First Internet Bancorp - Fixed- (INBKZ) Q2 2019 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the First Internet Bancorp Second Quarter 2019 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note that today's event is being recorded. I would now like to turn the conference over to Larry Clark from Financial Profiles Inc. Please go ahead, Mr. Clark.

Thank you, Kerry. Good afternoon, everybody, and thank you for joining us to discuss First Internet Bancorp's financial results for the second quarter ended June 30, 2019. Joining us today from the management team are, Chairman, President and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. David and Ken will discuss the second quarter results and then we’ll open up the call for your questions. Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of First Internet Bancorp that involves risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the Company's SEC filings, which are available on the Company's website. The Company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute to most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today, as well as a reconciliation of the GAAP to non-GAAP measures. At this time, I'd like to turn the call over to David.

Thank you, Larry. Good afternoon, everyone, and thank you for joining us today. We are excited about the earnings results for the quarter, which were driven by solid top-line revenue growth, strong production in our specialty lending areas, continued excellent credit quality and well managed expenses. We are also pleased with our ongoing balance sheet repositioning efforts, as we were able to effectively manage our capital for significant loan sale activity during the quarter. For a quick summary of our results, we posted second quarter net income of $6.1 million and diluted earnings per share of $0.60, up 7.5% and 7.1% from the first quarter respectively. The primary driver of our financial performance was revenue growth, which increased again this quarter and was supported by strong performance from our direct-to-consumer mortgage business, which had its best quarter in more than two years. During the quarter, we sold $148.4 million of loans and $30.6 million of lower yielding securities. These asset sales are part of our balance sheet management strategy, which involves repositioning portions of our loan and security portfolios in order to improve the mix of earning assets. We are particularly proud of the fact that we were able to successfully execute on this strategy without having to pull back on our origination activity, enabling us to capitalize on the opportunities, our lending teams have, while also preserving capital in the current interest rate environment. Total loan commitments during the quarter were $267 million, up 19% from the first quarter, as we saw increased activity across virtually all lines of business with Commercial Real Estate and Healthcare Finance leading the way. The interest rate environment remains challenging as the rapid decline in short-term rates impacted asset yield, while the decline in longer-term rates did not have a significant impact on loan portfolio yields during the second quarter. New origination yields in certain lines of business may drift slower should long-term rates remain well for an extended period of time. To mitigate the risk of declining interest rates, we have implemented price floors in most of our commercial lending areas. The upside of declining interest rates is that we have been able to aggressively lower CD rates throughout the year. However, new production rates are still above the cost of maturing CDs, which combined with the strong production volumes that we experienced in the quarter that put further pressure on our net interest margins. That said, our Residential Mortgage business turned in a strong performance as origination activity picked up due to continued decline in mortgage rates during the quarter. The Mortgage Banking revenue was up significantly from the linked quarter, providing a natural hedge in the down rate environment that softened the downward pressure on net interest income. As we position for the future, further diversifying our revenue stream and expanding our asset-generation channels in a capital-efficient manner remains a top priority. Our expansion in the small-business lending and deposit services has been a key component of that strategy that complements our existing business lines. There are opportunities on both sides of the balance sheet, on the asset side to the production of higher-yielding loans for our portfolio, while generating incremental gain on sales revenue and on the liability side with small business and commercial deposits gathering initiatives. During the quarter we continued to advance our small business banking initiative as our pipeline of new lending opportunities has grown significantly due to the combined efforts of the SBA team we have put together and our C&I lenders in Indianapolis and Phoenix. We also began to see tangible results on the deposit side as business money market accounts provided over $34 million in new balances during the quarter. We are excited about the opportunities small business banking provides and we are working diligently towards building a full-service, nationwide platform. Related to credit, overall, our asset quality metrics continue to remain among the best in the industry, as our non-performing ratios were well below those with comparable banks. As I've stated before, this is driven not only by our strong credit culture and disciplined approach to the underwriting, but also our focus on certain specialty lending lines that include lower risk asset classes, such as our public finance and our single-tenant lease financing business. With a lower percentage of risk-weighted assets to total assets and strong credit metrics, we believe we can leverage our capital further than other comparably sized institutions. We also believe that this will position us well relative to our peers in the event the economy softens. Before I turn the call over to Ken to provide additional details on our financial performance, I'd like to state that I am very proud of our team that we have assembled and I thank them for their dedication to helping us generate strong results and what was a very active quarter. We are proud of the strong culture we have at First Internet and the high level of engagement from our team members remains a key to our success. As always, we continue to further our mission by serving customers in the digital economy, providing them with customer-centric digital banking solutions, while maintaining the personal touch of relationship banking. Ken?

