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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to the Cadence Bancorporation Third Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. The comments are subject to the forward-looking statement disclaimer, which can be found in the press release and on Page 2 of the financial results presentation. Both of those documents can be located in the Investor Relations section at cadencebancorporation.com. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded.
I would now like to turn the conference over to Paul Murphy, Chairman, and CEO. Please go ahead.
Good morning, and thank you all for joining our third quarter 2019 earnings conference call. With me today on the call are Valerie, Sam, Hank, and David. As was reported in our release, on an adjusted basis, we earned 44 million or $0.34 a share. This is 10.5% return on tangible common equity right out of 1% return on assets, and our efficiency ratio improved 200 basis points linked quarter to 48.1%.
Before I discuss the quarter, I’d like to first take a moment and thank our investors and analysts for the candid feedback we received since our last quarterly call. The entire management team and Board of Directors are listening very carefully and I want you to know that you were heard. I expect you will see a number of your suggestions incorporated into our communications going forward.
This quarter for example, we included some additional disclosure in our earnings release and slides on credit migration, and you’ll hear more color and on the make-up of our charge-offs we’ll also provide some context about how we think about managing credit over time, and most importantly, how we ultimately generate returns for shareholders.
I would like to emphasis the point that I have strong conviction, we have strong conviction in our strategy. By no means are we satisfied with the recent results, but we remain confident in our team and our ability to generate attractive returns. I’d also like to ensure investors that we are aligned with them. To illustrate this conviction and alignment, I think it’s important to point out that our board and senior management team collectively own approximately 4.4 million shares or $75 million plus worth of Cadence stock.
In 2019, members of our board and executive management team have acquired over 6 million shares of common stock. Additionally, in the third quarter, we completed a repurchase of roughly $10 million worth of shares, which was part of our previously announced share repurchase authorization. So, simply put, we are invested alongside you and we believe Cadence is an attractive investment.
Now, turning to our third quarter results, as many of you have seen in our press release, we experienced another quarter of elevated charge-offs and we’ve taken provision higher as a result of some pressure we’re seeing in certain pockets of our portfolio. I think it’s significant to note that the predominance of our elevated credit stemmed from a few loans that hit us really hard opposed to a broad-based deterioration.
In the third quarter, charge-offs totaled 31 million and provision was 44 million. The 31 million in charge-offs in the quarter 15 came from one non-SNC C&I credit. Of the 50 million charge-off year to date, 20 million was from the same C&I non-SNC loan. This credit resulted in a very high severity of loss proven by complex set of reasons, which we will talk more about in a moment.
I would like to reiterate my comments from last quarter, which is that we're not seeing a weakening economy. That said, I would like to provide some detail about what we see on the ground in sectors where there has been some negative credit migration. A good place to start for this discussion is with the disclosure that I noted earlier. As you can see in our press release and earnings deck, we have had an uptick in criticized and classified assets. This drove approximately half of our loan loss provision for the third quarter. These increases were primarily from general C&I and energy.
Specifically, our classified assets rose linked quarter, but in-line with prior periods criticized assets also rose and are also and in-line. The increase in special mention is partially offset by a decrease in doubtful credits. So, of course, I ask myself do these increases suggest the recession is coming or is this more of a return to a normal level of criticized and classified loans typical of our portfolio like ours.
At this point, I think it’s the ladder. And of course, I’ll continue to study this and report back to you and monitor further in the future, but for now let’s talk about the pockets in our portfolio where we are experiencing some pressure. First, let’s discuss our restaurant business, which stood at [$1.050 billion] outstanding, 8% of loans at quarter-end. By the way, this is down from a peak 12% of loans several quarters ago.
Within the restaurant business, the underlying consumer demand seems to be pretty good. I wouldn't see strong, but solid. That of course will generally be a major concern for the sector where we enter recessionary environment. So, if it’s not the consumer than what’s pressuring our borrowers. It’s really three factors. Our over-supply, wage inflation, and delivery. So, first we would note that casual dining is clearly the most at-risk of this portfolio and we’re pleased to report that’s about only about 14% of our book.
75% of the portfolio is quick service restaurants, QSR, and fast casual, which historically has been more resilient over time. Second, as we noted on the last call, we have slowed our originations in restaurant overall, and we’re monitoring keeping a very close eye on all the dynamics impacting each of our borrowers. We've raised the bar on new credits and we’re closely monitoring existing relationships.
On a positive note, we are seeing several operators have effective cost reduction strategies that have been improvement that are improving results. So, in summary, the restaurant portfolio risk remains elevated. We had one restaurant SNC charge-off of 4.4 million in the third quarter. We had one credit that was upgraded to pass. Other nonperformers progress is mixed. Couple are moving towards upgrades, others are in various stages of restructuring to improve operating performance, while others are considering a sale of all our parts of their business.
I think it’s going to take 6 months to 24 months for the $52 million classified credit portfolio to be resolved. Additionally, we’re fresh to memory. We have 58 million in special mention credits that we’re monitoring closely. Our restaurant team has been thrown stress periods in the past and they’re really good bankers. However, I think it’s fair to say that the stress this time might be a bit more challenging.
