Good day, and welcome to the Byline Bancorp, Inc. second quarter 2017 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Allyson Pooley of Financial Profiles. Please go ahead.
Thank you, Nicole. Good morning, everyone. Thank you for joining us today for Byline Bancorp's second quarter 2017 earnings call. Joining us from Byline's management team are Alberto Paracchini, President and Chief Executive Officer, Lindsay Corby, Chief Financial Officer, and Tim Hadro, Chief Credit Officer, is also with us and will be available for the Q&A session. We will be using a slide presentation as part of our discussion this morning. If you haven't done so already, please visit the Events and Presentations page of Byline's Investor Relations website to download a copy of the presentation. Alberto and Lindsay will discuss the second quarter results. Then we will open the call for 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 Byline Bancorp that involve 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, for the 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 the reconciliation of the GAAP to the non-GAAP measures. With that, I'd like to turn the call over to Alberto.
Great. Thank you, Allyson. Welcome to our second quarter earnings call, the first one for us as a public company. Before I get into the slide deck, I'd like to start by thanking you for participating in the call today. We've had the opportunity to meet and get to know many of you during the IPO process. We look forward to working for you and our stockholders in the quarters and years ahead. I would also like to take a moment to thank our customers for allowing us to earn their business on a daily basis. Also thank our employees for their hard work and dedication to the company. We would not be at this point in our journey without their commitment to our company. Now, moving on to page three of the deck.
Since this is our first call as a public company, I'm going to begin by providing a brief overview of Byline. We are a commercial bank with over a 100-year history. The current management and our board assumed control of the company after recapitalizing it in 2013, in what was at the time, the largest recap of a bank in Chicago in over 25 years. With $3.4 billion in assets, today we are the largest community bank by deposits and branches in the city of Chicago. We're a new public company, having successfully launched and priced our IPO at the end of the second quarter.
We have a diversified loan portfolio with a commercial orientation, as you can see in the lower left-hand side of this slide, and have a very attractive deposit base that has a significant proportion of non-interest bearing deposits, a high concentration of core accounts, and an attractive funding cost. Our capital levels are very strong, and our profitability continues to improve, as shown by our return on average assets of 75 basis points and an efficiency ratio that stands at 66% as of the end of the quarter. Moving over to slide four. Our franchise consists of four distinct business lines. Our retail banking business provides funding to all of our lending activities and has 57 branch locations serving the needs of small businesses and consumers within our footprint. Our commercial banking business serves business owners, middle-market clients, and well-capitalized sponsors.
The business consists of commercial banking, commercial real estate, sponsor finance, and treasury management. Our small business capital unit originates and services government-guaranteed loans throughout the Midwest and other selected states in the country. It is the sixth most active SBA lender in the U.S. and the number one lender in the states of Illinois and Wisconsin. This is a highly specialized business focused solely on government-guaranteed lending. Lastly, our small-ticket leasing business provides vendor financing programs and solutions in industry verticals such as healthcare, manufacturing, and energy efficiency. Moving over to the next slide. Our growth strategy is fairly simple. First, we want to continue to grow our business organically and expand our product capabilities. We have room to further increase share and are not constrained by overconcentrations in any particular loan category.
Second, we feel our culture, platform, and the opportunity we offer will allow us to continue to attract talented bankers and teams to our platform that will drive incremental growth. Third, we'd like to deploy more of our liquidity into loans via selective acquisitions of portfolios or niche businesses. Lastly, we want to be in a position to participate in what we believe will be additional consolidation in the marketplace. Now turning over to the highlights for the second quarter. As far as earnings were concerned, we had net income of $6.1 million, which represents an increase of 136% from the prior year. As previously disclosed at the time of our IPO and our subsequent 8-K, we completed an early repurchase of our Series A preferred stock.
EPS for the quarter, excluding the impact of the Series A preferred repurchase, came in at $0.24 a share, including the one-time impact of the preferred repurchase, EPS for the quarter was a loss of $0.18 a share. ROA was 75 basis points for the quarter compared to 80 basis points last quarter, reflecting a slightly higher provision expense. Our pre-tax pre-provision ROA came in at 168 basis points, which was nine basis points higher than the previous quarter. In terms of revenue, our net interest margin was steady for the quarter at 4.02%, and non-interest income was up 7.2% from last quarter, driven by strong gain on sale income from our small business capital unit. Loan production for the quarter was strong and came in at $155 million. Loan pipelines remain healthy, and we continue to add talented bankers to the company.