Thanks, David, and thank you, everyone for joining us today. Given the continued challenging interest rate environment, we were very happy with our results for the quarter. We were especially pleased with the net income and EPS growth, while demonstrating the ability to manage loan growth through the significant loan sale activity we conducted during the quarter. While total asset growth appeared strong for the quarter, I will point out that cash balances at quarter end were inflated, as two of our loan sales closed during the last week of the quarter. Additionally, the securities that we sold also closed during the last week of the quarter. We expect to deploy the excess liquidity resulting from the loan sales throughout July and August to fund new loan originations, as well as fund run-off of maturing CDs. The proceeds from the securities sale has been fully deployed into higher-yielding investments. Overall, total loans outstanding at the end of the second quarter were $2.9 billion, an increase of $21 million or 0.7% from the first quarter. In terms of portfolio composition, total commercial loans were up $86.3 million or 4.1%, compared to the linked quarter and driven by $167 million of funded originations, primarily due to solid production in single-tenant lease financing and healthcare finance. Total consumer loans were down $78.2 million or 10.9%, compared to the first quarter, due primarily to the sales of portfolio residential mortgages. However, trailers and recreational vehicles originations were up almost 18% over the prior quarter with the balance in these portfolios up 3.7%. As David noted earlier, we sold $148.4 million of loans during the quarter in connection with our balance sheet management strategy. Let me take a few moments here to provide more details on these transactions. First, we sold $95 million of portfolio of residential mortgages in two separate transactions, which included a mix of jumbo fixed rate and seasoned lower yielding adjustable rate mortgages recognizing a combined loss of $759,000. As these loans had a weighted average yield of 3.86%, these transactions not only helped to preserve capital, but also improved earning asset yields through redeployment proceeds into higher yielding new loan originations. Second, we executed a sale of $30.9 million of single tenant lease financing loans at a price of 102, generating a gain of $684,000 to help offset the loss from the mortgage sales. And third, we sold $22.4 million of public finance loans at essentially book value. These loans were originated back in 2017 and had a fully taxable equivalent yield of 3.21%, and effectively funded $24 million of new originations during the quarter with a fully taxable equivalent yield of approximately 4.5%. Related to the securities we sold this quarter, those consisted of $30.6 million of lower yielding seasoned mortgage backed and U.S. government agency securities with a weighted-average yield of 1.88%. We recognized a loss of approximately $500,000 on this transaction, but have reinvested the proceeds in new securities with yields north of 3%. We also took advantage of an opportunity to sell our holdings of Visa Class B shares, which generated a gain of $500,000 and offset the loss in the securities transaction. When you combine the gains and losses from all these balance sheet management activities, the net result was a nominal gain of $17,000. As a result, the $0.60 of EPS we reported for the quarter was a plain operating number. Going forward, we expect to continue pursuing loan sale opportunities in order to manage balance sheet growth and capital while also helping to improve net interest margin and profitability. Moving on to deposits and funding. During the quarter, the cost of funds related to interest-bearing departments increased ten basis points to 2.39%, while average interest-bearing deposit balances increased $150.3 million or 5.5% and period-end total deposit balances increased $195.2 million or 6.9%, compared to the first quarter. Rates paid on new CD production declined compared to the first quarter, dropping across the curve. However, despite the reduction in pricing, our overall cost of deposits increased as rates paid on new CDs came on at a weighted-average cost of 2.74%, as compared to maturing CDs that rolled off at a weighted-average cost of 2.22%, a difference of 52 basis points. To put this in perspective though, in the second quarter of 2018, when rates across the curve were rising and deposit competition was intense, this difference was 109 basis points and last quarter, it was 88 basis points. Subsequent to quarter end, we have seen new weighted-average production rates come down almost another 20 basis points to 2.55%, while the cost of scheduled maturities for the third quarter is 2.35%. Over the next twelve months, we have approximately $1 billion of CDs maturing at a weighted-average cost of 2.72%. The key take away from this is that for the first time in the many quarters, we feel pretty good about where deposit pricing is going and we are rapidly approaching the inflection point where new production rates are below rates on maturities. Turning to net interest margin, our NIM declined to 13 basis point from the first quarter on both a reported and a fully taxable equivalent basis. The fully taxable equivalent net interest margin came in at 1.91%, well below where we were estimating for the quarter. This was due primarily to two factors. First, the pace of decline in three months LIBOR during the quarter, which outpaced the forward curve projections had a greater than expected impact on the swaps used to hedge public finance loans and longer term securities. Second, despite our constant reduction in CD rates, deposit growth was strong during the quarter, which had a volume impact on net interest margin. And additionally, the issuance of $37 million of subordinated debt in June had a one basis point negative impact on net interest margin. With regard to our outlook on net interest margin for the third quarter, the two items we see driving margin lower are, one, a full quarter's impact of the new subordinated debt issuance, and two, the expected continued decline in three months LIBOR. However, pursuant to my earlier comments on deposit pricing, we are estimating very little impact on margin from deposit costs. Additionally, we expect asset yields, excluding the impact of LIBOR on the interest rate swaps to remain relatively flat. Looking beyond the third quarter, we are forecasting modest net interest margin expansion in the fourth quarter. As we did in the second quarter, we will continue to pursue strategies to improve net interest margin including further loan sales, disciplined loan pricing, additional restructuring of securities and wholesale borrowing portfolios if opportunities arise and utilizing excess liquidity to fund a portion of CD runoff. Now turning to asset quality, as David already touched upon, credit quality was again solid as our ratios of non-performing assets and loans remain among the best in the industry. We did see an increase in both delinquencies and non-performing loans, which was due primarily to a commercial relationship consisting of two loans, a C&I loan, and an owner-occupied commercial real estate loan, that was placed on non-accrual status during the quarter. As a result, the ratio of non-performing loans to total loans increased to 19 basis points from 12 basis points in the first quarter. We also recorded a specific reserve of $600,000 related to this relationship, which negatively impacted earnings per share by $0.06. As a result, the provision for loan losses was up slightly from $1.3 million in the first quarter to $1.4 million in the second quarter, partially offset by the impact of loan sales during the quarter. Outside of this commercial relationship, credit results were consistent with our historical performance. We continued to have minimal net charge-offs, which were $254,000 during the quarter or four basis points of average loans on an annualized basis and were generally confined to the consumer portfolios. With respect to capital, our capital levels remained sound with total regulatory capital enhanced by the new subordinated debt issuance, which allows us to strengthen capital levels at the bank level without diluting shareholders, while tangible common equity to tangible assets declined to 7.37%. Some of the decline can be attributable to the higher cash balances at quarter end that I mentioned earlier in my comments. As we deploy this excess liquidity and continue to pursue loan sale opportunities to manage balance sheet growth, our goal is to keep the tangible common equity ratio flat to modestly up through the end of the year. And finally, we continued to repurchase shares under our stock repurchase program. During the quarter, we repurchased 112,129 common shares at an average price of $21.28 per share. Subsequent to quarter end, we purchased another 37,862 common shares at an average price of $20.75 per share and since inception of the program, we have repurchased 246,174 shares of stock at an average price of $20.86 per share, which represents approximately 2.4% of common shares outstanding at the end of the fourth quarter of 2018 when we initiated the program. The combination of solid earnings and share repurchases allowed us to increase in tangible book value per share to $29.10. We remain committed to producing consistent growth in both EPS and tangible book value per share. With that, I will turn it back over to the operator, so we can take your questions.