I know the team is working very hard to collect every loan and resolutions are progressing. I would not be surprised to see other credits added to the NPA list in the future, but that’s not necessarily a given.
Now, let me turn our attention to our energy loan category. The majority of our exposure there has been midstream, which has performed well through recent energy downturns and not been as susceptible to impact by energy prices. Midstream loans are 946 million or 63% of our portfolio. We had seen an increase in criticized and classified loans in energy and let me give you a little bit more color, especially on the E&P portfolio.
In 2014, we felt that terms and conditions were beyond what we were comfortable with and re-elected to change and tighten our underwriting parameters. Our E&P portfolio went from 590 million, down to 275 million over the next three years. We exited numerous credits, we restructured others to meet our post-2014 underwriting standards. Today, the E&P portfolio is roughly 380 million outstanding.
We had one energy charge-off in the quarter of 5.3 million, lifetime today all of our E&P charge-offs had been pre-2014 originations. We have remaining three pre-2014 credits on the books today that are slated to exit and they total $29 million. While the post-2014 energy portfolio has done very well so far, I would say that energy capital markets are very constrained. I’m comfortable with our book today, but we're not relaxed.
With respect to any new energy loans, we are highly cautious, it is a very high bar you must clear for any new energy originations. Our intent is to keep the portfolio flat or see it reduce over the near-term.
Next, let’s talk about the migration across the general C&I categories. As I mentioned on numerous occasions in the past, I view our leverage loan portfolio without moderators as one of the higher risk categories in the bank. This portfolio peaked at 840 million back in June and has declined at the end of September to 782 million. Debt in moderation is an acceptable part of the business plan, and we believe this portfolio has been well underwritten and we continue to be cautious with respect to new loans there.
However, we are looking to reduce risk on this portfolio and what I mean by that is that we are actively managing anything that is at the high-end of the leveraged spectrum. We’re looking to see higher leverage companies come down to a more modest risk profile. We have 63 credits and 109 facilities in this portfolio. The credits are diversified by industry and by geography.
Refreshing quickly on our private bank consumer mortgage portfolio, 2.6 billion outstanding continues to report pristine credit results, gross charge-offs originated on these residential loans over the last five years have been less than $0.5 million, Cadence and legacy $1.2 billion CRE portfolio continues to report exemplary credit statistics, no charge-offs, no nonperformers, no substandard credits in the last five years.
Legacy Kate Cade CRE portfolio numbers are very good also. This portfolio has performed better than expected when we did our due diligence 18 months ago. Our healthcare and technology portfolios are generally stable with modest migrations. The risk profile of these two businesses is very much in-line with expectations.
So, in summary, leverage lending in restaurants or the portfolios we’re working most actively. With respect to energy, we're highly cautious. The rest of the bank is business as usual, and steady in the boat. Going back to the one-large C&I charge-off and why was the reason the loss severity was so high; it is the company experienced some materially negative operating results caused by an expansion strategy that quite simply failed.
The company had liquidity pressure that required a costly restructuring process that ultimately ended with a highly distressed sale. The remaining exposure on this credit was paid off yesterday. There are several unique elements to this credit that are not found and other existing Cade loans today. In other words, we do not have a portfolio of similar credits we have to work through.
To be fair, we are seeing sector specific factors that are positioning credit in more general way and that led to some of the provisioning that you saw in the quarter. But I really want to distinguish that the potential loss content from the sector specific factors are going to look a lot less severe than what experienced in the outlier scenario.
We’re not, for this one, outsized credits impacting our last two quarters, our charge-off and provision numbers will be up from prior years, but would be in a normal range. Because we are in late stage resolution of this group of credits previously mentioned, we’re confident that our results for these credits reflect the risks accurately. As you expect, the last two quarters credit results have resulted in a reduction in the management bonus accrual.
Last topic I would like to discuss on credit before moving on is about returns. And I say this really not in defense of the loans that have not performed to our underwriting standards, but instead to say that our focus is on our ultimate performance and returns on the entire loan portfolio, especially for the risk that we’re taking. So, for example, our restaurant portfolio we’ve seen an uptick in criticized assets there, they’ve originated about 2.5 billion in loans in the last eight years they’ve been with us. Their lifetime to-date charge-offs are $6 million or roughly 3 basis points.
So, because I mentioned the 24 months would be a special period, but I fully expect the returns over time are going to be attractive. Same with C&I, our charge-offs have been acceptable. We previously mentioned that we anticipate 25 basis points, 30 basis points charge-offs for portfolios over time. 2017 and 2018 we were unusually low at 6 basis points and 2019 is going to be at the other end of the spectrum. So, while we are now by no means happy with the elevated credit cost for the past two quarters, we believe that this is not indicative of our overall portfolio quality.