During the second quarter, we added one C&I team and one banker in our commercial real estate group. From a balance sheet perspective, loans increased by $5.5 million and were impacted by a higher level of unexpected runoff during the quarter. Deposits and deposit costs remained stable, and we saw a favorable shift in mix with non-interest-bearing DDA replacing runoff in our CD portfolio. We've worked hard on becoming more efficient over the last year, and that's reflected in our efficiency ratio of 66% for the quarter. From a credit quality perspective, we had provision expense of $3.5 million and net charge-offs of 26 basis points for the quarter. Our allowance to loans at the end of the quarter increased to 65 basis points. For a more detailed review of our performance for the quarter, I'd like to pass the call over to Lindsay.
Thank you, Alberto. Good morning, everyone. We are excited about the progress we have made and the trends we are seeing in our financials as outlined on page seven. I'd like to highlight a few metrics in addition to what Alberto has previously covered. The loans and leases as a percent of deposits continues to be an area of focus for us, showing a small increase this quarter to 84.87% versus 74% a year ago. Our tangible common equity ratio was 11.16% as of the second quarter, providing ample capital to support our growth strategies as outlined by Alberto. We continue to show improvements in our key performance ratios, which we will expand upon in the upcoming pages. Turning to our balance sheet. We'll start with our diversified loan and lease portfolio on slide eight.
Our total loans and leases were $2.15 billion at June 30th, an increase of approximately $6 million from the end of the prior quarter. As Alberto mentioned, the new production was largely offset by a higher level of runoff in the portfolio as a result of several commercial real estate construction projects that stabilized and prepaid prior to final maturity. The refinancing of syndicated credits that we opted not to participate in renewing and a single commercial loan. The growth in our originator portfolio and lease portfolio was primarily driven by increases in commercial, government-guaranteed lending, and small ticket equipment leases. Looking at our total deposits on slide nine. They were down during the quarter, although we saw an improvement in our overall mix. Total deposits were $2.5 billion at June 30th, compared with $2.6 billion at the end of the prior quarter.
We experienced a favorable shift in mix with non-interest-bearing demand deposits increasing by $49.4 million, primarily due to an increase in business accounts, which included a commercial relationship of $28.3 million that was later utilized to finance a transaction. This was partially offset by a decline in interest-bearing deposits due to the seasonal decrease of a municipal deposit relationship and the runoff of time deposits added through the Ridgestone acquisition. Overall, deposit composition remains stable, with core deposits at 84.9% of total deposits. I'll start on slide 10 with a discussion of our net interest income and margin. Our net interest income increased $300,000 from the prior quarter to $29.8 million and $9.4 million or 46% compared to the prior year. Compared to the prior quarter, the second quarter benefited from a higher level of accretion income and the impact of rising rates.
Compared to the prior year, the increase was driven by higher balances and accretion resulting from the Ridgestone acquisition, as well as the positive impact of rates. Our net interest margin for the second quarter of 2017 was 4.02%, a two basis point increase from the first quarter of 2017. The second quarter margin benefited from the higher earning asset yields resulting from the increase in accretion income and higher rates offset by an increase in the cost of interest-bearing liabilities. Within the various assets and liabilities, we had an increase of 33 basis points on cash at other financial institutions due to the increase in the Fed funds rates. This was partially offset by an increase in Federal Home Loan Bank advances of 48 basis points due to increased expense related to swap transactions. We also had a decrease in other borrowings of 43 basis points.
The loan accretion income contributed 23 basis points in the first quarter and 33 basis points in the second quarter. As our interest earning asset mix continues to change, the yield on earning assets will continue to expand. Our overall cost of deposits was 30 basis points in the second quarter, up six basis points from the prior quarter. The increase in deposit cost is attributed to the time deposit category. As our CDs mature and renew at higher rates with the stronger loan production we anticipate for the second half of the year, we have chosen to get in front of rate increases for our CD balances as part of our liquidity and interest rate risk management strategies. As the CDs acquired from Ridgestone mature, we are also seeing a decline in the purchase accounting benefit to our cost of deposits.