[Operator Instructions] The first question will come from Andrew Liesch of Sandler O'Neill.

Hello everyone. How are you?

Doing good, Andrew. How are you?

Good, thanks. I just wanted to touch on the share buybacks here. Just kind of curious like, why not be a little bit more aggressive with these? What's the govern around that?

Well, I think – I mean, obviously, where tangible common equity is today, as you know, call it, 7.4%. For us, we need to be conscious of not really allowing that ratio to go too low. Obviously, using loan sales and other means to manage balance sheet growth helps us participate in the share repurchases plan. But I think for us it's just a balancing act between – obviously, we are very conscious of not running that level too low, the TCE ratio too low, given where the stock price is trading today. So, I mean, it's – again, I think, maybe perhaps the ability to drive, perhaps, larger loan growth may influence some of that repurchase activity. But again, it's – for us, it's a just balancing act and being conscious of where the TCE ratio is at any given time.

Okay. Are there opportunities to maybe step on the accelerator for some of the loan sales and then use those proceeds to buy back stock? Or is that plan still to just sell some of the lower yielding portfolios and recycle that in the new higher-yielding production?

Well, I think – I mean, I think, our results on the loan sales side this quarter were pretty aggressive. I mean, I think, we were very pleased with the volume of loans we were able to sell. I think if it were up to some of us here, we'd love to be able to sell $150 million of loans a quarter, but having all that come together in one particular quarter is tricky to manage and our teams internally here work extremely hard to get that done. I mean, like I said in the prepared comments, we are still actively pursuing loan sale opportunities across all – the various areas within the Bank and our objective is to get as many of those deals done as we can in the third quarter and in the fourth quarter.

Gotcha. Okay. And then just one question on – just on the pace of the asset growth. I mean, you referenced to some of the cash coming in late in the quarter, but also just the large CD growth even with the decline and you guys offered rates. What's – what drove that – to that deposit growth in the quarter, if you can – if you don't need to be offering rates that high with lowering deposit ratio down at 95%, why not lower them further and try to slow that deposit growth?