Before I turn the call over to Sam, let me touch on a couple of highlights in the quarter. First, we showed nice growth in our pre-tax, pre-provision earnings, we grew from 96.1 to 108.8, up 4.7 million, it’s roughly 5% nice quarter. Second, our timely interest rate caller has insulated the bank well from lower rate environment. And just a high-level summary or reminder, we have about 9.5 billion in floating rate loans at the end of the quarter.
We have a $4 billion five-year hedge that we put on back in February of this year. We have 2.3 billion in deposits that are indexed. So, this leaves really 3.2 billion floating rate loans that are not perfectly hedged, so to speak. Our deposits are a little higher priced than most, so in a falling rate environment, we expect to see our deposit costs come down, perhaps more than some others.
Specifically, linked quarter total funding caused came down 9 basis points and our cost of deposits came down [7 basis points]. So, when you look at all of these variables and kind of reflect on the implications, they may suggest they'll have more stable NIM outlook for the foreseeable future.
Next, I’d comment just quickly on expense growth and we had a good quarter with non-interest expenses declining from 96 to 93.3 million, and as I mentioned efficiency ratio improved to 48.1. We have a good expense culture and a good focus on continuing to manage expenses tightly. And looking back at state, the merger really has exceeded our expectations.
We achieved our cost saving goals and we're pleased with the growth opportunities, and the quality of the deposit franchise has really had a wonderful impact on the balance sheet overall. [San Felipe], Atlanta and middle market hiring and opportunities we see there should really feel nice growth for the company in the future.
So, last, we're making nice progress on our core deposit funding, and I'm going to ask Sam to take it from here and tell you more about that.
Thanks Paul. For the last several quarters, we’ve commented on some pretty solid deposit performance, but we are particularly pleased with our deposit performance for the third quarter. Core deposits, excluding brokered were 14.3 billion, up 658 million or almost 5% versus the second quarter. Notably non-interest-bearing deposits grew 306 million or 9.3% linked-quarter. This growth just continues to be the result of motivated bankers, our banking team is really focused on deepening customer relationships, all of our branch associates and further penetration of our Treasury management services.
The increase in our deposits has led to meaningful reductions in brokered and wholesale funding, with our broker deposits declining to 3% of total deposits at quarter-end. So, the improved non-interest-bearing mix wholesale reduction in overall reductions in deposit rates led to a 7-basis point linked-quarter decline in deposit cost as Paul mentioned earlier.
Loan to deposit ratio also dropped to 92% in the quarter down from 94% in the second, and this is again the result of our core deposit growth and our moderated loan growth. Our new loan originations in the quarter continue to be solid, but had been largely offset by higher payoffs. We are continuing to expect mid-single-digit loan growth for full-year 2020.
Paul talked about State Bank and I just want to reiterate how pleased we are with the merger and the opportunity this presents for Cadence and Atlanta and throughout the state of Georgia. Our retention of Georgia clients in key customer facing bankers has been solid. And we've made some strategic hires to launch our commercial middle market and wealth efforts and we've really been pleased with the early results and some exciting new customer conversions.
We believe back in May of last year when we announced the merger that there was strong strategic rationale and I can share that now after being in Atlanta for a year, I feel even better that this merger is a meaningful enhancement to our franchise.
So, with that, let me turn over to Valerie to hit a few other details on the quarter.
Right. Thank you, Sam. As noted previously, we are very pleased with the 5% linked-quarter growth in our pre-tax pre-loan provision net earnings and all the business drivers behind that growth. The solid operating revenue, up 1.2% from the prior quarter, as well as the reduction in total expenses, down 6% from the prior quarter.
Speaking to the revenue increase, net interest income for the third quarter was relatively flat at 160 million, down less than 1% linked quarter, driven by a modest decline in average earning assets combined with a 3-basis point decline in our net interest margin. The decline in the linked-quarter earning assets was largely driven by the second quarter sale of about 130 millions in loans, very late in the quarter. And other pay downs in acquired loans exceeding the new moderate loan growth.
The 3-basis point decline in the net interest margin was the impact of a lagging deposit data on our now materially neutral interest rate position of our balance sheet. Non-interest income increased nicely in the third quarter, up 2.9 million or over 9%, driven by increased service fees across many of our business lines, due to increased volume associated with broad business growth post-merger.
Additionally, adjusted noninterest expenses of 93.3 million came down 2.7 million or 3% from the prior quarter, due to lower comp and benefit expenses as we align our incentives and other accruals with performance. Deferral of acquired loan cost previously expensed and lower FDIC insurance assessments this quarter. The combination of the revenue and non-interest expense dynamics drove our adjusted efficiency ratio back down to 48.1%, right in-line with our expectations.
Lastly, let me give you an update on CECL as we continue to prepare for that adoption. In summary, the day one phase-in capital impact is expected to be minimal, at less than 10 basis points of total capital. Regarding the estimated reserves, based on third quarter 2019 data, we would expect a 35% to 45% increase in our reserve levels for our originated portfolio. With the greatest percent increase from our consumer portfolio with the life of the loan under CECL is much longer than the current loss emergence period.
