CSTR - CapStar Financial Holdings Inc. (CSTR) Q1 2023 Earnings Call Transcript

2023-04-21 14:38:02 ET

CapStar Financial Holdings, Inc. (CSTR)

Q1 2023 Earnings Conference Call

April 21, 2023, 11:30 AM ET

Company Participants

Tim Schools - President and CEO

Mike Fowler - Chief Financial Officer

Kevin Lambert - Chief Credit Officer

Lee Hunter - Executive Vice President, Commercial Real Estate Lending

Conference Call Participants

Will Jones - KBW

Brett Rabatin - Hovde Group

Kevin Fitzsimmons - D.A. Davidson

Graham Dick - PSC

Feddie Strickland - Janney

Presentation

Operator

Good morning, everyone. And welcome to CapStar Financial Holdings First Quarter 2023 Earnings Conference Call. Hosting the call today from CapStar are Tim Schools, President and Chief Executive Officer; Mike Fowler, Chief Financial Officer; and Kevin Lambert, Credit -- Chief Credit Officer.

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 will 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 performance and 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 public 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 like to also offer you -- we also refer you to the page two of the presentation slides for disclaimers regarding forward-looking statements, non-GAAP financial measures and other information.

With that, I will the presentation over to Tim Schools, CapStar’s President and Chief Executive Officer.

Tim Schools

Okay. Thank you, sir. Good morning and thank you for participating on our call. In first quarter we reported earnings per share of $0.30 and a return on equity of 7.41%. These results included a $2 million write-off equating to $0.07 per share of Signature Bank subordinated debt, which I will discuss in a minute, as well as $216,000 of loss equating to $0.01 per share related to our Mortgage and Tri-Net divisions, which are valuable businesses, but volume -- who volumes are impacted by current market rates.

Additionally, our SBA division had $400,000 of fees equating to $0.015 per share, which were deferred into early second quarter 2023 due to delayed closings. I will also note, we returned nearly $10 million to investors in the first quarter through dividends and stock repurchases, as well as increased our dividend 10%. We have now increased CapStar’s dividend 120% since early 2021.

As everyone is aware, the industry has faced deposit challenges the past 12 months as market rates have risen at one of the fastest paces in history. A side of this and warrant of the outlook in our second quarter 2022 earnings call when many banks were still communicating expectations of deposit growth.

The fastest change in market rates in a long time has caused industry deposit outflows, migration within banks from non-interest-bearing to higher yielding alternatives and overall price competition.

One of the biggest competitors in the past year has been the U.S. Treasury, where customers often in non-interest-bearing accounts moved money to earn 4% to 5% in six-month and 12-month treasuries.

In January, banks in our markets began to offer money market rates and nine-month to 12-month CD rates approaching 5%. We have been disciplined trying to balance the repricing of our deposit portfolio, while still trying to grow deposits by introducing brokered CDs.

As a younger organization, CapStar’s deposit organize -- franchise historically had a heavy emphasis on correspondent banking deposits in larger wealth management investment type accounts. Over recent years, we have worked hard to lessen their overall emphasis.

While average customer deposits were down for the quarter, we are pleased our end-of-period customer deposits were up and stable following the Silicon Valley and Signature events. Our team has worked hard to communicate with our depositors.

Throughout the fall and into 2023, we have worked to reduce loan growth, specifically by raising our expected spreads and curtailing commercial real estate loans, which tend to have lower deposit opportunities. Despite these efforts, loan growth was up 7% annualized on an average basis and 16% annualized in the period in the first quarter of 2023. In each case, C&I and residential real estate loans led the growth with declines in non-multifamily commercial real estate.

As noted, we have had a write-down this quarter or in first quarter of Signature Bank sub debt. I’d like to take a minute to discuss this and summarize our investments in these securities. When I joined CapStar in the summer of 2019, CapStar’s balance sheet had significant wholesale type balances on each side of the balance sheet. Loan participations in HLT loans had at 1 point been in the 40% to 50% of loan range and CapStar had had a loss of $10 million and $4 million on single individual credits. Outside of participations in HLT, CapStar loans had grown 3% a year the prior five years.

At that time, we set out to transition CapStar to a Tennessee-based bank focused on relationships we would lead. As a bridge, we invested about $70 million into investment grade, liquid, more granular investments from $10 million-plus non-secured non-guaranteed participations that were often out of state as we developed loan capabilities.

Today, we are proud that our SNCs are less than 1% of loans at $6 million and other participations are $85 million and 4% of loans, 100% of those balances are in the State of Tennessee.

Alongside this, we have now also have $450 million of loans in Asheville, Chattanooga and Knoxville, in which we lead and are largely have collateralized and guaranteed positions. Unfortunately, Signature resulted in a loss.

As many of you are aware, Signature has had a stellar reputation for many years and was investment-grade rated when we purchased purchase, as well as at the beginning of this year. We have outlined the profile of our sub debt portfolio in our investor slides, as well as the underwriting criteria that was used to select these. We have recently performed a review of our remaining investments and feel good with our holdings at the current moment.

Switching to non-interest income, we were pleased with the first full quarter of our SBA Group. As I said previously, $400,000 of fees rolled into 2Q 2023, but they also generated another $350,000 of fees that require seasoning under the SBA before they can be sold, which will likely be in third quarter. So in total, their activity generated approximately $1.7 million in fees in the first quarter. This Group has a lot of potential.

Mortgage volumes increased in March and looked good for April and May. The gain on sales spread also increased in the first quarter. If rates stay in the 6% to 6.5% range, we would expect similar volumes to the first quarter.