We are, Andrew, in fact, we have lowered rates on a weekly basis, I think for seven weeks in a row here. We don't want to get 110% out of the market. But we dropped them again as of today. I would go back to the beginning of the year, particularly on the commercial side of the deposit base, some of the CD rates, all of the rates across the board are down at least 50% from what they were at the beginning of the year. Some of the commercial are over a 100 – or 50 basis points down. Some of the commercial are over 100 basis points down from rates we were offering at the beginning of the year. So we are moving it down. What's happening, I guess, everybody is trying to second guess what the Fed is going to do next week. We turned away a $75 million deposit opportunity this week as we just don't need deposit. So, we are conscious we are watching large dollar items coming in and we are just kind of turning them away. We can't close the virtual doors, because they are very hard to reopen. But we are moving them down, five, six, seven basis points a week.

Okay. That clarity is very helpful. Thanks much. I’ll step back.

Thanks Andrew.

Thanks Andrew.

The next question will come from Michael Perito of KBW.

Hey, good afternoon guys.

Hey, Michael.

Hey, Mike.

Thanks for taking my questions. I wanted to ask kind of a strategic question for us. Just as we look at the margin down here, south of 2% and it sounds like – I guess, first just to clarify the – so it sounds like there is a room for a little bit more compression next quarter and then inflection and some expansion in the fourth quarter. Just what's the interest rate assumptions behind that?

You mean, what – in terms of how are we looking at the forward curve? Are we looking at static rates? Is that your question, Mike?

Yes, like what type of rate cuts are you assuming in Fed funds, if any? And anything else pertinent to that, that's driving those assumptions?

Well, we use the forward – the implied forward rates that have some – that have fed rate cuts kind of baked into them on the short end of the curve. I mean, obviously, it's not just fed rate cuts that drive everything. You have LIBOR rates. You have swap rates. You have longer-term treasury rates. But it's essentially the forward curve - the implied forward rates that we have in our model.

Okay. And then, just as we think about kind of how you are managing the business here. I mean, it would seem like, I guess, where do you think – and I know we really have been in kind of a bizarre rate environment for a while. It's flat, it was moving up. Now it's moving down, but where do you think you can get this NIM too realistically? If – and I guess, the reasoning behind the question is, I mean, it doesn't seem like a south of 2% NIM what really – no matter what the expense infrastructure is really support kind of a peer-like profitability profile and I am just curious how you guys are thinking about that challenge and where you think you can move that NIM with your mix of business and what you are doing now to get to a point where we could see profitability maybe start to close the gap towards the peers?

As we – I think as we look forward, I mean, as I mentioned, we are going to have a couple of factors here that are going to put pressure on NIM here in the third quarter. But as I mentioned, I think the good thing from our perspective and what we are excited about is it's no longer being driven by a rapid pace in deposit cost. We are seeing deposit cost come down and we're going to start to see new deposit costs at lower levels than deposit cost rolling off the books. So, I think, as we'll probably – as we get into the fourth quarter and into 2020, we're probably not going to see net interest margin jump maybe 10 to 15 basis points a quarter. But I think we'll probably start to see it climb call it, 5 to 7 a quarter. And that just – and a lot of that depends on the shape of the yield curve as well. We are not trying to predict that by any means, if we get to actually a normalized rate environment where there is some spread between long-term rates and short-term rates, that's obviously – it's great for the industry and it's certainly great for us and that would help us accelerate the NIM north of 2% and growing beyond that.

Historically, in the 20 year history of the bank, Mike, we brought about 75 basis points below the NIM of our peers from beginning of time due to the craziness in the market starting kind of September of last year running through to March, the race to the top on CD rates and money market rates, et cetera. It's probably the worst – well, it is, by far, the worst compression we've ever seen. As Ken said, we've got almost $1 billion in deposits repricing over the next twelve months. We are seeing significant drops on a daily basis on that side of the balance sheet. We have floors installed in our loan side that are keeping our yields up and not affecting production and actually coming on at higher yields and what's rolling off. So we think we'll get back above that 2% level in the not-too-distant future. We will jump back up to the 2.50%, 2.75% we've run historically. We need to get slope in the yield curve to get back to that level. But we should see some nice changes over the next three to six months and definitely into the early part of 2020. Obviously, the higher yield activity in the SBA markets and potential earnings there create other opportunities for us that – the bottom line mortgages are staying strong as we discussed earlier. That's kind of our natural hedge as the markets fall apart. If you go back to our balance sheet, there is a lot of banks during earnings call that have predicated and set the market up for further reduction in the NIM during the third and fourth quarters as soon as the Fed does lower rate. A lot of our portfolio is static. So it's not going to have a tremendous impact on our loan yields and we'll have hopefully a very strong impact on our cost of funds. We've seen the markets and allies and big banks of the world pulling back on money market rates as well as CD rates and I am sure when the Fed drops – if they drop 25, 50 basis points next week, we will see pretty much overnight activity in those rates coming down further. So, everything poised in the marketplace today, it says we are going to have a strong second half of the year, up for grabs, I guess, kind of depending on what the Fed does.

