Amerant Bancorp - Q2 2024

Transcript

Operator (participant)

Good morning, and welcome to the Amerant Bancorp second quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to Laura Rossi, Head of Investor Relations. Thank you. You may begin.

Laura Rossi (SVP and Head of Investor Relations & Strategy)

Thank you, Daryl. Good morning, everyone, and thank you for joining us to review Amerant Bancorp Inc.'s second quarter 2024 results. On today's call are Jerry Plush, our Chairman and CEO, and Sharymar Calderón, our Executive Vice President and CFO. As we begin, please note that discussions on today's call contain forward-looking statements within the meaning of the Securities Exchange Act. In addition, references will also be made to non-GAAP financial measures. Please refer to the company's earnings release for a statement regarding forward-looking statements, as well as for information and reconciliation of non-GAAP financial measures to GAAP measures. I will now turn it over to our Chairman and CEO, Jerry Plush.

Jerry Plush (Chairman and CEO)

Thank you, Laura. Good morning, everyone, and thank you for joining us today to discuss Amerant's second quarter 2024 results. To start, I'd like to call your attention to how this quarter underscores the continued focus we have demonstrated toward executing on our strategic plan and driving growth. Excluding the impact of $5.6 million of deal-related expenses in connection with the sale of the company's Houston franchise, as we disclosed in Form 8-K on July 1, 2024, our core business demonstrated strong performance, highlighted by solid loan growth, continued improvement in the net interest margin and NII, higher non-interest income, and only a moderate increase in expenses compared to the first quarter, primarily from investments we are making in personnel and market expansion.

While total deposits declined by $62.2 million, organic deposit growth in 2Q nearly offset the runoff of higher-cost municipal deposits and reductions in two large corporate deposit relationships this quarter as well. However, the sustained high interest rate environment year-over-year and higher operating costs have impacted several of our borrowers, as we will cover in greater detail in just a few minutes. This quarter, we saw that upon the receipt of updated financial statements from certain borrowers and covenant testing, there were clear signs for five borrowers to be downgraded to substandard, three of which were previously classified as special mention. Two of the downgraded loans are larger relationships, both of which are paying as agreed.

One is a C&I legacy loan for $26.8 million, and the other an owner-occupied loan for $28.2 million, which are the more significant drivers of the increase in nonperforming loans quarter-over-quarter. Furthermore, regarding the aforementioned C&I legacy credit, again, while paying as agreed, we booked $8 million in provision this quarter, resulting from running scenarios for multiple outcomes. We remain optimistic about a positive outcome here in the next several months. Regarding the owner-occupied credit, we are in a very strong collateral position, in the 40% range. I think in the case of the downgrades this quarter, the guidance is clear that where there is a sign of a covenant not being met or other weakness exhibited, that downgrading is appropriate, and that's what we did.

More to come regarding credit in the upcoming slides, including the other components of the provision quarter-over-quarter. We also continued this quarter to execute on prudent asset liability management. Recent results on inflation and industry action to these reports suggest a positive outlook for potential interest rate cuts in the upcoming quarters. Therefore, we continue to position our balance sheet in light of this potential change in interest rates. Regarding our Houston franchise, we are continuously monitoring loan and deposit balances to be sold, and we reclassified assets and liabilities to held for sale this quarter, which resulted in the charges recorded this quarter associated with this transaction. We still anticipate closing in the fourth quarter of this year, and at that time, the premium from the sale would be recognized as income, net of any final investment banking and legal expenses.

So we'll turn now to slide three, and here you can see that total loans increased by $316.5 million, all driven by organic loan growth. The loan pipeline is strong for 3Q, as we've already closed on approximately $80 million month to date here in July, and $40 million more is expected before month end. Total deposits decreased $62.2 million, as I referenced earlier, as organic deposit growth was offset by the reductions on higher cost municipal and the two large commercial depositors. We increased FHLB advances by $50 million to add three-year fixed-rate funding as part of our asset liability management strategy. Our assets under management increased $94.2 million-$2.45 billion, primarily driven by market valuations and net new assets.

Non-interest income increased to $19.4 million, primarily driven by higher income from loan derivatives in the mortgage business. Non-interest expenses increased to $73.3 million. However, excluding the non-routine transaction costs in connection with the sale of our Houston operation, they remained at $67.7 million, comparable to the prior quarter and to guidance. Regarding our expansion in Florida, we officially opened our banking center in Downtown Miami, and we hired our new Palm Beach and Central Florida market presidents. Additionally, we signed agreements for a new banking center in Miami Beach and for our Palm Beach regional office and a banking center there as well, both of which we expect to open in the first quarter of 2025. Note that we've received regulatory approval for both locations.

We repurchased 200,652 shares for $4.4 million in the second quarter at an average price of $22.17 per share. We had $15.6 million remaining under the current approval as of the end of the second quarter. Of note, in closing on this slide, we paid our quarterly cash dividend of $0.09 per common share on May 30, 2024. We'll turn now to slide four for financial highlights for the second quarter. Looking at the income statement, diluted income per share for the second quarter was $0.15 compared to $0.31 in the first quarter. This was primarily due to the increased provision for credit losses during the quarter.