TriNet closed and sold its first loan since August and early April at a premium and is working on its second. We are optimistic pricing might be settling down where we can return to some level of volume. Again, our Mortgage and Tri-Net divisions in the first quarter had a net pretax loss of $216,000.

Asset quality remains strong across our credit portfolio. Three relationships, which had entered 90 days last quarter have entered forbearance agreements and are now current. Past dues this quarter are comprised of one significant relationship for which we are secured and have a personal guarantee. We are actively working with the customer. Later in the slides, Kevin Lambert will cover information related to our CRE portfolio, which we are actively monitoring and feel very good about.

I will now turn it over to Mike Fowler.

Mike Fowler

Great. Good morning and thank you everyone for joining. All right. On page four, a few brief comments on liquidity. So we have a diverse source, sorry, we have a diverse source of on- and off-balance sheet liquidity totaling $1.6 billion. That represents 160% of our $1.3 billion of uninsured and uncollateralized deposits.

So we have -- our securities portfolio remains a modest part of our balance sheet 12% of assets. We continue to have strong capital levels. We have brokered CDs. As Tim mentioned, we have been tapping wholesale funding. We have brokered of about $370 million and $55 million of home loan borrowings.

We have not yet accessed the Fed’s new Bank Term Funding Program. We are certainly considering that monitoring pricing relative to other options and I certainly tap that if the economics appear attractive.

In terms of page five, our deposit portfolio growth. As Tim noted, we have seen stability and increase in our customer deposit balances over the course of the first quarter. Average versus Q4 was down, but as Tim noted, we have seen an increase from year-end through 3/31.

We continue to have a consistent focus on deposit growth, especially operating accounts. We continue to be -- strive to balance being very competitive, while also being disciplined on pricing on the deposit side, and as Tim said, we certainly continue to do that on the loan side.

Post SVB, we were very proactive, as Tim noted, our bankers reached out to their largest customers and largest depositors, had discussions to ensure they were comfortable with our situation, our financial stability.

We did see some movement, about $150 million in movement within our deposit portfolio into reciprocal deposits, a product that we have offered for many years that as most of you know, will provide to the customer a full FTSE insurance. We have a solid pipeline on the deposit side and we continue to look for growth opportunities across our footprint.

On the next page, I will actually skip page six and seven, I think Tim covered all the key points there. On page eight, regarding key financial results, as Tim noted, EPS of $0.30; net interest income was down modestly due to a 20 basis points decline in the margin related to deposit-related pricing pressure; non-interest income is flat, we will go into more detail on that in a minute; and expenses were up and we will cover that in a minute as well; and then we have the $2.4 million provision, as Tim noted, $2 million of that relates to our Signature Bank sub debt.

I will go to page 10 and briefly comment on loan growth. Commercial loan pipeline has slowed due to a reduced market demand and to the cutback in CRE. Our current pipeline is about $220 million.

We continue to focus on disciplined pricing versus the match-funded home loan curve and you can see our pricing on the chart in terms of average yields on Q1 originations, 6.8% on fixed rate swaps, a higher 7.4% given the current inverted curve on variable rate loans overall 7.1%.

As Tim noted, we continue to strive to be disciplined on pricing on both sides of the balance sheet, and certainly, given the increased pressure with deposit pricing, we continue to reiterate to the field the need to be achieving sufficient and attractive pricing on the loan side.

Next, page 11, on the margin Deposit costs increased 58 basis points versus Q4. If you look at the chart in the bottom left, you can see the breakdown by category. So non-correspondent customer deposits rose 32 basis points to a level of 1.1% correspondent and broker deposits both rose about 98 basis points. Overall, deposits rose 58%.

So we are pleased that on the customer side, again, we are able to grow that modestly with disciplined pricing, being competitive where we need to be, but again, trying to balance profitability and growth, we would certainly target deposit growth to keep pace with loan growth challenging in this rate environment, but that continues to be the focus of the markets.

I will turn it to Kevin for a minute on page 12 to comment on loan portfolio performance.

Kevin Lambert

Thank you, Mike. We are very pleased with the continued strong performance of the bank’s loan portfolio. Asset quality remains very good with annualized charge-offs of only 3 basis points for the first quarter, as noted in the upper left-hand graph. Past dues ticked a couple of quarters ago as detailed in the upper right-hand graph, the increases in both the third and fourth quarters were primarily related to a couple of large relationships totaling $8.3 million, over $3.3 million of this total has a 90% SBA guarantee and the other relationship, which was acquired through a merger is now performing and is actually on pace to return to accrual status by the end of the quarter.

Excluding one long-term relationship that was delinquent at the end of the first quarter, past dues would have been 12 basis points at the end of Q1. As can be seen in the graph, in the lower left-hand side, the bank’s criticized and classified loan levels increased during the quarter, primarily due to the downward migration of a single previously watch rated credit. This credit continues to perform and is fully secured and maintains a sizable amount of deposits with the bank. So no loss is anticipated. In summary, asset quality remains very good with low levels of charge-offs and past dues and near record lows for criticized and classified loans.

Turning to the next slide, in terms of our provisions. The bank adopted CECL effective the 1st of this year, due primarily to the change in accounting methodology, the bank’s allowance has increased by approximately $4 million since the end of last year and now totals approximately $25 million. Based on our low historic levels of losses and the quality of our other portfolio, we feel the allowance continues to be sufficient.

Mike, I will turn the floor back over to you.

Mike Fowler

All right. Thank you. All right. On non-interest income on page 14. Overall non-interest income for the quarter is flat. However, as Tim noted, activity in the SBA business in Q1, generated revenues that will be recognized in Q2 and Q3 of $750,000.