Excluding the impact of fair value adjustments, our cost of time deposits increased seven basis points during the quarter. We anticipate another drop in the fair value accounting adjustment benefit on our time deposits in the third quarter, although not to the same degree as we experienced in the second quarter. Turning to slide 11 and our non-interest income. Compared to the prior quarter, our non-interest income was up 7.2% to $13.2 million. We saw increases across our major fee-generating areas, consistent with the seasonal pickup that we typically see during the second quarter. Gains on sale of loans continues to be stable and increased by $363,000 since the previous quarter, primarily due to higher net premiums. Moving to slide 12, let's look at our non-interest expense. At $29.2 million, our non-interest expense increased by 1% from the last quarter.
Within our specific expense items, the most notable variance was an increase in salaries and benefits expense, which was partially related to the addition of the new commercial banking professionals Alberto discussed. This was partially offset by a decrease in professional fees, which was related to our IPO preparation. On a year-over-year basis, you can see the results of our efforts to better leverage our infrastructure. Compared to the second quarter of 2016, our total revenues increased by more than 60%, while our non-interest expenses increased just 28%. As a result, we continue to see a steady improvement in our efficiency ratio, which improved to 66.2% from 67.1% last quarter and 83% in the same period last year. Turning to slide 13, we'll take a look at asset quality. Provision expense for the second quarter was $3.5 million, which was $1.6 million higher than the first quarter.
The increase in the provision for this quarter was impacted by the periodic reevaluation of cash flows done on our acquired credit-impaired portfolios. We recognized deteriorations in expected cash flows on the acquired credit-impaired loans immediately through provision expense, while improvements in cash flows are recognized prospectively over the life of the loan. During the second quarter, $1.6 million of our provision expense represented net deterioration in our acquired impaired portfolio while we were able to reclassify $11.8 million from non-accretable to accretable yields that could be recognized over the life of the portfolio. Our net charge-offs were $1.4 million, or 26 basis points of average loans and leases for the quarter, or 22 basis points year to date. The allowance for loan and lease losses was 65 basis points at June 30th, up 10 basis points from last quarter.
In addition to the traditional allowance as a percent of loan and lease metric, we also analyzed the allowance in conjunction with the acquisition accounting adjustments impacting the acquired portfolios. That balance was $37.7 million as of the quarter end. NPLs remained low at 76 basis points, but increased by $7.4 million during the quarter. The increase was primarily due to a government-guaranteed loan carrying an 80% guarantee and a well-secured commercial loan. I will turn it back to Alberto for closing remarks.
Thank you, Lindsay. We believe it's an exciting time for us at Byline. Our franchise is characterized by a strong position in our primary market, a seasoned team and board of directors, a high-quality deposit base, a diversified and growing commercial business, a disciplined credit culture, and a simple growth strategy. I would like to thank you for your time this morning, and now I'll open up the line for questions.
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question comes from Ebrahim Poonawala of Bank of America, Merrill Lynch. Please go ahead.
Good morning, guys.
Morning, Ibi.
Just wanted to first sort of get a better sense of the loan payoffs during the quarter. One, in terms of what drove these payoffs. Obviously, it feels like it was a little bit of a surprise in terms of the magnitude of the payoffs. Would love to get your thoughts around what drove this. Was it an impact from the interest rates or something else going on in the market? How you see payoffs trending as we think about the back half of the year.
Sure. I would say, Ebi, we were a bit surprised in a way, in the sense that I think the part that was more surprising is just the confluence of factors that kind of aggregated a lot of activity. It seems like throughout the first after January, we saw activity pick up in February, March, and then certainly continued a bit furthermore in the second quarter. I'll give you a couple of examples. For example, we had some in our real estate portfolio, and this is simply just a function of good loans, good construction loans that reached stabilization. And essentially the client opted to secure longer-term financing a little bit earlier than we anticipated. And that happened on two projects that were very much along similar timelines in terms of construction. They both stabilized. These were two student housing projects.
They both stabilized right around at the same time. I think with the dip in rates, the client opted to secure financing on a long-term basis and therefore we got paid off a bit earlier. Other activity that we saw, for example, on our syndicated loan book there was a fair amount of refinancing activity and in some cases we were fine with it in the sense that we decided to stay in the transaction. In others the levels at which the transactions priced were just simply not attractive, we opted to pass. Lastly, we had a loan that we had done approximately three years ago as part of a disposition, a trade that we did on our legacy portfolio to dispose of assets.