Helpful. Thank you. And then, how should we think about net loan growth, because to your earlier comments coming – to the last question just to do the same level of loan sales would be great, but challenging. So I guess, what are good baseline assumptions for loan sales and kind of net loan growth moving forward that you think are fair to model in?

I don't see a significant amount of loan growth. I don't know perhaps, maybe, 5% over the course of the year. I mean our forecast we are assuming a certain level of loan sales probably trying to be conservative here – less than $150 million a quarter. Probably, closer to the $75 million a quarter is what we have in our forecast. But I think we're – like I said earlier, if we can exceed those numbers that'd be fantastic. But we're – our origination teams, our commercial teams, public finance, healthcare, they are out there engaged. They are still originating. We want them out there. But we would love to be able to fund the majority of new production through loan sales.

Okay. So, mid-single-digit, net loan growth with about half of the loan sale activity is a good baseline then obviously that could alter from quarter-to-quarter depending on the market appetite for purchases and production levels?

Yes. That's a good way to look at it.

Okay. And then, just lastly, sorry if I missed it. But can you just talk about what your expense expectations are for the back half of the year?

I think, we – obviously, we saw expenses come up a bit here in the second quarter and a lot of that was driven by higher incentive compensation paid to the mortgage originators obviously, in conjunction with much – with this increased origination activity. I think for the rest of the year, we will probably – it will probably in the same kind of range. Again, I think right now if rates kind of stay where they are and mortgage rates stay where they are, I think, we should have a good back half of the year on the mortgage as well. I know we've had a really good July. So that's going to keep that comp number inflated a bit. But I'll take the trade-off on the higher revenue. But if we assume that that mortgage stays relatively consistent in the back half of the year, probably that $11.5 million to $12 million is probably a decent number, minus any other outside activities or impact from I guess, other strategic pursuits.

Got it. Helpful. Thanks, Ken. Thanks, David. Appreciated.

Thanks, Mike.

The next question will come from Brad Berning of Craig-Hallum.

Good afternoon, guys. Wanted to touch base, you have been making some progress on the deposit of franchise side and I was just wondering if you could expand a little bit deeper about the initiatives you are working on, the progress you are at, outlook for those initiatives? And then, the second follow-up question is, if you could go through the different kind of competitive dynamics on the asset side areas, you obviously, had some good growth in some areas this quarter. You're seeing opportunities. Just talk about the competitive dynamics that you're saying that has gotten your appetite strong there?

I'll take the deposit side updates and a little bit on loans and Ken can fill in. We’ve created a product, we internally are calling it Amplify that go after the small business market. We made some changes towards the beginning of the last quarter to streamline the process much like we did on the consumer side back in 2018 to get the online application process down to minutes instead of 15 minutes to 20 minutes. We introduced a small business check in accounting paying 75 bps, the money market account services. And those products literally almost overnight went from ground zero to 16 million to 18 million a month in new account openings. Through this morning, we're already at 17 million in new deposits and new customers in that segment. So, from our perspective, I think it blends in at somewhere in the mid 1.5, 1.6 on the cost of the funds. It's great accounts, good balances, good transaction and obviously the small business loan and the business credit card opportunities that come along with those clients. So, kind of hit the ground running and with minimal marketing effort, we wanted to make sure we had all the mechanics and pieces. We've introduced a new online product for small business that gives them a lot of the tools of the traditional big bank treasury management program in an online environment that we got converted during the quarter. Those seem to be running very effectively. So we think it's a good opportunity to continue to grow that side of the balance sheet significantly, which also enables us to cut back on the CD side and the higher cost.

It's good to hear. And then just a quick follow up on that before we switch to the assets. And so, if you are treasury management, is that on a cloud-based or is that an integration with systems? Just kind of curious as to the functionality that you are finding the markets are attracted to?

It's tied in with our online tools through digital insights. So it's on the web, it's not – I can't tell you for sure whether or not it's cloud-based. The mechanics on the back-end from those side on the actual tool itself, but it is seamless. It's on the front-end it gives them wire ACH origination capabilities, multi-tiered security logins. So you can segregate duties and abilities of individuals within the website. It truly allows them to really kind of run a zero balance accounting structure if they want to and just a lot of tools that you would normally see in the upper end. They can do again, back to the small business side, they don't need the $1,500 scanner. It has the mobile deposit capture via the phones. It's a very slick, and to-date both from our side and the consumer side, it's been a very seamless product to rollout with great growth and really no hiccups in it.