The net interest income was 3.56% in the second quarter, compared to 3.51% in the first quarter. The increase in margin resulted from the higher yielding loan production and lower deposit costs, as we reduced higher cost municipal deposits and replaced brokered CD maturities with lower cost ones. Credit quality events continue to be an area of focus, and reserve levels are carefully monitored to provide sufficient coverage. The provision for credit losses was $19.2 million, up $6.8 million from the $12.4 million we reported in the first quarter. And again, of note, one legacy credit accounted for $8 million of the provision increase.

Non-interest income was $19.4 million in the second quarter, up $4.9 million from the $14.5 million in the first quarter, while non-interest expense was $73.3 million, also up $6.7 million from the $66.6 million in the first quarter. Our total assets came in at $9.75 billion as of the end of the second quarter, slightly down from the $9.82 billion in the first quarter. Our total deposits decreased slightly, as noted previously, down to $7.82 billion, compared to $7.88 billion in the first quarter. Our total loans increased by $316.5 million, up to $7.3 billion, up from the $7 billion at the first quarter.

Our total securities were $1.5 billion, and that was up $51 million from the first quarter, and cash and cash equivalents decreased $350 million to $310.3 million at the end of the quarter. So if we move on to capital, our total capital ratio at the end of the second quarter was 12%, compared to 12.49% as of the first quarter. Our CET1 was 9.7% compared to 10.10%. Our tangible equity ratio was 7.3%, which includes $78.9 million in AOCI, resulting from the after-tax charge of the valuation of the AFS investment portfolio. And lastly, as of the second quarter, our Tier 1 capital ratio was 10.44%, compared to 10.87% as of the first quarter.

You'll also note that on July 24th, our board of directors approved a dividend of $0.09 per share that's payable on August 30th, 2024. So at this point, I'll turn the presentation over to Sharymar to cover metrics and get into the financials in greater detail.

Sharymar Calderón (EVP and CFO)

Thank you, Jerry, and good morning, everyone. I'll begin today by discussing our key performance metrics and their changes compared to last quarter. We continue committed to customer relationships, which increased the ratio of non-interest-bearing deposits to total deposits from 17.7% in the first quarter to 18.7% in the second quarter. Aligned with the guidance shared in our past earnings call, net interest margin improved to 3.56% in the second quarter, compared to 3.51% in the first quarter. As Jerry just mentioned, this is the result of higher yielding loan production and lower cost of deposits. Our efficiency ratio was 74.21% in the second quarter, compared to 72.03% in the first quarter, as a result of the non-routine expenses in connection with the Houston transaction.

Our ROA and ROE this quarter were 0.21% and 2.68%, compared to 0.44% and 5.69%, respectively, in the first quarter. These decreases were primarily driven by the increased provision for credit losses and non-routine expenses related to the Houston transaction Jerry just mentioned. Tier 1 capital ratio decreased slightly to 10.44% compared to 10.87%, due to the change in the asset composition. Lastly, the coverage of the allowance for credit losses to total loans increased to 1.41%, compared to 1.38% in the first quarter, driven by the provision for credit losses recorded this period. Moving on to Slide 6, we continue to have a well-diversified deposit mix composed of domestic and international customers.

Domestic deposits, which account for 68% of our total deposits, totaled $5.3 billion as of the end of the second quarter, slightly down by $6.8 million or 0.1% compared to the first quarter. International deposits, which account for 32% of total deposits, totaled $2.5 billion, down $55.5 million or 2.1% compared to the first quarter. Total time deposits for the quarter were $2.3 billion, an increase of $65.6 million from the first quarter, due to an increase in broker time deposits of $49.8 million, as well as an increase of $15.8 million in customer CDs.

Our core deposits, defined as total deposits excluding time deposits, were $5.5 billion as of the end of the second quarter, a decrease of $127.8 million or 2.3% compared to the first quarter. The $5.5 billion in core deposits included $2.3 billion in interest-bearing deposits, down $302.1 million, or 11.5% versus the first quarter. $1.7 billion in savings and money market deposits, up $106.5 million or 6.6% versus the first quarter.... and $1.5 billion in non-interest bearing demand deposits, up $67.5 million, or 4.9% versus the first quarter. Continuing on to slide seven, I'll discuss our investment portfolio.

Our second quarter investment securities balance was at $1.5 billion, slightly up from the first quarter. When compared to the prior quarter, the duration of the investment portfolio has extended to 5.3 years, as the model anticipated slower MBS principal prepayments due to higher market rates at the time of quarter close. The chart on the upper right shows the expected prepayments and maturities of our investment portfolio for the next 12 months, which represents a liquidity source available to support growth and higher interest-earning assets. Moving on to the rate composition of our portfolio, you can see that the floating portion remains unchanged at 12.9% compared to the first quarter. As we mentioned last quarter, we have continued positioning the balance sheet for a decreasing rate environment.