On the Mortgage side, you can see that gain on sale revenue doubled versus last quarter, as we are beginning to see a return to more normalized margins and modestly increasing originations, which, as Tim noted, we expect to remain at these levels or move modestly up if Mortgage rates remain at current levels.

On the next page, you can see more detail on our Mortgage and you can see that our primary focus continues to be purchase money volume. We have had very consistent originations on that side. You can see the revenue increased $650,000 from last quarter and you can see the margin is up sharply about 90 basis points to 240 basis points this quarter.

Next, page 16. In terms of SBA, as Tim noted, a business, we are very excited about. The new team that we hired in Q4 has really hit the ground running and we feel very, very strong prospects looking out over the remainder of this year.

You can see on the top left, if you take Q1 revenue annualized, we do have significant upside versus prior run rates. So $6.2 million on an annualized basis. So we feel very good about that group and its prospects.

On page 17, regarding non-interest expenses, we had a number of things contributing to the increase this quarter. Number one, you may recall, last quarter, we recorded a $730,000 recovery of Q3 operational loss.

Number two, we had salaries and benefits increasing, including $180,000 in the SBA team expansion. We had increased payroll taxes of a little more than $300,000. We had lower loan origination deferred expenses of about $110,000. And we also had something that everyone in the industry is seeing, we had increased FDIC assessments for us, that was about $140,000 for the quarter.

In terms of page 18, I would say, these continue to be the various options from a capital allocation standpoint. We continue to look to be balanced and disciplined in terms of deploying capital.

As you have heard us say in prior quarters, our first priority is supporting organic growth. We continue to increase our dividend over time. As was noted earlier, we continue to be in the market with authorized share repurchases. We did announce, as you recall, a new $10 million share buyback program in January. We have about half of that $5.4 million remaining as of March 31st.

All right. I will turn it back now to Kevin to talk about credit culture and CRE.

Kevin Lambert

Yes. Skipping to page 20. We did want to highlight our loan portfolio. We feel very good about the composition of our loan portfolio in general and want to highlight the bank’s overall portfolio mix, as well as address some potential concerns related to investment CRE loans, which are obviously a hot topic in the industry as properties feel the impact of higher interest rates.

As can be seen in this slide, the bank believes in a well-diversified mix with the goal of assets split into equal thirds in C&I, consumer and investment CRE. Our primary Tennessee markets, Nashville, Knoxville, Chattanooga, as well as our new market in Asheville, North Carolina, continue to enjoy robust growth and normally outperform other areas of the country during downturns.

Over the past several years, we have virtually eliminated shared national credits, which now account for less than 1% of our -- of exposure. Our focus continues to be on organic local growth with the current emphasis on C&I and consumer lending.

On the next slide, I wanted to give some details in regards to our mix of investment properties, which as can be seen here, the highest level of our concentration is in multifamily projects. We feel very good about our multifamily exposure as most projects have a minimum of 35% to 40% in equity injections. This is also true with our hotel exposure, which has performed very well.

Our retail sector of CRE includes approximately $100 million in credit TriNet exposure, primarily related to loans originated through TriNet. These loans generally have 10-year triple net leases and have performed well in downturns.

We continue to avoid A&D loans, which constitute a nominal portion of our portfolio. Several months ago, the bank began tightening its parameters and appetite for CRE loans. We have been busy analyzing our portfolio for potential weaknesses, especially in the opposite -- in the office sector, which is detailed in the next slide.

So, virtually, all of the bank’s office exposure is located in Tennessee, mostly in our metropolitan areas and usually not in central business districts. There is an exception in Chattanooga as it relates to Central Business District as most office buildings in this city are located in its CBD, which has remained very vibrant. This area, as well as others throughout the state continue to fare well as people relocate to Tennessee, which remains one of the fastest-growing and most physically responsible states in the country.

On the next slide, we show our general underwriting guidelines. This slide details the three broad areas within our bank that originate CRE loans. Our CRE Group led by a very experienced team of high caliber real estate specialists handle the majority of the bank’s investment real estate loans. Their portfolio is categorized by high levels of equity and that of TriNet.

On average, the bank CRE Group has loan-to-values in the 50% neighborhood of TriNet’s portfolio has an average loan-to-value of 60% based on our recent review. Our commercial bankers in our markets also do CRE loans, which are smaller in nature, but which unlike the CRE Group and TriNet typically have unlimited guarantees.

Loan-to-values are usually 80% or less and amortization periods are usually shorter as well in the markets. We feel very good with the standard due diligence and conservatism of our underwriting. We believe our CRE portfolio will fare well in the coming months.

In the next slide we will show the details of our maturing CRE loans with specific emphasis over the next two years as loans with fixed rates will be most impacted during this timeframe as loans were renewed.

A recent review of our upcoming maturities in our CRE Group showed the ability of our borrowers to continue to perform well even with the higher levels of interest in those that are currently in place.

Loans within the CRE Group, which tend to be larger that are maturing within the next two years, have a weighted loan-to-value average of less than 50% and the Group has -- had a debt yield floor of 9.5% or more depending on property type for several years. Its portfolio has been stellar with no losses in the history of the bank.

Also note that we expect $30 million in runoff in multifamily exposure during this quarter as a few projects are scheduled to be taken to permanent financing as is the normal course of business for these types of loans.

On the next slide, our loans are continuously reviewed. We reviewed this both internally and externally. External exams are done at least twice a year. Our rollover lease risk is mitigated with higher levels of equity on most projects. Interest rates are stressed at the time of approval and when renewed and the bank actively manages concentration risks, which are reviewed on a monthly basis.