Excellent. And the asset side?

I think on the assets side, Brad, if you just look at a couple of our different channels here. Healthcare finance was – actually had a very strong quarter in terms of growth. We originate those loans with our partners – through our partnership with Lendeavor, which is focused in the dental and veterinary and finance industries. They have been building their business over the course of several years now and they have hit their stride. They have made some strategic hires here in the past six months. Luring away producers who've been in the space for a long time with a track record from the larger kind of money-center institutions who play in that area. They've obviously – they've done a great job building their brand and getting their name out there. So that's obviously a very – I think every lending area is competitive. There is lending business because their time, their ability to get a loan from start through the pipeline to finish is much faster pace than the bigger banks they compete with. So, they are winning on speed and execution and customer service, which is fantastic. In the single-tenant space, it's obviously been one of our 800-pound gorillas here for a long time. I think that market is competitive. Again, it's one of those – we've developed an expertise in it. We know the product. We can get loans through the pipeline very quickly. We can get to a credit decision quickly. Obviously, in that space, we'll see sporadic competition whether it's a regional basis or you might have a regional player or credit union too who play in the space who really want to go after a loan. And we have pricing discipline and if a borrower gets an offer from someone else that's well below ours or below our offer, we'll just walk away because our pipeline is usually full. Now we do – we will probably see a little bit of seasonality in that business here in the third quarter. With people are on vacation and away from the office. So, pipelines usually decline a bit at the end of the summer and they will pick back up after Labor Day. But I think the dynamics are fairly consistent with what we've seen over the last several years. Our C&I teams are doing very well. They are out originating. We've added some personnel in our office in Phoenix. And they've got – get putting some wins on the board out there. We've had some strong origination. We've had a lot of activity in the owner occupied and the construction space with our teams. So origination activity has been strong. They just really haven't fully funded a lot of these projects yet, which hasn't made it's way through actual balances on the balance sheet. But again, it's like every other area it's very competitive out there. And people are doing – in some cases, doing crazy things to get to the high tier credits. But as David mentioned in his comments, we try to be obviously, manage the balance sheet, be disciplined on pricing and be cognizant of a declining rate environment. So we've put floors in place across most of our commercial verticals to ensure that we're adequately defending net interest margin and sometimes we have to walk away from deals because we put the floors in and competition is – we'll do something at 50 basis points less then we'll do it. But that's okay, because we have plenty of deals in front of us and we want to be prudent about manage –again, helping managing the decline in net interest margin and being prudent about what we've put on our balance sheet.

Just a step back, real quick, Brad too, on the healthcare finance side, we just had a meeting with the Lendeavor team, kind of got all the folks together in Columbus, Ohio and chat. And one of the things we're working on with them that still got some rough edges around how we pitch the deposit base in a corporate credit card. Obviously, we're approving the dentist for $1 million loan to buy a practice and build the new building. We can fill in a credit card. We can go after the deposit base and still a lot of mechanics and individual actions as we don't have it 100% automated yet. But the success rate has been tremendous for the folks that we've gone face-to-face. Again, we're picking up on average six-figure check in account and $25,000 kind of corporate credit card for them to work in the practice. So we've got a couple of things to tweak there yet this quarter. But that's also a great source and a good strong relationship for us on both the deposit side and the credit card as well as the loans.

Lastly, the consumer side, on the assets still?

Consumer business remains strong. We – last year, when we were raising – in the rising interest rate environment, I think we were pretty disciplined there and increased pricing in chunks of 25 and 50 basis points at a time in the consumer verticals and continued to generate originations. I think last year, our originations in the RV and the horse trailers businesses were some of the strongest they've been in their history. As we look here into 2019 – obviously, in the first quarter, seasonally slow. I think as I mentioned in my comments, originations were up 18%. We are obviously trying to be disciplined on pricing there as well. But I don't – I guess, it's kind of steady as she goes in that business. Originations remain strong, yields are hanging in there, not really seeing any cracks in the consumer credit side, FICO scores are where they've always been, in the 760, 770, 780 range and credit results have been consistent.

We did have a large national player jump into the horse trailer business for about 30, 45 days with just an ungodly rate, suck a lot of opportunities up. But they've come and gone already and as Ken said, we're kind of right back to normal and again, in all of our verticals, we'll have certain regional institutions or a national player jump in and do something just totally out of sorts. We don't compete with them. We sit on the sidelines. They come and go and still probably in all of our product lines, we are bidding on about 20% to 25% of what we actually take a look at or have an opportunity. Again, with that national footprint, it enables us to stick to our underwriting criteria and our pricing and we really don't have to play the whim of the game of whatever local institution or a credit union that might show up and really try to buy the deal. We just go on to the next deal and the pipelines are really, really strong, as Ken said, all across the country. So it’s not a situation that we're in order to – we're not buying business by any means.