Also note that 79% of our AFS portfolio has government guarantees, while the remainder is rated investment grade. Continuing on to slide 8, let's talk about the loan portfolio. At the end of the second quarter, total gross loans were $7.3 billion, up $316.5 million, or 4.5%, compared to $7 billion at the end of 1Q. This increase was organic, relationship-driven growth, and despite a reduction in indirect consumer loans of $31.4 million. The single-family residential portfolio was $1.6 billion in the second quarter, an increase of $107.4 million compared to $1.5 billion in the first quarter. This amount includes loans originated during the quarter, primarily done with private banking customers and commercial clients with residential income-producing properties as collateral.

Consumer loans as of the second quarter were $296.4 million, a decrease of $41.3 million or 12.2% quarter-over-quarter. This includes $131.9 million in higher-yielding indirect loans purchased prior to 2022 as a tactical move to increase yields. Again, we estimate that at current prepayment speed, this portfolio will mostly run off by the first quarter of 2025. Moving on to slide 9. Here we show our CRE portfolio in greater detail. We have a conservative weighted average loan-to-value of 58% and debt service coverage of 1.3 times, as well as strong sponsorship tier profile based on AUM, net worth, and years of experience for each sponsor. As of the end of the second quarter, we had 30% of our CRE portfolio in top-tier borrowers.

We have no significant tenant concentration in our CRE retail loan portfolio, as the top 15 tenants represent 21% of the total. Major tenants include recognized national and regional grocery stores, pharmacy, food, and clothing retailers, and banks. Turning to slide 10, let's take a closer look at credit quality. Our credit quality remains sound and reserve levels provide sufficient coverage. The allowance for credit losses at the end of the second quarter was $94.4 million, a decrease of 1.7% from $96.1 million at the close of the first quarter. Our non-performing loans to total loans are up to 138 basis points, compared to 43 basis points last quarter, which I will cover in detail in later slides.

Non-performing assets totaled $121.1 million at the end of the second quarter, an increase of $70.6 million compared to the first quarter, primarily due to the increase in NPLs Jerry mentioned in his remarks. The ratio of non-performing assets to total assets was 124 basis points, up 73 basis points from the first quarter. In the second quarter of 2024, the coverage ratio of loan loss reserves to non-performing loans closed at 0.9 times, down from 3.2 times at the end of the first quarter. Turning to slide 11, we show the roll forward of special mention and non-performing loans from the first quarter to the second quarter and provide color on the main drivers of these changes.

Special mention loans decreased by $8.5 million, primarily driven by $46.3 million in loans previously in special mention, which were further downgraded to substandard. $7.8 million in payoffs and $5 million in upgrades. These decreases were partially offset by $49.7 million in newly downgraded loans to special mention. The decrease in special mention loans was primarily driven by three commercial loans totaling $46 million that were further downgraded to substandard. These decreases were offset by new downgrades to special mention during the quarter, that although exhibit payment performance, were downgraded due to covenant failures. These consist of two non-owner occupied CRE loans in Florida, totaling $33.9 million, one commercial loan in Florida totaling $13.2 million, and one owner-occupied loan in Houston totaling $2.5 million. These increases were offset by paydowns, payoffs, and other smaller changes.

The increase in non-performing loans you see on this slide was primarily due to three commercial loans totaling $46 million, which were disclosed in the first quarter as special mention credits and were downgraded based on updated financials received in the second quarter. Additionally, there were two newly downgraded commercial loans totaling $47.3 million in Florida, primarily an owner-occupied credit of $28.2 million in the construction materials manufacturing industry. These increases were offset by paydowns, payoffs, and other smaller changes. Now, moving on to slide 12, which shows the drivers of the allowance for credit losses. At the end of the second quarter, the allowance was $94.4 million, a decrease of $1.7 million or 1.7% compared to $96.1 million at the close of the first quarter.

The provision for credit losses was $19.2 million in the second quarter. Excluding reserve for commitments, the provision was $17.7 million and was comprised of $12.8 million to cover charge-offs, $12.7 million in new specific reserves for non-performing loans, and $1.8 million due to loan composition and growth. The primary driver of the new reserves was one commercial loan totaling $26.8 million in Florida, which had been classified as special mention in the first quarter, and for which we booked $8 million in reserves. It is important to note that these were offset by a $5.3 million release related to credit quality and macroeconomic projection updates, and a $4.4 million release due to the Houston loan portfolio classification as held for sale.

During the second quarter of 2024, there were net charge-offs of $19.3 million, of which $5.4 million were related to purchase consumer loans, $9.9 million related to a commercial Houston-based loan, of which $4.9 million was provisioned in the prior quarter, and $4.9 million were related to multiple retail and business banking loans. This was offset by $0.9 million in recoveries. Please note, we decided to fully write off the aforementioned Houston-based credit this quarter, given longer than anticipated litigation and book recoveries as they occur. Next, I'll discuss net interest income and net interest margin on slide 13. Net interest income for the second quarter was $79.4 million, up $1.4 million, or 1.8% compared to the first quarter.