With this, I will turn it back over to Tim.

Tim Schools

Okay. Thank you, Kevin. The environment continues to be challenging and I am proud of our team, which is working hard to provide great service to our customers and ensure we protect the financial soundness of the bank.

That concludes our presentation and we are happy to answer any questions.

Question-and-Answer Session

Operator

Certainly. [Operator Instructions] Our first question comes from the line of Will Jones from KBW. Your question please.

Will Jones

Hi. Great. Good morning, guys. Stepping in for Catherine this morning. How’s everybody.

Tim Schools

Hey. Good morning. How are you doing?

Will Jones

Doing well. So, Tim, I just wanted to start on the margin. Obviously, it took a step down this quarter as you guys continuing to see deposit pricing pressure, as well as the mix shift play out. I am just hoping you could give us an outlook on where you think the margin trends from here and maybe you could comment on what the spot margin was in March? And just in terms of the mix shift there are playing out, as I look back over a year ago, non-interest-bearing deposits were closer to the mid-20% range of deposits and now that sits closer to mid-teens today. Just you -- how far along do you feel like we are in the mix shift store and where do you feel like those non-interest-bearing deposits eventually trough out? Thanks.

Tim Schools

Well, great questions. A couple of things on that. One is, I think, if you go back a year ago, we probably had zero in brokered CDs and now we have $370 million. So a big -- there’s been mix shift and there’s been dilution of the percentage by adding brokered CDs. I’d have to calculate it and see what the percentage was if we didn’t have the brokered CDs.

But there certainly is migration going on. Like I said, where people were getting when rates -- when Fed funds was at quarter or 50 basis points and there wasn’t much to get. And now they can go get a six-month treasury or Renasant has been offering 4.5% money markets here in Nashville in the newspaper. It’s just there’s a movement.

I know everybody wants the magic answer. I am a conservative person. Again, I was the one in second quarter or in July that said, hey, I think deposits are going to be tough for the rest of the year. I think they are going down. I know other banks were saying they were going up. And so well, I don’t have the magic answer.

And I think, hopefully, we are near the end of the rate increases from the Fed. Banks were slow to raise rates as they try to protect their deposit portfolio and it’s a real balance of trying to grow versus cannibalization and that’s why we introduced brokered CDs.

I would hope that if we looked at betas, the really people that were elastic to deposit rates. I hope they were impressive first and that those are the ones that moved or those are the ones that sought the highest price and that, that would trail off. But that’s about as best as information I could give you.

The March margin was around 3.10% and so there is continued pressure as marginal deposit costs to grow a bank, you are not really getting a lot of non-interest bearing, you find the operating account takes longer to move and you do give an earnings credit rate on that. So there is an inherent cost.

But the marginal cost right now of getting a money market or a CD is in the 4% to 5% range. As you see, our new loans are being priced at around 7%. But in general, the loan repricing of banks and ours has not repriced as fast the last 12 months as deposit rates have changed.

Mike Fowler

Yeah. I -- this is Mike Fowler. I would add to that, in terms of, your question about DDA and the decline in our DDA or non-interest-bearing DDA balance. As Tim noted, a lot of that is driven and we see this in reports through the industry.

A lot of that is driven by balance that are compensating balances for service activity. And customers obviously need to leave less with short-term rates where they are today versus where they were a year ago.

We do -- if rates stabilize or if we are near the peak, then I think that pressure should certainly subside and I think we could certainly expect to see some reversal of that when the Fed starts moving rates down, whenever that is.

Will Jones

Great. That’s very helpful. I know I am asking you to look into the crystal ball a little bit there, so I really appreciate the color. And just trying to growth, you guys obviously saw really good growth trends this quarter, both on the loan and deposit side. I appreciate the pipeline is slowing a little bit. Just looking to get any commentary on your appetite to grow loans from here and maybe where you see loan growth trending as we come into the second and the back half of the year here. Could we see a mid-single-digit pace?

Tim Schools

Well, I think, we have -- CapStar has been a transformation, right? And I don’t -- I just focus on what I can control. I don’t like to criticize. And so the starting point, as I said, had substantial wholesale really on both sides and we really set out in the summer of 2019 to transform both sides and we have made tremendous progress on the loan side.

As I said, SNCs less than 1%, other participation is less than 4%, blah, blah, blah. And we actually had aggressive actions on deposits in the fall of 2019 and then the pandemic happened and you had $400 million of deposits flow in and your phone would ring off the hook from investors, what are you going to do with those deposits.

They are sitting there. They are not earning thing. You need to do something. You need to lend them out. And so it’s hard to please. We would all love it to be a perfect environment every day and it’s different when you are an operator and you are running a company.

And so, ideally, in a stabilized market will -- I’d love to have a company. I was looking at Lakeland Financial slides the other day, 150-year-old bank, they have grown loans and deposits 11% each the last 30 years. I mean, wow, what a wonderful calibrated model they have and I think we have come a long way.

I think that in our markets with our team, there’s good CRE loans out there right now. I think it’s late in the cycle and do you really want to be doing development and I think they don’t come with deposits. So we have slowed that down.

But I think with our markets and our team, we could grow loans 8% to probably 14%. I don’t think that’s prudent in this environment. So we are really focused on the soundness of the bank, meaning asset quality, liquidity, profitability.

And so in the interim, I’d like to make sure that deposits have stabilized. They are coming at a cost for all banks, which is hurting the margin. But I’d like to see that stabilize. I’d like us to see us continue to build those capabilities. I think like we did on the loan side that we can prove over time that we can gather deposits. It never really was a long-term emphasis of this bank.

