. It was driven by growth, growth in our unfunded loan commitments. That expense is categorized differently than the funded on-balance sheet loans. through the reserves in the income statement, so just simply a function of growth. We still intend to drive positive operating leverage, growing revenue faster than expenses, and we are driving to keep expense growth to 12% year over year. We've got work to do to get there, but we will not sacrifice our long-term objectives and will continue to focus on serving our clients well.
spk07: Yes, I'll just add, you know, we're... I think both Jim and David summed it up well. We're excited about where we're going. We took about a four-week hiatus last year just to see where things would sort of level out in the second quarter, but absent that four weeks, we've continued to invest in the business, understanding where the opportunities are. Again, as we sit here around the table, we're as optimistic as we ever have been in all the lines of the business. I think Jim summed it up earlier. We couldn't be more happy with what we're showing here, and this makes sense to keep investing in this and staying ahead of it and rewarding not only paying off growth, rewarding investors, and rewarding our clients for continuing to grow with us.
spk09: Thank you all for taking my questions and the detailed response.
spk02: Thank you.
spk08: And ladies and gentlemen, we have a follow-up from Matt Olney from Stevens. Please go ahead with your follow-up.
spk04: Yeah, thanks for taking the follow-up. I guess as I speak with investors, it seems like the market's very concerned about tri-state impact to higher short-term rates. And we talked earlier about the floors that could be a potential headwind for at least the first few rate hikes. But I guess taking a step back, I'm curious what you'd expect from the bank's net interest margin on the first few rate hikes. If I look at the 10Q disclosures around the shock analysis, my assumption is that the bank does expect an initial downward move in the margin with the first few rate hikes, but would love to hear any commentary you can add to that.
spk03: So Matt, we just followed the dot plot, right? And so the dot plot would suggest there's two raises sometime in 23. But as I just look at our forecast for the next two years, which obviously is very preliminary, we see modest expansion throughout that period. So we're not tied to the 10-year. We're tied to short rates, as you point out. But between deposit cost moderation, things that we're studying in terms of sort of fixing rates for a longer period of time, and just the ability to deploy the liquidity quickly into income-producing assets, we see modest expansion through the next two years.
spk07: I think from a cost of deposits perspective, the one thing that's not modeled in there is, again, from a client perspective, our goal is to work with every product that they would need, and our goal is to own their entire relationship. So we have a blend of non-interest bearing and interest bearing deposits with them. But if you look at the service side of the business, and you look at our treasury management business, I think we've talked about it before, in a normalized rate environment, our goal is to run that business on the rate side at a LIBOR equivalent of minus 100 basis points. So LIBOR... you know, whatever index you want to pick, you know, less 100 basis points. So if you think about here, we're obviously, there is no 5 or minus 100. So, you know, we think that there's a lot of protection built into the existing business, which is a natural hedge, which is obviously the way we built it. And then obviously, you know, as you talked before, you know, with opportunities for us to build in term deposits and some other things as we get closer. But that breakeven point is pretty important, as you know, and So absent a real client demand, we're probably a little early in that process. But again, a lot of natural hedges built into the business that maybe weren't as robust in the 2018 timeframe.
spk04: And within the deposit balance, can you remind us what percent of those are indexed and how would you expect that to change, if at all, over the next few years?
spk07: Yeah. So if you look at... Overall, we talked about it in the release, that we talked about 60% of non-time interest-bearing deposits are linked to an EFF or some equivalent index. If we look at overall, it comes out to about 21% of total deposits that would be indexed in that way. moderating that pretty significantly. At one point, we were probably more in that 45% range. We think, again, a good diversification across the deposit portfolio. We still like that from a pricing perspective. It's the source of a lot of sophisticated relationships with us who we have private bank relationships with and other lending aspects. We're happy with that. you know, that component of the portfolio. But it's a good measure of where we continue to diversify the deposit base and the pricing base.
spk04: Okay. That's great, Brian. Thanks for that. And then I guess the last question is around capital. And I'm looking at the leverage ratio at the bank. I think we're now, I call it 734. And I think we saw the capital raise last year when we got down to that 7% level. So we'd love to hear any updated thoughts you have on on addressing the capital needs of the bank, especially given the strong outlook for loan growth from here.
spk03: Yeah, Matt, as you point out, we've grown the balance sheet at the higher end of our expectations this year, strong growth, and we expect that to continue. We've worked hard to put the capital raise last year to use in high-quality new loans and increased balance sheet liquidity in the investment portfolio. We're striving to get that to 15%, and we're close now. I talked a little earlier about our ROE, or return on equity. We're pleased that it's at 1037. We believe we have more room to improve that in the coming quarters. And that's up from 6.5% this time last year, so great improvement there. The capital we've raised is now deployed and starting to generate meaningful returns. We continue to be very thoughtful and flexible around capital strategies. We don't necessarily need to raise capital before year end, and we define starting 22 with the current levels in terms of the balance sheet composition, loan growth, and where capital sits. Having said that, we'll continue to look at opportunities to raise capital in what we would describe as a very economical and most efficient way with a continued focus on the shareholder. Given the market conditions, sub-debt could be a very attractive form of that additional capital given where rates are, And as you know, you raise that at the holding company, push it down to the bank, and it counts as tier one. So no immediate plans to access the capital markets, but, you know, it's something we're looking at as the coming quarters play out.
spk07: Yeah, and I think I would add that, you know, Tim used the statement, you know, what our primary job is, our mission is. And so, you know, we saw it as obviously having raised $200 million, you know, in a pretty rapid fashion. time period in 2020, again, taking the moment in time to realize that we were going to have some pretty significant growth opportunities, which we would consider better than the market or better than the industry, and we knew that we needed to take that time to invest so we could be there for those opportunities. So we're certainly bringing those to bear, and we viewed it as part of our job on a risk-adjusted basis, responsible growth basis, to deploy that capital as quickly as possible to basically cover the lag on capital raises. So we're very happy with where we've done it. If you look at the asset growth relative to, for example, the loan to deposit ratio is 91%. It's clearly reflective of our ability to raise deposits and deploy that into other assets. Those assets, that asset mix could give us some flexibility as well. is how we look at funding the loans at any particular time. We've talked about it before. From an investment perspective, staying very high quality and relatively short duration. Again, our goal is to be as agile as possible between funding and capital and asset and balance sheet management. We have some flexibility in there, as David pointed out, timing but certainly being opportunistic. We have some historic opportunities to Ahead on the growth side, probably the capital if we wanted to pursue that in the sub-debt space and otherwise just to manage our balance sheet.
spk04: Okay. Thanks, guys. That's all from me. Congrats on the quarter.
spk07: Thanks, Matt. Thanks very much.
spk08: And ladies and gentlemen, with that, we'll conclude today's question and answer session. I'd like to turn the floor back over to management for any closing remarks.
spk02: Thank you very much for your continued interest in Tri-State Capital and your participation today. We certainly look forward to updating you on the third quarter results in October. Have a great day.
spk08: Ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.
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