The increase was primarily driven by higher average balances and rates on total interest-earning assets, mainly on loans and securities available for sale, and lower average balances on transactional accounts and brokered deposits, as well as lower average rates in DDAs and brokered CDs. The increase in net interest income was partially offset by lower average balance in deposits with banks and higher average balances and rates on FHLB advances and customer CDs, as well as higher rates in money market deposits. In terms of our deposit beta, considering there was no change in the Fed funds rate this quarter, there is no beta calculation for this period. However, we observed a beta of approximately 49 basis points on a cumulative basis since the beginning of the interest rate up cycle, unchanged from the first quarter, indicative of a flattening trend and nearing inflection point.

This cumulative beta reflects the combined effect of rate increases in transactional deposits and repricing of time deposits that had not repriced at current market rates. Moving on to the net interest margin, we show in slide 14 the contribution to NIM from each of its components. As mentioned, NIM for the second quarter was 3.56%, up five basis points quarter-over-quarter. This change in the NIM was primarily driven by the higher interest income resulting from growth in higher-yielding loans and non-interest-bearing deposits, paired with the reduction of high-cost deposits from municipalities and the replacement of broker CD maturities with lower cost ones. In the short term, we expect the margin to be stable due to higher yielding loan production, partially offset by the reduction of the indirect consumer loan portfolio and deposit costs, given market competition for domestic deposits and demand for higher rates.

I'll provide some additional color on NIM in my final remarks. Moving on to interest rate sensitivity on slide 15, you can see the asset sensitivity of our balance sheet with 51% of our loans having floating rate structures and 58% repricing within a year. Also, we continue to position our portfolio for a change in rate cycle by incorporating rate floors when originating adjustable rate loans. We currently have 49% of our adjustable loan portfolio with floor rates. Additionally, you can see here that within the variable rate loans, 36% are indexed to SOFR. Additionally, we continue to execute ALM strategies, including hedging interest rate risk, as we expect a downward trend in interest rates starting in the second half of 2024 or early 2025. Our NIM sensitivity profile remains stable compared to the first quarter.

We also show here the sensitivity of our AFS portfolio to showcase our ability to withstand additional negative valuation changes, although we should start seeing an organic improvement in AOCI if monetary policy changes and interest rates start to decrease later in the year as expected. We will continue to actively manage our balance sheet to best position our bank for the upcoming periods. Continuing to slide 16, non-interest income in the second quarter was $19.4 million, up by $4.9 million, or 34% from $14.5 million in the first quarter. The increase was primarily driven by higher loan level derivative income, as well as higher other non-interest income due to higher mortgage banking income and the absence of a loss on the sale of the Houston CRE loan portfolio that we had in 1Q.

Contributing to the increase was also the gain on early repayments of $595 million in FHLB advances. This increase in non-interest income was partially offset by higher security losses during the quarter. Amerant's assets under management totaled $2.5 billion as of the end of the second quarter, up $94.2 million or 4% from the first quarter. This increase was primarily driven by net new assets and market valuation. Turning to slide 17, second quarter non-interest expenses were $73.3 million, up $6.7 million, or 10.7% from the first quarter. The quarter-over-quarter increase was primarily driven by an increase in occupancy and equipment expenses, mainly due to the valuation impairment charge of $3.4 million in connection with the Houston branches being for sale.

$1.3 million in losses on loans held for sale in 2Q for the transfer of approximately $552 million in Houston that were in loans held for investment prior to the transaction. An increase in advertising expenses in connection with our sports partnerships. Yes, going for rounds in the Stanley Cup playoffs increased expenses. Higher legal fees in connection with the Houston sale. An increase in salaries and employee benefits due to higher average FTEs in the quarter. And an increase in loan-level derivative expenses, which were driven by a higher volume of derivative transactions into Q compared to the first quarter. The increase in non-interest expenses was partially offset primarily by lower telecommunications and data processing fees and lower FDIC assessments and insurance fees.

In terms of our team, we ended the quarter with 720 FTEs, which is higher than the 696 we had in the first quarter. We added to our business development team again this quarter as part of our growth initiatives. Moving on to slide 18, we show the elements that contributed to the change in the EPS this quarter. We reported second quarter diluted earnings per share of $0.15 on net income of $5 million, compared to $0.31 on $10.6 million net income in the previous quarter, which was primarily driven by the higher provision for credit losses and non-routine expenses in connection with the Houston transaction. I'll now give some color of our expectations for the third quarter. We expect the NIM to be stable compared with 2Q.

Regarding non-interest income, we expect it to be approximately $17 million. We expect operating expenses to remain at the $68 million previously mentioned, including onboarding new team members towards our growth plan. Finally, we expect provision for credit losses to be in or around $12 million next quarter, as we do expect asset growth, as I previously mentioned, so at least half of this amount would be related to growth in the quarter. We currently estimate the Houston transaction will close mid-4Q, with the premium on the transaction settling prior to year-end. This premium, while in a different quarter, will more than offset the charges recorded in 2Q. We are focused primarily on achieving the 1% ROA and 12% ROE targets we established for ourselves.

It is more likely now that the 60% efficiency ratio could slide to 1Q 2025, as we continue to see opportunities to keep investing in our future. I will pass now back to Jerry for closing remarks.