And so I would say that, what I would like to see is I’d love to see where our team can bring in deposits and loans in the 8% range and let’s get that going, and then once we get that going, we could up it. But we are threading a needle through this challenging economic environment.

Will Jones

Understood. All fair and I appreciate the commentary there. Thanks.

Tim Schools

Thank you, Will.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Brett Rabatin from Hovde Group. Your question, please.

Brett Rabatin

Hey. Good morning, gentlemen. I wanted to start…

Tim Schools

Good morning, Brett.

Brett Rabatin

Good morning, Tim. I wanted to start with just looking at from a regulatory filing perspective, you have got about a third, a third -- a third of assets repricing less than one year, one year to five years and over five years. Could you maybe give us any clarity on how much you have our pricing in the loan portfolio here in the next couple of quarters and then similar on CDs?

Mike Fowler

Sure. Yeah. Good morning, Brett. This is Mike. So on the loan side, I would say, yes, about 60% of our -- I don’t have the maturities on the loan side over the next few quarters. I can follow up with you on that off-line. But we have got -- as you said, we have got about 33% of our portfolio that is variable that will reprice immediately and about 6% that will reprice beyond the year. So I will maybe come back to you in terms of the breakdown on the fixed rate that is maturing and will reprice over the next few quarters. On…

Brett Rabatin

Okay.

Mike Fowler

On the deposit -- yeah. On the deposit side, I would say, we are certainly actively repricing our non-maturity deposits as market rates move. I don’t have the breakdown. I will come back to you in a few minutes in terms of breakdown on the CD side by maturities. So let me come back to you in a few minutes later on the call.

Brett Rabatin

Okay. And then, Tim, you talked at length about the environment and what you do when things like this happen. Nashville is obviously a highly competitive market. I wanted to hear your thoughts on what you were seeing funds transfer pricing spreads. Is there a widening in terms of spreads, and if so, do you feel like that’s a function of lower credit availability or just where the yield curve is? Thanks.

Tim Schools

Yeah. Great question. And again, I have talked about this in the past and we all have different backgrounds. And I understood there was some misunderstanding after a previous call. But my experience here and at larger banks is banks price their loans off of a funds transfer pricing, equivalent matched wholesale curve, whether it be the swap curve or whether it be the FHLB.

So when I talk about spreads, it’s not spread to our deposit costs, it spreads to a theoretical match term if you had no deposits. So anywhere I have been, I have sort of been trained to try and seek 200 basis points or higher on the commercial side relative to match funding.

If you go back to the fourth quarter of 2021 from memory, our FTP spread, match funding spread on commercial loans was 250 basis points. And that’s a good target, Brett, because if you get like a sheet of paper out and do 200 basis points in Excel on $1 million or $10 million loan, you have got to subtract out, and again, that’s FTP.

So that’s got your funding cost. You have got to subtract out some level of operating expense, whether it be servicing or incentive, you have got to back out potential, whatever you estimate for credit and you have got to back out a tax rate.

So if you don’t get about 200 basis points, you are not going to end up with a 120 basis points, 150 basis points ROA on that relationship. So we had 250 basis points. As you entered 2022 last year, the first half of the year, our FTP spreads were in the 150 basis points range, 175 basis points range.

And what it was, Brett, and I am not criticizing all banks don’t use fund transfer pricing and are not sophisticated on pricing and you have got everybody competing for volume. So when rates started shooting up in the first half of last year, I would say, both competition, people wanting to get volume, as well as some lack of sophistication, they were low. It was sort of like heart in the Mortgage world, in our Mortgage company where they have now come back.

And so what I would say is that happened through maybe third quarter and since third quarter, spreads have started to come back. I think that is banks seeking less growth and so some of it is banks can get more. I think some of it is banks wised up and finally raised their spreads, because the deposit rates going up.

And so, in March, I had my March numbers in my head, what we did is some to offset the deposit pressure, some to slow loan growth. We said in first quarter, let’s target 250 basis points on 3 rated credits and better. Let’s target 275 basis points on 4s and 300 basis points on 5-rated credits.

We didn’t always get that, but that’s been our target. And I think our weighted average in March was much improved, and our weighted average was more in the 225 basis points range. So we didn’t always hit what I just said on our goal, but we are creeping back to what it was in that fourth quarter of 2021.

Brett Rabatin

Okay. That’s really helpful, Tim. And then if I can sneak one last one in. My line was…

Tim Schools

Sure.

Brett Rabatin

… breaking up a little bit when you were talking about slide 17. Mike, I just want to make sure I understood sort of the run rate from here on, in particular, the salary employee benefits line and then just the other line?

Mike Fowler

So I will answer that real quick. We are going to work hard to target expenses at the current revenue level in the $18 million to $18.5 million range. And obviously, if SBA does really well and TriNet comes back and Mortgage comes back, there are variable expenses related to those.

But we had the $700,000 come back in fourth quarter. And then you do have FICA tax that starts over deferred loan expense because volume is down, we didn’t have as much benefit as fourth quarter and then you have the FDIC.

There were one or two bills that when you are a small company, our health insurance, it tripped over -- it was about $150,000 from fourth quarter, but we are going to work hard through better management, as well as seeking some expense reduction to try and manage these between $18 million per quarter and $18.5 million per quarter.

Brett Rabatin

Okay. That’s helpful. Thanks for all the color, gentlemen.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Kevin Fitzsimmons from D.A. Davidson. Your question, please.

Kevin Fitzsimmons

Hey. Good morning.