Greatly appreciate all the thoughts. Thank you.

Thank you.

The next question will come from Joe Fenech of Hovde Group.

Good afternoon guys.

Hey, Joe.

Hey, Joe.

Hey guys, just to lead off, just hopefully a pretty simple question. I mean, just setting aside the noise and the near-term gyrations from what this first rate cut from the Fed might mean for you, I know that's where most of the questions have been focused. I mean, just looking out way longer term, are you guys just thinking about this as a major inflection point for your model? You're among the most severely impacted from the rate environment the past two years. Logic would seem to suggest that the opposite might now be true if you think we are at that inflection point. I mean do you agree with that or am I looking at that too simplistically?

I would probably tend to agree with you a little more than Ken might agree with you. Yes, and I go back and we've seen obviously cycles over the last 20 years. This one has been so far off the chart in the play both from the Fed level and then the financial institution's reaction to the bumps. I mean, Fed is moving 25 and they are moving 35. It's just the craziest thing I've seen. And I think we are going to see that same kind of rates back down to the bottom faster than some folks think. They historically don't raise rates, particularly on the cost of fund side as fast as they'll bump the loan rates, but when they go down, they plug-in instantaneously. So, I think we could see a real significant shift over the next six months and put us back into kind of the driver seat. And again, when you take a look at the big scheme of things, over the last couple of years, we've grown a couple of billion in assets, literally doubled our size and headcount and internal expenses. We're now down to non-operating or non-interest expenses down in that lower than 120 basis points. So, that number is getting better day-by-day, and yes, I think we have an opportunity. We're going to see a significant shift in the next three to six months. And then without question if the Fed comes in, if they do 25 and then another 25, set the stage for something before year-end or if they come in to do 50, I mean, we could see the bottom fall out on it, deposit rates again.

Yes, okay. And then, guys, what becomes now if that derivative swap progress and the implications? And what are the implications of what you've already put on as a result of this inflection point in rates?

Obviously, we put the hedging strategy in place in late 2017 when rates were increasing and as they rapidly increased throughout 2018, we continued to hedge. I guess the one thing that I would point out with that is even with – even when you include the impact of the swaps, our loan portfolio is 70% fixed, 30% variable or adjustable, which – when I look at some of the – I track a lot of the higher performing $20 billion to $30 billion commercial-oriented banks, their loan books are flipped, right? They are about 70% to 80% variable, and much of which are tied to LIBOR. LIBOR-based, C&I, middle-market and larger corporate credits. So, obviously, with the rate environment being where it is today and the risk that LIBOR continues to decline, we haven't put any new swaps on this quarter and of course, I don't foresee us doing any other hedging here assuming where the interest rates stay where they are. Obviously, in terms of managing long-term interest rate risk, which is something our regulators focus on, hedging in any market is good when you have as many fixed rates loans as we have. But we've made a conscious decision to kind of manage longer-term interest rate risk through other means, predominantly loan sales, always having swaps in our back pocket if we had to worry about that. But I don't really see us doing much hedging. But we probably won't really be unwinding those hedges either right now. That would be prohibitively expensive. But it's just going to be, LIBOR's, looking at the rates that are on Bloomberg. LIBOR is down again today as it continues to kind of creep down and leads the Fed. So I think it puts us probably in the same boat as some of these other commercial-oriented banks that have large LIBOR-based commercial loan portfolios.

So, I guess, what sort of the timeline, if you were to really simplify it, Ken, where, it’s a period of time, I am guessing where what you've already put on eats up some of the benefit of this new rate environment. I mean, how should we think about that? And sort of when you get over the hump? And what needs to happen from a rate perspective for that not to be as big of an impact to you?

Well, I think and I'll go back to my comments earlier on kind of our forecast today of where we believe net interest margins go. And again, I think the two biggest drivers that will put pressure on margins during the third quarter are going to be, again, a fully baked quarter of the subordinated debt and the combination - again, the impact of LIBOR on the hedging that we've put in as kind of asset yields are expected to remain fairly consistent. And deposit costs the impact of rising deposit costs isn't really expected to have a meaningful impact and as we see margin go forward, margin increased modestly in the fourth quarter and beyond. Obviously, we are still absorbing the cost of a lower LIBOR rate, I mean we're not forecasting LIBOR to go up in those future periods. LIBOR is still low and remains low. So I think, we're absorbing the cost of that through the inflection in deposit pricing, as well as just being disciplined on the fixed rate side of the loan book.