Jerry Plush (Chairman and CEO)

Thanks, Sherry. So before we move to Q&A, I'd like to briefly comment on some of the initiatives we're working on to accelerate the execution of our growth plans here in Florida. So as I noted earlier, loan production was strong in the second quarter, and the pipeline for 3Q 2024 is on track with our previous guidance of 10% annualized growth. Our deposit growth to fund projected loan growth continues to be our top priority as part of our Deposits First initiative. We continue to actively recruit for additional commercial relationship bankers, private banking officers, as well as market managers in Broward County, Palm Beach County, and the Greater Tampa market. As we ramp up building our team in Palm Beach, we've already taken temporary space in the same building where our regional office and new banking center will be.

As noted before, as part of our expansion in the Greater Tampa market, we intend to open up five additional banking centers over the next 24 months. Please note, we're already close to signing a letter of intent for the first location in downtown Tampa. In summary, our focus remains on the execution of our strategic plan as we pursue our goal of being the bank of choice in the markets we serve. At the same time, we also fully intend to reach prudent and timely resolution to the non-performing loans that we've discussed here today. With that, I'll stop, and Sherry and I will look to answer any questions you have. Daryl, if you would, please open the line for Q&A.

Operator (participant)

Thank you. At this time, we'll be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for your questions. Our first questions come from the line of Tim Mitchell with Raymond James. Please proceed with your questions.

Tim Mitchell (Senior Equity Research Associate)

Hey, good morning, everyone.

Jerry Plush (Chairman and CEO)

Good morning, Tim.

Tim Mitchell (Senior Equity Research Associate)

Just want to start out on credit. Appreciate all the color from Sherry and the prepared remarks, but just curious, you know, is there one or two of those credits that were downgraded to, to nonaccrual this quarter that are particularly concerning to you? I understand you're still kind of working through a lot. And then just kind of your outlook for, for charge-offs through the rest of the year. Thanks.

Jerry Plush (Chairman and CEO)

Yeah, look, I'll take the first two, or the first question and then ask Sherry to add some color. You know, in terms of, you know, the credits for the quarter, when you look at the five, you know, the comments that I made earlier, you know, we have painted multiple scenarios on the one that we expect a resolution to in the next several months. And I think that we took a prudent approach to booking the $8 million. That doesn't mean that we think that that's the most likely outcome. And so, you know, we see that with the private equity backing in that particular relationship, we definitely see that there could be a very positive outcome that comes from that.

Regarding the other one, and again, remember, these two large credits were the driver of the bulk of the non-performing downgrades. The other one, the collateral behind the deal is so strong, you know, with the where we are from a coverage perspective, I think it's actually even more favorable than 40%. Our view is that, you know, we can see a positive resolution there as well. You know, in that particular case, there was an incident that occurred, you know, with a leadership transition that we think is now well on its way to getting worked through. So, you know, with that color, I think the two larger ones, we feel that there's positive outcomes that can come from those.

Sharymar Calderón (EVP and CFO)

And then in terms of-

Tim Mitchell (Senior Equity Research Associate)

Great. Yeah, that's great.

Jerry Plush (Chairman and CEO)

Yeah, and then you had asked about charge-offs for the rest of the year. Sharymar, if you want to-

Sharymar Calderón (EVP and CFO)

Yeah, sure. So in terms of charge-off, and I'm going to give more of a rate, excluding indirect consumer and excluding this one time, charge-off that we recorded this quarter, to fully write off a, a credit. We should be in around 25-30 basis points. If we add up back the indirect consumer, which is going down in balance quarter-over-quarter, we should be something closer to the 70 and progressively going down until we get to that 30, normalized level.

Tim Mitchell (Senior Equity Research Associate)

Okay, great. I appreciate the color. And then switching gears to loan growth. I understand you guys are certainly a higher growth bank than most, but the industry really hasn't seen much growth right now. Just hoping you can lay out some of the key drivers of the 10% number, and then as it relates to deposit growth, you know, do you expect deposit growth to kind of you know, maybe pick back up here, or just kind of level, let's see the loan deposit ratio trend over time?

Jerry Plush (Chairman and CEO)

Yeah, look, I think it's important to note we've set a target of 95%. You know, our view was we were never gonna continue operating in the 87%-88% range that we had dipped down to post, you know, when we did the sale transaction. And so we've utilized that excess cash, obviously, this quarter. And as we noted, we had higher cost commercial-to-commercial clients that had some significant paydowns, you know, reductions as well as the higher cost municipal go out, which then offsets all the hard work of the growth, right, on the organic side. You know, so we had a net down $62 million. Our view is always, it has been and will continue to be, that we need to grow deposits in tandem with loans. We want to stay, you know, in and around that 95%.

That doesn't mean that, you know, we'll always hit 95. We can be within a range of that. So whether it stays in this 93 and change, or whether it goes up to 97 and change, our view is the 95's the target, and that's what we want to maintain. You know, regarding the loan production, it's a combination of, you know, in my mind, two things. The drive that's happened across both the consumer and the commercial portfolios with all of the people, you know, the quality people we've added, you know, particularly over the last 12-18 months, coupled with the quality people we had in the organization. That continues to build, and again, we added a significant number of business development personnel this past quarter. You know, as Sherry referenced in the increase in headcount.