Tim Schools

Hey, Kevin.

Kevin Fitzsimmons

Hey, Tim. Listen, I know it’s difficult with the -- going back to margin and maybe also we can tie in dollars of NII to it because I think that’s important. I know it’s difficult to the kind of crystal ball question, but we have heard from a number of banks and whether they are right or whether they are too optimistic indicate that second quarter there would be additional margin pressure but probably at a diminished pace from -- that we saw in the first quarter and then likely to see margins start to stabilize in the back half of the year. And I think that’s all assuming the Fed does one more hike in May and then pushes away. Is that -- and then coin -- and then in conjunction with that, I think, there’s a sense that once the Fed has done that mix shift really starts to abate. All that said, I mean, it’s -- can you kind of characterize how you are looking at that relative to that outlook we are hearing from a number of banks? Thanks.

Tim Schools

I think that would be my overall thesis as well. If you ask me from a probability standpoint, what do you think is more likely to play out? I am very conservative. So I probably would delay it one or two quarters than what you described.

I mean I think we are near the tail end of rising. I think the most aggressive people sought early in either moved or switch products. I think that as that slows, you are going to have your loans catch up.

And so I think your thesis, I would agree with that thesis. When it kicks in and when it has a material effect, I am not sure. But I think what you described I would believe in and sounds the right direction.

Kevin Fitzsimmons

Okay. Great. And then maybe on -- you have talked in the past year or two about the burden of having too much capital, and I think, it’s probably a good thing to have right now, but you guys were active with buying back the stock where the stock price is, it seems to definitely make sense. How is your appetite for that going forward? We have heard some of the bigger banks indicate that there’s probably could be a regulatory pushback from getting too active in buying back stock, but just how your thought is on that front?

Tim Schools

Yeah. Great question. So the first thing I will say is, the buyback firm we are using right now, I talk to them regularly and I mean you know this because you are in this industry, and I guess, people on the phone should know this too. But our buyback, and he does buybacks for banks across the country. And he just says, can not to tell you there’s no buyers for bank stocks.

And so unfortunately, it is a challenging environment, and due to the environment, the supply and demand on bid ask, there’s just not a lot of buyers. And so you have got people that are financial focused funds, the prospective says they will only buy financials. So they have got to stay in it. But absent that, our trader just says there’s very little interest in these stocks. And so that makes it a buying opportunity.

With that said, there’s little volume and so there’s rules around buybacks where I am not an expert. It’s the average of some amount of your prior four-week volume. You can do one block a week. So we have been very active. It’s actually harder to pick up shares than you would think in a stock that doesn’t trade a lot.

But we are buyers are -- we did a $10 million authorization in January. We had our Board meeting Wednesday, we talked about potentially increasing it. You have different views on a Board. We had a director who, I can’t, was in Washington and had meetings with certain folks. And the feedback was, could be a challenging economy. There was a lot of discussions around CRE and different things.

And so I was a buyer of our stock in the summer of 2020 when it went to $9 and I had conviction in what we were doing in our credit portfolio and I didn’t want to go buy a ton, but what we buy $5 million or whatever. And our Board at that time was very conservative relative, we don’t want to ever dilute our shareholders. So why the little bit of gain we could get, why take that risk.

And so I’d say we are in the middle right now. We certainly have directors that think it’s attractively priced and we have directors that are buying, Director, Tom Flynn. And -- but at the same time, there’s people with very deep business experience to say, it is very uncertain out there. And so I’d say we are in the middle, we are a buyer right now and happy to answer anything further.

Kevin Fitzsimmons

Okay. Great. One quick last follow-on. The loan relationship you are referring to within delinquencies and then the single loan you are referring to in criticized. Are those different loans and if -- on the one that’s driving the increase in criticized, I understand that, that you feel good about it and has a lot of deposits attached to it, but can you say what industry or what kind of loan it is?

Tim Schools

So I will talk about the first one first. The first one in past dues is -- and again, we don’t want to talk to specific about…

Kevin Fitzsimmons

Yeah.

Tim Schools

…one of these. But the first one is a great well-known strong operator in one of our markets that has a high character and high reputation who -- their businesses are just having some challenges as good businesses can do. They are collateralized. The borrowers work with us and actually given us additional collateral over the last year. We are actually meeting with them again next week, and we will learn more. So at this point, it’s not something that we feel has any significant loss to it.

I don’t want to get too complex with it, but its due date is the first of every month and you report 30 days and over and past dues, that’s probably at former banks, Kevin. We had strategic timing on when we did loans on due dates. We would have never had a due date for a loan on the first of a month, because on a 30-day -- 31-day month, if they wait and pay at the end of the month, it missed 30 days.

So I say that, that I think there’s a good operator. We will learn more about the improvement of the operations. It’s not like it’s 60 days or 70 days past due. I think it possibly could have been just it was a 31-day month and the guy sent the payment in on the 31st or the first and it missed it. So we will get more on that. On the criticized classified, I will let Kevin talk about that one.

Kevin Lambert

Yeah. And just to add on to Tim’s comment about the first one, probably, about $4 million of that exposure is liquid secured. So we feel very good about that with nominal, if any potential risk of loss.

On the other relationship, it has been a long-term customer. It’s basically in the medical industry, hospice and they were formed probably about five years or six years ago I am guessing and they just continue to scale. They just haven’t reached a breakeven point yet from a cash flow perspective. But they continue to be very well capitalized and have a lot of liquidity. So we feel very good about their potential prospects.

Kevin Fitzsimmons

Okay. Thanks very much guys.