Okay. That's helpful. And then last one from me, guys, geographically speaking, where were the non-performers? And what was the approximate size of each, the increase this quarter?

The one is $1.6 million, it's here in Indianapolis, we took the $6 million. We have real estate and receivables to cover roughly $1 million and we took the $6 million special reserve and we got aggressive on that one. We don't know that it's going to be $6 million that got some work out folks in there taking a look at it. So, we put it together and the other one is actually our first STL property that's located, I am going to say off the top of my head, I think it's in North Carolina. It hit the 60 day and that the person who owns the property, it went dark. The restaurant team that was in there went into bankruptcy. It went dark. She has another tenant that is supposed to come in and start picking up payments, August 1. They are in the midst of build out, but she has just refused to make payments. So, that one could completely reverse itself here in the next 30 to 45 days.

And Joe, to clarify, the single tenant loan that was an increase in delinquencies, not non-performers.

Got it. Thank you guys.

The next question will come from John Rodis of Janney Montgomery.

Good afternoon, guys.

Hey, John.

Hey, John.

Ken, just real quick. You said, operating expenses $11.5 million to $12 million in response to an earlier question. It that with or without the new SBA team?

That is – that’s without.

Okay. And then, Ken, the tax rate going forward?

Every time, I think it can't go lower. It seems to go lower. I guess we're in kind of the 5% range. Obviously, as we manage that single or excuse me, the public finance portfolio and drive revenue from other taxable side, I mean, again, I'd probably steer you to the mid-to-high single-digits just to be conservative. I know it was 5% and it was 6% and changed last quarter. So I think, if you want to use anywhere between 5.5% to 7.5%, that's probably a good estimate.

Okay. And maybe Dave, just your comments on the STL loan, you just said North Carolina, it's not non-performing. But can you just remind us, I guess, that portfolio, the average LTV and maybe specifically on that loan, what is the LTV?

Yes. On that particular loan, LTV is 50%. We just had a new appraisal done on the property. So we're – if the lady does – refuses to pay, we are in good position. She actually had an offer to sell. But it was less than she originally paid for the property. So she passed on that. She is not as we found out a real seasoned real estate investor. Portfolio as a whole, John, has approached $1 billion. Overall, we are at a 50% loan-to-value on all of the properties and we've originated close to $2 billion in this asset class since we first got into it and this is the first loan that we've had in a – it's the first loan ever hit the delinquent schedule period. So, I think, John, we are very well positioned and technically, she has a new tenant coming on board, she should get cleaned up here in the next 30 to 45 days.

Okay. Thanks, guys.

The next question is a follow-up from Michael Perito of KBW.

Hey guys. Thanks. So, just one quick follow-up here. It sounds like, when we - talking about the net loan growth kind of in the mid-single-digits, I mean, but it sounded like from some broader comments earlier in the call that deposit growth might not slow quite to that level. So I am just curious if you could make a quick comment the liquidity in the investments and cash in the quarters was a little elevated. I mean, do you expect those levels to kind of persist going forward and the loan-to-deposit to stay sub-100 given the net loan growth expectations?

Yes. I think, the loan-to-deposit ratio will remain below 100%. I mean, I think, it may trickle up slightly throughout the end of the – through the end of the year. But it's definitely going to remain below 100%. I mean, I would expect as – we'll probably keep the level. I would expect the level of cash, as I said before, it's inflated at the end of the quarter. So that cash balance of $350 million will not – will trend down over the course of the year. I would expect securities balances to kind of be consistent – call it on a percentage basis, consistent with where it's been the last several quarters as a percentage of the overall balance sheet. I mean, we kind of try to target what we call liquid assets in the range of 18% to 20%, which obviously consists of cash mortgages held-for-sale and securities. And deposit growth, as we've mentioned a lot here on this call, we've been reducing rates throughout the course of the year, have continued to reduce rates here in July and we will continue to do so. So I am not – if you look at the deposit growth, I mean, we do have some deposit growth models. But I wouldn't say it's an excessive amount.

Got it helpful. Thank you.

Hey guys, I want to jump back in with clarity on the two commercial loans that went on to non-accrual. It was actually the same client. It's two separate loans. It was a owner-occupied real estate and then a working line of credit. So, when we say that the commercial loans bumped up two one on non-accrual, it's actually the same and it is combined. It is that $1.6 million figure that I threw out. So, just for clarity and Ken was correct. The other STL is not in non-performing status, just in the first time to have an STL loan in delinquent status.

And this concludes our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

Guys, we appreciate your time today. As you know in the past we're always is available if you think of anything later in the day, Ken and I are around. We appreciate your time. And look forward to catching up to several of you next week when we are in New York. Thank you very much.

Thank you. The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.