You know, when you get those folks added in a quarter and now they're here onboarded and beginning to produce, you've now got full quarter's worth of production that they're now bringing to the table. And so, you know, that's the way we're getting to that annualized growth number.

Tim Mitchell (Senior Equity Research Associate)

Awesome. Thanks. Thanks for taking my questions, guys.

Jerry Plush (Chairman and CEO)

Okay, thank you.

Operator (participant)

Thank you. Our next question has come from the line of Will Jones with KBW. Please proceed with your questions.

William Jones (AVP of Equity Research)

Hey, great. Good morning, everyone.

Sharymar Calderón (EVP and CFO)

Morning, Will.

William Jones (AVP of Equity Research)

I wanted to go back to the current discussion, Sherry. I appreciate the commentary on just where you think charge-offs are going, and I know, you know, 70 basis points is a little bit higher than, you know, kind of the 40-50 that we had previously talked about. I guess the broader question is, you know, if we see, you know, more charge-offs in the 70 basis point range and you think normalized is closer to 30, you know, what do you feel like is the timeline to get back to that 30 basis point range? Is it gonna be, you know, a 2025 event in your mind?

Sharymar Calderón (EVP and CFO)

The reason for the 70 basis points is primarily driven by the indirect consumer portfolio. Once the indirect consumer portfolio runs off, which we're estimating would be primarily by the first quarter of 2025, we're expecting to be back at the normalized level of charge off, lower than 30. So it should be early 2025.

Jerry Plush (Chairman and CEO)

Yeah, Okay. And I think. Yeah, Will, I think it's also important to add, you know, we obviously took a significant, you know, commercial charge-off. Sherry referenced that in her comments, half of which had previously been reserved in the balance. Our view was because of what we think is gonna be a protracted, you know, period of resolution on that, you know, I think the litigation that goes on sometimes in these, in the resolution, it's better for us to get it behind us and recover it in future periods. And I think, you know, that pop, obviously, that was much more significant when you see quarter-over-quarter.

But, you know, that's probably the one case where we felt that it was important, rather than to continue to, you know, observe and see how things went quarter to quarter, was to take a more, you know, proactive approach, get it off, and then recover as we move forward.

William Jones (AVP of Equity Research)

Yeah. Okay, that makes sense. Jerry, I'll just kind of give you the floor here. What's your kind of pitch that you know, you have your arms ring-fenced kind of around what credit issues you see that are in front of you? I mean, we saw, you know, further migration this quarter, you know, charge-offs are high, and they're still gonna kind of be, you know, in an elevated range. What kind of gives you the confidence that, you know, you—we will ultimately see an inflection that you have your arms kind of ring-fenced around, you know, what potential credit problems are out there?

Jerry Plush (Chairman and CEO)

Yeah, look, I think what we're seeing, right, and I've referenced this, you know, you're looking at a 500 basis point, you know, swing in interest rates that's impacted, you know, particularly as Sherry's referenced, right? Most of the floating rate we've got is on the C&I side. And so, you know, when you look at the credits that we're talking about today, the majority are on the C&I side, where those borrowers have had more financial pressure than you had. You know, they've also had higher operating costs, right, year over year, right? You know, things just simply such as the insurance costs, you know, the increases year over year. So our view is, the ones who can sustain going forward, right?

That we've seen that they've met their debt service covenants, they've met their, you know, their coverage ratios, they've met their requirements for getting their financials done on time, and that we're not seeing deterioration. I think we've seen a pop here of what happened year-over-year in the portfolio. And, you know, frankly, if you think about the timing of when you would expect year-end financial information, it's the second quarter. You know, so most of those audited financials or reviewed financials are coming in in 2Q. And so, you know, that's, that's what I think, you know, from our perspective and the discussions we've had, you know, gives us, you know, more confidence as we look forward on the portfolio. Look, it's not to say that there can't be something else.

You know, and by the way, I do wanna just make a comment. Anyone who's listened to our calls and investor conferences knows that we book fairly, you know, solid financial exposures. When you think about credits we book, you know, we're referencing $20-$30 million exposures. You know, we're booking a lot more of commercial production on our books, you know, so whether it's C&I or CRE, than probably other banks our size, who probably got bigger 1-4 portfolios, than we do, et cetera. So I think with us, you know, that's something else also to take note. And that's why I wanted to highlight it, it was two larger credits, it was very specific situations in both of those.

You know, again, the timing of the second quarter and the receipt of information is really important to take into account.

William Jones (AVP of Equity Research)

Okay. And thanks for all that commentary. And then I just wanted to clarify just two quick things. On the Houston sale, you know, so I know it'll take place in the fourth quarter. And in the deck, you kind of called out, you know, about $5 million of personnel costs that are associated with that, that'll kind of exit as that transaction comes through. But are there any other costs or any other formal cost savings that you expect to kind of harvest or realize from that transaction that maybe we're not thinking about as we move into 2025?