Tim Schools

Thank you, Kevin.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Graham Dick from PSC. Your question, please.

Graham Dick

Hey. Good afternoon, guys.

Tim Schools

Hi, Graham.

Graham Dick

So most of the stuff has been touched on, obviously, but I just kind of wanted to hear a little bit from you guys on what you are seeing on the CRE front as that’s worrying you or that’s making you cautious about lending into that segment right now, because we hear a little bit from banks that say we are pulling back and then other ones say, actually, there’s a lot of opportunities for us right now because people have pulled back to get loans at more attractive rates. So any color you can provide there on the health of that market and how you guys view it would be really helpful?

Tim Schools

Sure. So we have Lee Hunter, who has joined us here and he’s a real talent. He -- his whole career has been in this, grew up in First Horizon, which has been a great bank and then has been back here about eight years or so.

Keep in mind, we have CRE right now really in three buckets. Lee has had a dedicated CRE team that has guided that since he joined. And as we have transformed some, we have allowed our markets to do CRE in the smaller end. And then last year, you will remember or recall that we kept $105 million of TriNet due to market rates.

So Lee, I am going to ask Lee to speak he can offer two things. I mean he’s just a wealth of knowledge on the general overview of the economy and our market and what we should be thinking about, but he can also speak some to our portfolio and maybe how we feel or maybe how we are different. So, Lee, I will turn it over to you.

Lee Hunter

Sure. Sure. So I would say, first of all, we have pulled back on our CRE lending as have most of our competitors, talking to some clients over the past week or two, kind of asking for advice of where to go for commercial real estate loans right now. So there’s definitely more leverage for those that are making real estate loans right now, both from a structure and a pricing standpoint.

As it relates to our book of business, I would say, we have done a deep dive particularly focusing on loans maturing this year and next and I feel really good about those. Kevin kind of touched on some of those metrics. But if you stress them to a pretty worst-case scenario, we are still in good shape. And so I feel really good about the quality of our loans and feel really good about the overall ability to renew those loans and still have good loan to values, good positive cash flow.

Graham Dick

Okay. That’s really helpful. You mentioned you guys stressing each of those credits. What are the stress tests entail, I guess, where you guys are seeing that the portfolio is still healthy upon renewal, even if you do stress level, what does that mean in terms of vacancy rates and cap rates, et cetera?

Mike Fowler

Well, I think, we have looked -- I know we have looked at the overall debt yields of these projects and we have kind of said, okay, at the average debt yield currently. If we ran those -- today the most of our stabilized projects -- most of these maturing are stabilized projects, the vast majority.

And we would typically do a five-year loan and if you looked at the five-year and priced it today at some of the spreads that Tim talked about, you would be kind of, call it, mid-6s. So I would just tell you that if we stressed it at about 7%, 25-year ARM, we are still at kind of a 150 debt service coverage.

And then if we stressed from a loan-to-value perspective, a 1% increase in cap rates would get us to kind of low 60s kind of loan to value if we stressed it to a 2% increase in cap rates would get us into the low 70s.

So and talking to appraisers, most of them would tell you that in the last six months to 12 months, there’s been a zero basis points to 50-basis-point increase in cap rates depending on the market and the asset class. So we feel like the two stresses that we did both for cash flow and loan-to-value, which still puts us in a very strong position.

Graham Dick

Okay. Great. I guess just one more follow-up there and then that will be it for me. What is like the -- I guess, what are the cap rates -- what did you guys underwrite that portfolio? And do you guys like have an average underwritten cap rate for that portfolio that you could share, just so I can kind of know where the starting point is. You mentioned that like 1% increase, a 2% increase and whatnot?

Mike Fowler

Well, it’s across the board. I mean, obviously, some of the multifamily cap rates and even industrial have been extremely low and then we have got a hospitality in there as well. So it’s across the board.

But basically, if you take if you take the starting LTV that we have got that Kevin referenced and just take the 1% increase in cap rates and the 2% increase, that’s where it would get you up from kind of 50%-ish to kind of 60%-ish and 70%-ish with the two increases.

Graham Dick

Okay. All right. That’s helpful. That’s all for me. Thanks, guys.

Tim Schools

Okay. Thank you, Graham.

Operator

Thank you. And one moment for our final question for today. And our final question for today comes from the line of Feddie Strickland from Janney. Your question, please.

Feddie Strickland

Hey. Good morning, guys.

Tim Schools

Hi, Feddie. How are you?

Feddie Strickland

Good afternoon, I guess. Good. Forgive me if I missed this, but were the expenses -- what were the expenses for Mortgage, or I guess, what were the core bank expenses this quarter? I was looking for that in the release, but I didn’t see that?

Tim Schools

Yeah. We can get that for you right now. Hold on, we will look at that.

Feddie Strickland

And while you are looking for that, does efficiency for Mortgage potentially improve over the next couple of quarters just as you have more volume on seasonality?

Tim Schools

Yeah. And that’s what I was getting at earlier. I mean it -- nobody likes the environment we are in, but our Mortgage company and TriNet right now lost together. If you take their revenue and their direct expense, they lost $216,000 together.

I think Mortgage was a loss of 40,000 and 170,000 would be in TriNet for first quarter. And so, obviously, I mean, I don’t have the exact numbers in front of me, but their efficiency ratios are like 100%, right? So their expenses are the same as their revenue.

So as -- if revenues return, yes, they have some variable comp from incentives, but it’s a smaller proportion or percentage of the revenue. So you definitely would think that their efficiency ratios would improve, their pretax income would improve, their efficiency ratio would improve, our corporate efficiency ratio would improve and obviously would improve the pretax pre-provision to assets, because they don’t really have a lot of assets because they sell everything.