That loan had been paying off steadily and essentially paid off in full just a bit earlier than we anticipated early on in the second quarter. I think the surprise was more there's one thing to note here, sometimes when you make good loans, good loans eventually paid off, as we saw on those two construction projects. I think the biggest surprise was just everything kind of happening at once. I can tell you that starting off in the third quarter, we've seen payoff activity dropped off considerably. We certainly are not expecting the same level of runoff that we saw in the first and second quarter. Hopefully that answer your question, Ebi.
No. That was good color. I guess as we think about it, I know it's difficult to predict what payoffs will be, assuming that we are originating somewhere around what we did in the second quarter, what's the reasonable net loan growth that we should think about as we think about this year? Generally, as you think about what Byline should be growing, given the team that you just brought on board. If you have any plans to hire additional bankers through the next few months.
I'll take the latter part of your question, Ebi, and then Lindsay will take the early part of the question. As far as bankers and teams and pipelines we continue to actively look for talented bankers to join our company. We had additional success this quarter. We attracted a team of three bankers in our traditional commercial banking business. We also did a hire of one banker that joined our commercial real estate group. In terms of new teams it usually takes a little bit of time for that team to build a pipeline and start contributing in terms of outstandings to the portfolio. They've hit the ground running and certainly we're starting to see the pipeline build. We're pretty excited about that. We continue to talk to people in the marketplace.
As I said earlier in my remarks, we think we have a very attractive platform, a great culture, and we offer opportunities for people to be able to grow. We think that we'll continue to see that going forward. Lindsay?
Sure. Thank you. Ebi, it's pretty consistent with the guidance that we've previously given. We really want to stick to those estimates in terms of where we think we're going to end up. I don't think it's going to be really any different from the previous guidance. We see it as very robust right now for the second half of the year. The payoffs obviously will be muted. I think it's pretty consistent with what we've previously disclosed.
Understood. One last question and then I'll hop off. Now that we're done with the IPO, you've got the cash and the capital in-house. Would love to get your thoughts around outlook for M&A and in terms of where you see the market around seller expectations. Is it realistic to assume that there might be an opportunity over the coming months? I know it's always hard to predict, to deploy some of that capital towards a whole bank deal.
Ebi, let me just comment on that. There's certainly a lot of conversations taking place in the market. I think that's been consistent now for some time. As you pointed out, the gestation period of these things sometimes it can be shorter, sometimes it can be longer. I think what I would say on there is we continue to talk to people. We think that again, now having a public currency, it certainly makes us a very competitive potential acquirer for other institutions. We feel good about where we are and with respect to M&A. First and foremost, we kind of focus on the things that we can control, which is let's execute our organic strategies primarily and certainly be in a good position to participate and take advantage of opportunities as they surface in the market.
All right. Thanks for taking my questions.
Thank you.
Our next question comes from Nathan Race of Piper Sandler. Please go ahead.
Hey. Good morning, everyone.
Good morning, Nate.
Hi, Nate.
Just wanted to start on the uptick in NPLs this quarter. It sounds like one of the credits was tied to a small SBA deal. Can you kind of just provide any additional color on the other credit, maybe in terms of geography, industry type, and if this was a credit that was previously on substandard or watch?
You want to take it, Tim?
Sure. To answer your first question, there's no common theme in terms of industry or geography. In terms of the individual credits, there were five credits, which essentially account for the increase in NPL. Of the approximately $7.6 million total, $5.8 million is either covered by a government guarantee or, in fact, cash collateral for the principal. It's a high-quality non-performing position. We have, as part of identifying these were previously identified as concerning credits. During the quarter, we sat down and did the review. We determined that the deterioration had taken to the point where we needed to carry them as non-performing loans. We also, as part of our review set up the appropriate reserves. In fact, subsequent to the quarter, one of the loans has already been. We expect it will return to performing status shortly. Nate, does that answer the question?
Yeah. That's great color. I appreciate that, Tim. Then just kind of changing gears on the NIM looking forward. Lindsay, can you kind of just help us in terms of thinking about core loan yields and just the reported loan yields going forward? It sounds like purchase accounting accretion contributed to the uptick we saw in loan yields this quarter. Any commentary you can provide in terms of thinking about both loan yields and the margin particularly, given that it sounds like you guys kind of increased your deposit price this quarter to try to get ahead of some competitive factors within your footprint.