As you know, CECL requires establishing a reserve for acquired loans even if they were recently marked as our State Bank acquired portfolio was, resulting in an effective double count. So, accordingly, including our acquired portfolios, we currently expect the total deserves to increase between 55% and 65%.
So, with that I think operator, we like to turn it over to questions.
[Operator Instructions] First question will come from Brady Gailey of KBW.
Hi, morning guys.
Hi, Brady.
So, why don't we start time, I mean criticized were up 40% linked-quarter on annualized, now a little over 4% low as well. Just talk about some of the inflows into criticized on a linked-quarter basis?
Yes, Brady, page 24 for those of you who have it in front of you might be a helpful reference point. You’re right, the linked-quarter increase is noteworthy. Some historical perspective, criticize has been as high as 4.4% back at the time of the IPO, so we are at 2.3% today, I'm sorry just the classified that is. And totals have gone from 5.8 back in prior periods to 4.2, your question about the linked-quarter increases, David I’ll ask you to comment about that.
Be happy to Paul. Good morning, Brady. I'm going to point you to Page 21, where you see kind of the mix of that quarter-over-quarter walk, so thinking about – first I will tell you what is not and that’s CRE and RESI. Consumable book holds – is holding up really well. Commercial real estate book is performing above expectations, really, really pleased with how that portfolio is performing.
So, that is driven by C&I, look at the components of that. So, the first being Energy to add a $35 million increase on a linked-quarter basis. This movement was really centered in midstream and it's primarily into the special mention category. We think this has a very different risk profile than the E&P, particularly the E&P pre-2014 credits, the one particular that drove the charge-off this quarter. So, but we feel comfortable with kind of the underlying outlook for those midstream credits.
Next in the healthcare, we have a $24 million increase on a linked-quarter basis there, the majority of that exposure is actually covered by significant real estate collateral. So, again, still feel good about severity of healthcare involved [indiscernible] going forward, but again, healthcare into the Special Mention not substandard or doubtful.
And lastly, General C&I and Paul mentioned some of this in the prepared remarks. But there's really kind of a number of larger denomination credits, but diverse by industry sector geography and originating group, and we really wouldn't expect to see correlated movement within these particular credits. So, kind of collectively, we feel better about the outlook for these credits and really the underlying loss, given default profile relative to the credits that drove the outsized net charge-offs for the quarter.
Okay. Alright. And maybe another one on credit. So, maybe the second quarter of a fairly elevated provision from you guys, what? When do you think their provision will normalize lower? Is that something that you think we could see happen in 2020, or is there so much uncertainty, it's just hard to say when the provision will normalize lower?
Yes, Brady, trying to predict it on a quarter-to-quarter basis is tough and understand your questions, what about next year? Yes, I think, it depends on what happens with restaurants. And if we see any of the high leverage credits, leverage without moderators deteriorate further.
And so, at this point, I don't have a visibility that there are significant problems with either of those books, but the restaurant portfolio is the – is one that, it's going to take us sometime to work through that. And so, I guess, fundamentally, I feel good about our credit outlook. But I have to put an asterisk by unless there's some things that shake out of either of those two portfolios that become more challenging than what we have visibility on as of today.
Brady, this is Valerie. I would just add to that. About half of our loan provisions this quarter were associated with the credits that we charged-off. And those loans are either resolved or in the process of resolution. And we believe that the results that are established for those are their last and final. And so, that's a big chunk of that provision in this order that we don't anticipate having a go-forward aspect to it.
Alright, great. And then my last question is just on the margin. I'm used to thinking of cadence as a fairly asset-sensitive company, but I know you’ve got the color, which really limits to that asset-sensitivity. Valerie, I heard you say think about Cadence is somewhat neutral to rates going forward. I mean, with the Fed continuing to cut here, do you think the NIM can be stable, or do you think we will see some downside?
Yes. No, I think that once, I think, we may see another quarter or so of a little bit of a lag in our deposit costs coming down, that came down very nicely this quarter. Total funding costs down 9 basis points, deposit costs down 7 basis points. We expect that will accelerate in the fourth quarter. And once that gets to kind of our fully modeled level of 50% beta, I think that on a core basis, we're going to have a pretty flat margin. And that is absolutely driven by the impact of the color that we put in place, combined with the fact, that half of the interest rate swaps that we have on the book will be rolling off at the end of this year. So, the combination of those two really sets us up very nicely for 2020.
Yes, that color was well timed. Thanks for the color.
Yes.
Thanks, Brady.
The next question will come from Steven Alexopoulos of JPMorgan.
Hi, good morning, everybody.
Good morning.
Good morning.
A follow-up on credit. So, regarding the provision in net charge-offs taken this quarter, which are basically for problem credits identified last quarter, what changed so dramatically between the two quarters that you've taken the disposal value down by so much?
Well, on the one large credit, as was mentioned, it went through a distressed sales process that was completed during the quarter that had an outcome that was materially negative, worse than anticipated. So, that's the biggest part of it right there. And then, as Valerie just mentioned, the provisions related to the increase in criticized and classifieds, that's about half of the provisions for the quarter. And so, really those two things.