Mike Fowler

Yeah. And in terms of Mortgage expenses, they were right at $1.5 billion for the quarter and so the non-Mortgage expenses for the quarter were about 17.6%.

Feddie Strickland

Got it. And that guide you gave earlier, the 18% to 18.5% range for second quarter, that’s the all-in expense, right?

Tim Schools

Correct. Yes, sir. Correct. And I just -- every company I have been in, we have done a very good job on expenses and we had the garnishment operational loss in fourth quarter come in and out. And you have got FICA come back and you have got the FDIC assessment, which I saw Pinnacle cited and theirs came [ph].

I mean that’s $150,000. That’s going to be $600,000 for the year, additional, which is $0.03 a share. But I still think there’s other things we can do, both personnel, as well as operating expense and I am hopeful that we can operate that within $18 million to $18.5 million.

Feddie Strickland

Got it. And just one last question from me. I was just wondering if you could talk through a little bit more of your thinking. I think you talked about some of the different funding sources. I know you said you consider using the bank term funding program. Honestly, I am surprised more banks haven’t said they consider using it if rates better and the terms are better. But just wonder if you could talk through your thinking a little bit on that?

Tim Schools

Well, I will add some and then Mike, because he’s more of the expert. I can tell you, as the operator, I went to Hawaii in the summer of 2007 and was six months before the financial crisis happened. And when TARP came out, we were part of a public company there called Hawaiian Electric and a lot of people wanted to get TARP from a security standpoint.

I had a lot of personal pride. As the CEO of that bank wanting to run a great company, I thought it can improve it. I viewed it sort of as like a badge I would always have. And so I really studied that bank, and I didn’t think I need a tarp and we didn’t take TARP. And that bank is still here. It’s a great bank. And so I am just glad I never had to rely on that.

Now was that ignorant, -- was that a young TIM that was ignorant and you should have it for security, perhaps. I would say right now, we have asked around, would there be any stigma from regulators or investors or anybody if you used it. We are hearing though.

Mike can talk about the pricing. At first, we thought there was going to be a big pricing advantage. So we were thinking about, hey, maybe as some brokered CDs mature, maybe we put it in that for a year or two, because we thought it would be several basis points. The last I heard is I think Mike thinks it may not be as cheap as we originally thought.

Mike Fowler

Yeah. So let me comment briefly on that. We -- when they rolled out -- so we contacted the Fed about the new funding program. Again, well, probably, the day after SVB went down the Monday after. And it took a few weeks for them to get us through the approval process or the setup process.

And in that time, as Tim said, the price advantage dwindled quite a bit. So when they rolled it out, I believe that the initial rate was $4.30 [ph] and you could pick your point, you can pick your duration any point up to a year, you could prepay at any time with no penalty and if you get to the point when the Fed starts cutting rates, you can -- the Fed has told us you can prepay and 2 minutes later turn around and apply for a new lower rate advance.

So we certainly looked at that. As Tim said, we are sensitive to if there is a stigma the Fed assured to us in their mind, it certainly would be it would be viewed as a prudent use of liquidity tool. Today, though, the rate -- over the last few weeks, the rate has moved up. And as of today, there’s really no pricing advantage other than you have that three option to prepay if rates start moving down. In my mind, it’s a valuable option.

But with rates at 495 today for the Fed program, that’s right in line with where we could issue brokered out to a year and it’s pretty close to where we could issue if we wanted to tap home loan borrowings.

So I think we probably will use it. One advantage of that from a liquidity standpoint, as many of you might know, is everybody’s investment securities portfolios are underwater given the Fed hiking rates, ours is no exception.

And, so if you were to use those securities to borrow anywhere else, your borrowing capacity is based on the market value less some haircut. The Fed is trying to provide more liquidity here, so they would let you borrow at par with no haircut and no deduction for any unrealized loss on the portfolio.

So for us, we look at that as another $60 million source of liquidity. So we do intend to be ready to tap it. I suspect we will have it. We think it’s prudent to do that, and it would be strictly based on the economics.

Feddie Strickland

No. That makes a lot of sense, especially if you can turn around to repay it as soon as rates stop going up. So I appreciate additional color. Thanks, guys.

Operator

Thank you. This does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Tim Schools for any further remarks.

Tim Schools

Okay. Before we go, Mike, can you follow-up? Do you have the CD maturity schedule? I think it was Brett Rabatin that perhaps asked for that.

Mike Fowler

Yeah. I do. And I can comment briefly, and Brett, if you want more detail or anyone else wants more detail, just let me know. But you had asked about both loan and deposit and CD maturities. So what I will give you, let me rattle these off quickly, and if you want to shoot it to you afterwards, Brett.

But, so in terms of CDs over the next three months, $53 million; over the second three months out, $73 million; over six months to nine months, $63 million and -- yeah, so over the remainder of 2023, I am calculating about $190 million on CDs.

Now if you look on the loan side, I don’t have maturity split, but what I have got is kind of a liquidity is a repricing gap on the loan side. And so the sum of balances that will reprice or are scheduled to pay down or pay off are about -- they are pretty smooth, they average about $160 million a quarter for the next year.

Tim Schools

And he’s probably muted now. Okay. So sir, thank you, and that concludes our call. We appreciate everybody calling in. If anybody has any follow-up questions, please don’t hesitate to call Mike and I hope everyone has a great day and weekend. Thank you.

Operator

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.

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CapStar Financial Holdings, Inc. (CSTR) Q1 2023 Earnings Call Transcript