Sharymar Calderón (EVP and CFO)

I think that in addition to direct costs that we have covered as part of the transaction disclosure, I would see opportunity to be able to redeploy some of the Florida team members that also work in connection with the Houston team, to be able to focus on the increased production that we're gonna have in Florida.

Jerry Plush (Chairman and CEO)

Yeah, I think that's really well said, because we are still right up through the closing, which we expect, again, as we've talked about some time in the fourth quarter, giving full support, right? So, you know, whether you think about it for operation support, tech support, facility support, you name it, you know, that's all part of, you know, what Sherry's referencing there. So yes, those folks can be either repositioned to focus on, you know, opportunities here, the growth opportunities and support here, or, you know, if there's any kind of attrition that we've got of existing personnel to offset that. So I think it gives us some capacity, you know, as we continue to grow down here in Florida.

William Jones (AVP of Equity Research)

Yeah. Okay. And then, just as we think about how, you know, how that would, you know, translate to where 2025 expenses land, if we get, you know, some of this cost savings, you know, from the transaction, but a lot of that, you know, is reinvested. What is kind of like a good growth rate to think about into 2025 as we think about expenses? And I know we're, you know, a long ways away from that, and, you know, I'm not trying to pin you to guidance now, but just trying to think about, you know, how expenses could look as we kind of exit 2024.

Sharymar Calderón (EVP and CFO)

I think that when we think about the expenses from after we adjust for the Houston transaction, I think we would still see ourselves closer to the $68 million. And it's kind of a repurposing of the expenses towards our investment here in Florida, so it should be more of a normal, normalized level.

Jerry Plush (Chairman and CEO)

Yeah. Well, I think that, you know, the thing, and we'll give clearer guidance on this, you know, next quarter, in the fourth quarter, but the ramp-up that we're having now, and that's kind of where we were going with the, you know, the incremental spend, is not just on people, but it's also the expansion of facilities, right? The growth push into Palm Beach, the growth push, you know, to Miami Beach, you know, where we had no coverage, or we had no coverage heretofore, and then the push into, you know, get some size and scale in Tampa. You know, that's some of those expenses, obviously, are gonna be part of that offset that Sherry was referencing.

William Jones (AVP of Equity Research)

Okay. That's helpful. And then the last thing for me, just housekeeping, the provision this quarter, that also included the $4.4 million reversal from Houston, right?

Sharymar Calderón (EVP and CFO)

Correct.

Jerry Plush (Chairman and CEO)

Yes.

William Jones (AVP of Equity Research)

Yeah. Okay. All right, thanks for my questions, guys.

Sharymar Calderón (EVP and CFO)

Thank you.

Jerry Plush (Chairman and CEO)

Sure, Will.

Operator (participant)

Thank you. Our next questions come from the line of Stephen Scouten with Piper Sandler. Please proceed with your questions.

Stephen Scouten (Managing Director and Senior Research Analyst)

Hey, good morning, everyone.

Jerry Plush (Chairman and CEO)

Hey, Stephen.

Stephen Scouten (Managing Director and Senior Research Analyst)

I guess I'm curious. I know, Jerry, you said these are kind of some specific situations around some of the commercial loans, but, you know, it's just obviously outside of what we've seen from, from most of the industry this quarter. So I'm kind of curious, do you think there's any trends happening specifically in Florida in terms of, you know, overall economic or business trends that maybe are not as positive as what we've become accustomed to over the past few years? Or are these more idiosyncratic in nature, in your view?

Jerry Plush (Chairman and CEO)

I have to tell you, Stephen, I think they're far more idiosyncratic. You know, we've talked about the one being a specialty healthcare industry-related credit. The other one is absolutely the change of leadership. You know, I don't wanna go into all the details, but the CEO change or the passing of someone, obviously, you know, had a significant impact in that particular credit. Our view is there's a path to a good resolution on these. And again, you know what I said before, I think we ran multiple scenarios to make sure that we took a prudent, we'll call it, you know, approach to the one to make sure. But again, given that's private equity backed, we feel that there's a path to getting done, and we're gonna know that here in the next couple of months.

Stephen Scouten (Managing Director and Senior Research Analyst)

Yeah. And does what you've seen, and you kind of noted there are a couple of larger commercial loans, which, you know, maybe your balance sheet looks different than some other like-sized banks. Does it make you any more apprehensive about near-term growth, specifically maybe in larger commercial?

Jerry Plush (Chairman and CEO)

You know, I think we're continuously refining, you know, on a risk appetite perspective, to make sure that we're not gonna be booking something that becomes so specialty oriented or, you know, could create some sort of other more challenging scenario for us if there were a credit, you know, event there. And I think that, you know, our view on this... And again, remember, the interesting thing with these, Stephen, is you're dealing with a situation where these loans are performing, right? They're paying as agreed, you know, so it's odd to say they're non-performing, right? In that respect. But I think that the way I look at it going forward is still...