Paul, was that one large credit covenant light loan?
No.
Was it – just seems odd that more collateral protection on the credit?
It’s a credit that we deeply regret.
Okay. And then just from a big picture view, I mean, credit is not an issue really anywhere else. But you're seeing credit – negative credit, credit migration again this quarter. Did you guys change anything internally? Is there a scrubbing of the portfolio something that's causing these problems to come to the surface now?
No, Steve. I mean, we every quarter, go through the portfolio and scrub it and look for changes. And this is a period, where more than average number of credits were boosted for size of classified.
Steve, I would just also follow-up on the larger credit that Paul mentioned. We have been really a scrubber portfolio evaluating and feel comfortable that there are no other credits that have the makeup of that credit. And so, again, I believe that it is somewhat unique in its characteristics and unique in its last severity.
Okay. I guess, every shareholder on this call really wants to know one thing. Is this, it, in terms of the negative credit migration, or is this now going to become a quarterly event, where we're reporting problems coming out of leverage, problems coming out of restaurant? How do you think about that? Is this going to become a recurring event moving forward? Thanks.
Well, I – Steve, I guess, the way I'm thinking about it is that, over time, the returns in our portfolio were going to be attractive on a quarter-to-quarter basis. It can be lumpy. This one outlier credit is not something – the severity of loss on that is not something that we would expect to experience again. And the vast majority of the bank's loan portfolio is performing great. It’s really sort of an isolated thing. But there is stress in restaurant. And we're watching the how – how their leverage without moderating portfolio like a hawk and looking for every opportunity to improve the risk profile there. So, I think next year is going to be a much better year for credit.
If I would just also, you know we spoke recently about kind of the broader view of our portfolio fit with the 25 basis points to 30 basis points expectation for net charge-offs. Now, clearly the last couple of quarters are higher than that. The last couple of years prior to this were lower than that. So, it does sometimes have a lumpy effect to it, but on a broad basis, we still feel very comfortable with that 25 basis points to 30 basis points performance for the portfolio. And we may be getting into a time period, where that will be on a more consistent basis than the years that we had in 2017 and 2018, but at that level that the returns that the organization can provide, which is, I think, evidence by a pre-tax pre-provision earnings this quarter, we believe is a very attractive result.
Okay. Thanks for taking my questions.
The next question will come from Ryan Nash of Goldman Sachs.
Hi, good morning, guys.
Good morning.
So, maybe a follow-up to Steve’s question. I guess, were there any factors contributing to the rise and criticize outside of your control, such as the SNC exam? And then maybe of the $160 million to $165 million of increased criticize, do you have any sense of the breakdown of between SNC and non-SNC and maybe just what percentage of those loans where do you actually the lead on?
Yes. So, Ryan you are correct. The SNC exam results are included in this quarter's results and I am going to pause for a second and see, who can maybe best answer the percentage question there or…?
I don't know, if we have an exact percentage of that, but I would say that there is probably at least a decent chunk of them that are shared national credit, but we don't have a specific number for you. I don't know David if you have any other cover on some of those. No, okay.
Okay. Paul, if I take a step back, the strategy of the bank has been to recruit bankers from larger institutions you guys run with higher hold limits because you know those are lot of the clients that the bank is, that your bank has historically banked. I guess, given where we are at the cycle, does that strategy still makes sense at this point in time, like, are you guys considering making any changes to the overall underwriting, you know the whole limits, the strategy of the credit portfolio at this point in time?
Yes. Ryan you make a good point, and I guess the way I would summarize it is that, we did raise a billion dollars to start with, we – our legal owned limit is north of 300 million, we have an in-house limit of 25 million. When we merge with State Bank, we really didn’t change the in-house hold limit. We sort of tweaked that a little here and there. And so, I think it’s fair to say that we did start with a higher hold limit than per dollar capital than maybe some other banks, but that we are sticking with it as we and not seeing it increase.
I would say the plan is working. I mean notwithstanding these two quarters, the fundamental credit performance of the company over eight years has been very good and we're sticking with the plan.
Got it. I guess one last follow-up, if I could sneak one last one in. I think Sam mentioned mid-single-digit loan growth, I understand you guys need to continue to grow the business, but given all the credit issues that you are experiencing, I guess does it makes sense given where we are in the cycle, given your client base to continue to grow at that pace until a much more thorough review of the portfolio has been done or at least until a lot of these energy restaurant and leverage credits have been worked out? Thanks.
Ryan, I would say that mid-single digits is a material change in the trajectory of our growth from prior years and it’s appropriate and it’s largely by design. Again the way you mentioned the credit situation is really one outlier credit is materially impacting our year, were not for that, the rest of the credit charge offs would be in the normal range and so we’re focused on the long-term returns and managing the portfolio over time and feeling like we’re going forward with some confidence.
Hi, Ryan. This is Sam. Thanks for the question. As Paul pointed out, this is a pretty material deviation from a growth trajectory and part of that is, you know we are certainly being cautiously at the portfolio that we’re managing at a different direction such as restaurant. Our underwriting standards are, I think are appropriate and tight, but you also have the growth factor opportunity here in Atlanta. We have a brand-new middle market team on the ground, it has already started to get traction that's going to be growing off of the base of zero and so that is going to favorably impact our trajectory.
I might just add a little bit of color than that. Our pipelines are good. We are down from the peak that they are good. We are seeing nice volumes in senior loan committee and as many have already stated, we are slowing down in some areas. However, the community banking, business banking, and private banking areas are still seeing nice volumes. They had the benefit of bringing in a lot of deposits as well. And our CRE teams, the existing team and digital State Bank team are seeing good activity in their respective areas. Sam mentioned Atlanta, but I also would like to mention Dallas. We’re pretty through with the process to putting that team together, and excited about the opportunities, they’ve seen some nice growth over the last couple of quarters, but as Sam said, we’re starting from a zero point in Dallas as well at Atlanta. So, good focus on those areas.
Thanks for the color guys.
Thanks Ryan.
The next question will come from Jennifer Demba of SunTrust.
Thank you, good morning. Few questions. What was, of the total loan production you had in the third quarter, how much of it came from Atlanta? If you know?
Jennifer, this is Sam I don't know if we really have that broken per say. I know that our Atlanta real estate group was very active in the quarter. I think it continues to have – have really solid momentum and the middle market team has just gotten underway and has just put a handful of nice new relationships, but …
It’s early days of the Atlanta C&I team and it takes time to build that business and as you know the sales cycle is long in banking. So, Jennifer I know you’ve heard me say it. Our focus is on building it right, not building it fast, and we’re going to invest some time and see that business grow for the next several years.
Okay. Back to credit for a second. Can you give us a sense of what you're largest nonperforming loans are in terms of size or industry, at this point if you have that data? [Indiscernible] at this point.
We will see what we can provide you on that. You know, I’d say that it is pretty consistent with our averages in the book on an overall basis. Our credits do tend to be at least some dis-population on the C&I side 10 million to 12 million kind of on average. I mean like David kind of expand on that, but as a whole that’s what you might expect.
Yes, Jennifer this is David. So, that would be from non-accruals at [930] there will be five credits that would be north of 10 million, but nothing more than 12 million, and then it gets pretty plan granular down from that.
Okay. And my final question, Paul, you mentioned the investor and analyst survey at the top of the call, any major surprises out of that work for you and the management team?
I mean, for the most part I was saying that investors had shared with us directly in face-to-face meetings and no major surprises.
Okay. Thank you.
The next question will come from Michael Rose of Raymond James.
Hi, guys. I thought I would ask a non-credit question. So, the deposit mix and the efforts that you have continued to make have continued to improve the mix of the portfolio, just as we think about from here, is the call eventually kind of get rid of all the broker deposits as you find what seems to be slower than you typically grow in core loan growth and then what efforts are you making to continue to further reduce cost? Thanks.
Yes. So, I’ll start with that one. So, basically, we use I think I have said this before, we use broker deposits as really just a tool of funding tools, and at this point, we’re down, you know a low peer level. And so, it may go down a little bit, but it will probably hover around this year really just kind of as we manage quarter-to-quarter liquidity, but yes you are right. We have had a nice opportunity of being able to bring that down and when you look at our quarter-over-quarter deposits, while the deposits in total may not be of has significantly because we significantly declined brokerage, same on the average side.
The average core deposits increased substantially while the brokers came down. As far as what we’re doing on the cost, we are working actively to reduce our cost. One of the benefits that we have is, Paul mentioned is, we've got about 2.3 billion that are indexed base, and so those come down naturally, and that really will help our assuming that we get the right cut this month and then in December, you know significantly help our deposit costs. We’re actually looking at – also a number of our CDs that mature in December, we’ve got between 15% and 20% of our CD book that’s maturing in December, and that will come back on it probably 50 basis points lower than they’re rolling off.
So, that will be a positive. In addition to that, we’re working actively with all the relationship managers on the customer accounts and ensuring that we’re proactive and not reactive to rate changes and expect the material improvement in our deposit costs continuing in the fourth quarter.
Alright. So, that's all reflected in your margin outlook, correct?
Certainly, yes. Yes.
Okay. And then maybe for Sam, maybe back to Ryan's question. Can we impact the loan growth a little bit? I guess, I look at it. Energy is probably not going to grow materially from here as you work through some credits. Restaurants been kind of flattish, healthcare, you're not really growing, CRE impacted by a higher level of paydowns. How do you get to the 5%, I guess? I mean, what are the drivers and maybe what are the detractors as we look forward? Thanks.
Hey, you pretty much hit on the detractors. I mean, we expect restaurant to not just be flat, but probably down sequentially and Energy probably in the flattish range. I think, we will see some growth in real estate over time. And our originations there has been solid and much of that is construction lending, and so that will fund up over time. But back to Hank’s point about Dallas starting from a base of zero, Atlanta, again, same thing.