Look, we've got a lot of expertise in the building, and we've added a lot more expertise, both on the biz dev side, I mean, you know, from the leadership of the core commercial bank, on down through the leadership in credit. I mean, we've added, you know, really, really strong folks in both the C&I and the commercial real estate side. So I think the strength of the teams gives me a lot more confidence about the forward view, you know, when you think about in meeting the growth.

Stephen Scouten (Managing Director and Senior Research Analyst)

Yeah, that's helpful. Okay. And then just maybe last thing around this topic is as you get to, let's call it 2Q 2025 for argument in the indirect, consumers run down and, you know, we're past these more elevated net charge-offs, what's a kind of fair percentage for the loan loss reserve? I mean, would you expect it to come down from this 1.41 back to, I don't know, maybe 1.20 level we saw in 1Q 2023? Or what's kind of a normalized level for the reserve?

Yeah, look, I think it's always gonna be something probably closer in the 125 range. Remember that in our particular case, there's a couple of specific reserves in that mix of the 140+ right now. So as you get to a resolution on those credits, I think you'll naturally see us be more in the 125 range. You know, and as we think about production on a go-forward basis, we're always looking that it's roughly around 1%, just given the asset mix.

Yeah. Perfect. Okay. And then just last thing for me is on the, you know, you guys noted some talk about balance sheet preparation for lower rates. Can you remind me what that looks like, and if there's anything that should materially change kind of your asset sensitivity as it stands?

Sharymar Calderón (EVP and CFO)

Yeah. So in preparation for the downward rate trend, we're working with floor rates as we continue loan production on the credits. We also have multiple hedging alternatives, including low and high floors. And we also work into the deposits that are tied as deposit covenants to these loans. They're interest-bearing deposits that would reprice automatically as the loan reprices as well. So under a downward rate scenario, we have calculated shocks of 25 cuts, and it would represent a full quarter's activity, less than $500,000 for us.

Stephen Scouten (Managing Director and Senior Research Analyst)

Okay, great. Thanks for all the color and the transparency today. Much appreciated.

Sharymar Calderón (EVP and CFO)

Thank you, Stephen.

Jerry Plush (Chairman and CEO)

Okay, thanks, Stephen.

Operator (participant)

Thank you. Our next question has come from the line of Jake Civiello with Janney Montgomery Scott. Please proceed with your questions.

Jake Civiello (Director of Equity Research)

Hi, good morning.

Jerry Plush (Chairman and CEO)

Good morning.

Sharymar Calderón (EVP and CFO)

Hey, Jake.

Jake Civiello (Director of Equity Research)

Was there... I apologize if I missed this, but was there any negative impact to the NIM from the interest accrual reversals due to the higher non-accrual loans in the quarter?

Sharymar Calderón (EVP and CFO)

There was an impact, but because most of these credits are still performing, the amount that we had to reverse for that last period was not as significant. If they had been without payment performance, the reversal would have been higher. But there was a slight impact into the NIM, yes. It's

Jake Civiello (Director of Equity Research)

Okay.

Sharymar Calderón (EVP and CFO)

- roughly $700,000.

Jake Civiello (Director of Equity Research)

Okay. Thank you.

Sharymar Calderón (EVP and CFO)

Sure.

Jake Civiello (Director of Equity Research)

And then the one other question that I wanted to ask was just any updated thoughts around, potential for utilization of the buyback? Obviously, this quarter was a little more elevated than it has been in recent periods, and, just kind of wanted to get your updated thoughts there.

Jerry Plush (Chairman and CEO)

Yeah, look, I think we, you know, we've noted that we're authorized still for another 15.6, I believe the number is. You know, we, we basically, you know, during the second quarter, just given everything that was on, we put it in a 10b5-1 and, and set parameters and, you know, we're pretty much continuously in the market. You know, right now we're still in that plan. And, you know, look, as always, we'll evaluate, you know, capital needs, growth plans. You know, I think that we've said repeatedly that, you know, maintaining, you know, the strong capital ratios that we have, you know, and putting, you know, the obviously, future earnings are gonna be very critical for us continuing, you know, to wanting to continue buybacks, you know, post-third quarter.

So, you know, our expectations are for stronger performance going forward in order to continue to support it, you know, to continue it as, you know, you start to think about late third quarter going into the fourth quarter. But our view is that it's a, it's an important tool. We've said that all along and, you know, the sense is that, you know, we believe that, you know, we should have... You know, obviously, we take very seriously what has happened this quarter as it relates to the impact, you know, and the additional provision. But, you know, sans the provision, obviously, you can see it was very strong performance, and we believe we can achieve that strong performance on a go forward.

Jake Civiello (Director of Equity Research)

Appreciate the thoughts, Jerry. Thanks.

Jerry Plush (Chairman and CEO)

Absolutely. Thanks, Jake.

Sharymar Calderón (EVP and CFO)

Thank you.

Operator (participant)

Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to Jerry Plush for closing comments.

Jerry Plush (Chairman and CEO)

All right. Thank you everyone for joining our second quarter call. We appreciate your interest in our company and your continued support. Have a great day.

Operator (participant)

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.