I think – in just our General C&I, we operate in some great markets. Tampa team is doing great. Houston is just a fantastic economy, and then we've got the other Dallas and Atlanta new opportunities. I think all in net-net would drive us to that mid-single-digit guidance.
Okay. Maybe one final one for me, Paul. Previously, you’d talked about a 44%, 46% efficiency target. I know it's still early, but any thoughts on how that may shake out next year?
Ryan, I would still kind of remain optimistic about the efficiency ratio improving over time, but I would have to say, I think, we need a little more time to get to that level. I could see – we had a good quarter this quarter on our expenses that, I could see next year being closer to the flat to the 48% efficiency ratio. And let us continue to let some of these offensive hires that have been put in place, their businesses develop and mature, but I mean, they're still good operating leverage in this model. And we're still working hard on expenses all day every day to work both sides. I think, you'll see – as far as a long way of answering your question. I think you'll see improvement over time, but not as fast as what we've seen in the last couple of years.
Understood. Thanks for taking my questions, guys.
Thank you.
The next question will come from Brad Milsaps of Sandler O'Neill.
Hi, good morning.
Good morning.
Paul. I appreciate all the color and background on credit. Wanted to maybe follow-up on the restaurant book, and specifically, the charge-offs you had this quarter in the restaurant portfolio. It sounds like frequency may pick up there in terms of a few more MPAs or criticized assets coming on. Just curious the severity of the loan that you did charge-off this quarter, and kind of how that would compare to what you typically see with other restaurant credits?
Hi, this is Sam. Good morning. Yes, the restaurant charge-off was – had been a long-identified problem for the past several quarters. It was a bankruptcy situation and we've got it fully resolved for the quarter. In terms of other material losses in the book, we've – I think, we’ve got the book graded appropriately, where our clients are really doing a great job in restructuring and cutting costs, injecting capital, personal guarantees, selling assets. And so, we feel good about the mode of our clients and it's again, it's back to client selectivity. That's how we built this book in the first place. We banked top tier operators that have operated through cycles. And so, we're seeing some incremental improvement there and we're seeing incremental improvement in top line sales, same-store sales growth.
So, don't need to paint overly optimistic picture. It's just – it's still a stressful industry, for sure. But I think we're in – that was a casual dining. And that's, as Paul pointed out earlier, our loss for this quarter, that is one that is very much that's an area of stress. Again, I want to point out that a significant portion of our restaurant book is quick serve. And quick serve has been very resilient through cycles.
That's great. I guess, I was just trying to get a sense of severity on that specific case that went to bankruptcy and in terms of, kind of how that would be overlay with other loans that might go that way, or to take the other side, this one would be most severe case that you might see out of that book?
I think the way I would answer your question is, this would be the most severe case. It’s the – first one that go into bankruptcy – it is the worst one. We anticipate it will be the worst one.
Okay, great. And then maybe just one follow-up. Now that you guys through the SNC exam, you've done a somewhat thorough review of the book. You look like you're going to build capital based on your loan growth guidance. Might you gotten – get more aggressive with a share repurchase? Just kind of curious, kind of how you're thinking about that today maybe versus a quarter or two ago in terms of what you might buy back?
Yes. We're probably unchanged from prior periods in terms of how we think about it something we will revisit from time-to-time. We have authorized the 50 million, as you heard us say, we purchase 10 million. So, we'll just continue to revisit. I would expect that over time, we’ll probably be in a pretty conservative place on it.
Okay, great. Thank you.
The next question will come from Ken Zerbe of Morgan Stanley.
Great. Thanks.
Hi, Ken.
I guess just sticking with a loan growth topic. I guess, when you first announced state, your target, if I'm not mistaken, it's sort of that 9%-ish growth. And now it's mid-single digits for 2020. I mean, I’m more curious, just in terms of why, right? Like is it because you're pulling back in restaurant leverage into energy, which I totally understand. And that's why loan growth is declining. Is it because of the payoffs that you mentioned? We’re elevated in 4Q, do you expect those to continue? Is it more intentional in terms of the other categories? I mean, just trying to figure out like the driver of why loan growth expectations are coming down so much?
Ken, I mean, I think you really hit it. I mean, you – first off, I would say, it's intentional. Second, the lob of large numbers just with state, their growth was a little slower than ours on a combined basis, it would be slower. We're really working the leverage portfolio hard. You saw that come down linked-quarter $60 million. Restaurant, flat to down.
So, net-net, with – we're moving towards a lower risk place in the portfolio and we feel good about it. We think it's still will be nice growth and still provide some operating leverage. And as we mentioned several times, it's really all about long-term return on tangible common equity and building the quality profitable portfolio.
Okay, understood. And then I guess in terms of the problem credits you guys have with this restaurant or leverage, et cetera, is there a market for you to actually try to sell any of these loans into like, or is that just you would take such a huge loss on those that it's just not worth it?
I – Ken, there are always people interested in talking about buying participations, reading, allocating portfolios, things of that nature, what we're focused on is managing the book that we have with the teams we have and staying focused on being – doing a good job for customers being responsive.
So, I mean, if we would never say never, of course, but you heard us say on the call, I mean, we manage the energy, E&P book from $590 million, down to $275 million, now back up to $380 million through a very challenging cycle. So, that would be for the ordinary course of business, the way we do things and we're managing restaurant down a bit, given the stress in that sector. I would think there probably won't be a day not too far from now, where we'll be looking to grow that business. But right now, down is the direction.
Got it. Understood. I would just imagine; I think if reducing the balance sheet risk could probably do a lot of positive things for your multiple on the stock. I guess, maybe just a third question if I might. In terms of the restaurant loans, you talked about how they are trending lower over time. What's the normal duration of a restaurant loan? Like how fast do they actually run off?
Ken, this is Sam. So, in the restaurant space, you're typically doing term lend – the term lending of five-year term with an amortization of anywhere from 7 to 12 years. And so, you'll generally see the restaurants, everything just amortizes as steady, at least, half over the five-year period. But most of these deals get redone and retreated in a couple of years, as they do acquisitions or other changes happen, and that could give us the opportunity to actually and we have exited some credits where we did not like to trends.
Alright. Perfect. Thank you very much.
[Operator Instructions] The next question will come from Jon Arfstrom of RBC.
Yes. Thanks. Good morning.
Good morning, Jon.
Good morning, Jon.
Couple more credit questions. On your NPL balances, how much of that is related to the three other credits that you talk about that are in the final stages of resolution? And also, maybe the bigger credit, it sounds like that was moved out as of today or yesterday?
Okay, let me be sure, I understand that your question is, how much of the non-performing loans today are related to the three-energy exit – E&P exit credit?
You've got four credits that you're highlighting as bigger credits. And I'm just curious at [930], how much of the NPL balances included? How much of those are in – how much of the NPL balance is those credits?
Yes. I mean, I would say, go ahead.
Jon, it’s just over 20 million associated with those four.
Yes.
…is remaining at 930.
Remaining at 930, okay. And you're saying that the three credits, the other three credits, this is on Slide 8 or in the final stages of resolution. Can you just maybe talk through that a bit with us? I mean, the question is, are you going to get out of those without any more pain?
Yes, the expectation is that the provisioning that we've provided in the third quarter is all that will be required to complete that resolution and given the nearness that we have to that situation and kind of the end of the story, if you will, feel pretty confident about that.
It should be done.
Yes, I agree that.
Okay, good. That helps. And then in terms of the criticized increase, you've talked a little bit about SNC impact. You probably did a little bit of a deeper dive is my guess. And you're saying maybe it's back to normal levels or it goes up and down. Are you – you're not signaling that there's a wave of further increases coming in the criticized bucket, or are you?
We are not signaling that.
Okay. Good. That's helpful. And then in terms of the provision, you talked about half of the provision is from the specifically identified charge-off, so that's 23 million. You have a little more coming from the criticized increase as well. So, is the message on the provision that it could potentially be back in that $15 million or below type range?
So, Jon, I think that's a fair way to think about it and a reasonable comment. And my only [asterisks is] that if something happens in restaurant or high leverage that I don't have visibility as about today. If something happens there, then it would be north of that.
Yes. Okay. Alright. So, big picture message and I know we're all nervous about credit, but you're saying criticized is not going to spike potential for NPLs to come down and potential for loan loss will the way we sit today, potential for that provision to go back to some sense of normalcy with some caution in terms of – you can't 100% predict the future, is that fair?
I think that the increase in criticized and classifieds are not terribly alarming, and that it would not generate outsize provisions or charge-offs in the future. I think it's more – ordinary course of business what comes to mind, maybe it's something a little different than that. But it's an ebb and flow and what happens with a credit portfolio, and it's in-line with historical levels, and slightly north appear, but not out of control. So, my outlook for credit for next year is improving and positive.
And, again, we would just kind of go back to that, I hate to keep harping on it, but kind of the broader view the 25, 30 basis point net charge-off expectations and it's one outlier to you that, but that's our expectation. We've been better than that previously. But we – that's kind of what we expect as we look forward.
Okay. Alright. Thanks for that help. I appreciate it.
Thank you, Jon.
And this conclude our question-and-answer session. I would now like to turn the conference back over to Paul Murphy for any closing remarks.
Okay. Well, thank you all for joining us. Just to summarize, pre-provision earnings were up sequentially and this will drive solid returns on return on equity and return on assets over time. You know, assuming these charge-offs of 25 basis points, 30 basis points, our goal and our expectation is that our bank will be able to achieve return on assets in that 1.6 range and return on equity in the 17% range.
We are protected from lower interest rates by virtue of the hedge that we have in place and our ability to bring down deposit rates. So, it is really fortunate that our strong deposit growth and slower loan growth has helped reduce our dependence on the broker deposits and it has really put us on a strong liquidity and a strong capital position.
On closing, I think we have got a great franchise. We are in some really attractive markets. Terrific team of bankers working very hard to do a good job for clients. I think we have a rock-solid strategy and I remain confident that we are going to generate attractive return over time. With that, we’re adjourned.
This conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Have a great day.