Sure. Loan yields, we expect that they'll continue to expand, Nate, in terms of the go forward. Pretty consistent in terms of what we've previously disclosed. Again, we haven't seen any real change there. The only difference, as we talked about earlier, was the accretion. We did have a slight uptick in terms of accretion just due to the fact that the portfolios were improving. In terms of the NIM, we see it expanding, but it will be offset by rising rates of cost of liabilities, obviously. Again, consistent with previous disclosures that we've provided, it's going to slowly expand through the cycle. We do have expectations of rising rates, you can see an expansion of another 10 basis points approximately.
Nate, just to add there in terms of how we think about interest rates going forward. We have just one 25 basis point increase in 2017, one in 2018, and one in 2019. In aggregate, 75 basis points all the way through to 2019 is kind of how we're modeling rates at this point.
Understood. If I could just sneak one last one on SBA gain on sale revenue. Nice uptick this quarter in the 4%-5% range, and it looks like gain on sale margins ticked up a little bit as well. Is it fair to expect this kind of build to persist near term, or how should we be thinking about the pace of growth within fee income as it relates to SBA revenue?
I think that's a good assumption, Nate. So far, as you saw in the results, I think it's fair to say that things are pretty stable in this place right now. Obviously, that can change, so far we're not seeing anything that would jump out at us to change that view.
Got it. I appreciate all the color, guys. Thank you.
Thank you very much, Nate.
Our next question comes from Michael Perito of KBW. Please go ahead.
Hey, good morning. Thanks for taking my question.
Good morning, Mike.
Morning, Mike.
A few for me. Maybe just following up on the SBA question. I understand there's obviously the gain on sale and there's the piece that kind of, I think is even loosely split between C&I and CRE balances. Just maybe taking it from a broader perspective, I guess, what do you guys think is kind of an overall realistic growth range annually for the small business capital unit at this point?
Sure. Mike, I think the way we kind of think about that at this point is, if you think about gross originations for that business, the current run rate right now is about 100. We did about $110 million in gross originations for the quarter. If you, roughly speaking, annualize that, take about 75% of that being the guaranteed portion, and then you have the remainder being the unguaranteed portion that we keep on the balance sheet today. That should give you a pretty good sense in terms of growth and kind of where the business is at this point.
Okay. Is there any, maybe of course a better question for Lindsay, but is there any, I don't know if seasonality is the right word, but is there any kind of choppiness or volatility on a quarter-to-quarter basis that we could anticipate in the gain on sale SBA business or historically at Ridgestone, was it fairly consistent on a quarter-to-quarter basis?
They're fairly consistent. I'd say the beginning of the year, you see a little bit of a dip, but nothing drastic. It's a pretty stable outlook for the gain on sale.
Okay.
One thing to add there, Mike, and this is just we're not seeing anything in the horizon, but a couple of things to keep in mind. Fiscal year for the SBA ends as of September 30th. From time to time, the SBA program, like many other government programs, there's political noise around it. At this point, there's nothing in the horizon that would seem to be in play right now. Those are two things to just keep in mind.
Helpful. Thanks, Alberto. Maybe switching over to the expenses in the quarter. It sounds like the new team of three lenders kind of came on mid-quarter. Any sense on where the quarterly expense run rate could trend? Is it fair to assume that there could be some pickup in the third and fourth quarter with the full quarter from that team and maybe the other hire as well?
Yes, that's a fair assumption, and as Alberto mentioned, we're continuing to look for additional teams and professionals throughout the industry. That's a consistent assumption.
Okay. I just have one more quick clarification question. I think last quarter, the accretion recognized was about $5.8 million or so, in that ballpark. Lindsay, do you happen to have that number for the second quarter as well?
For the second quarter for accretion?
Yes.
It's about $7 million for second quarter.
Perfect. Thank you very much, guys. Appreciate it.
Thank you, Mike.
Again, if you have a question, please press star then one. Our next question comes from Terry McEvoy of Stephens. Please go ahead.
Thanks. Good morning, everyone.
Morning, Terry.
Just trying to put the $149 million of loan kind of run-off or payoffs in perspective. Do you have that figure for call it the first quarter of this year and the fourth quarter of last year, just to put some context behind that?
Terry, we don't have that in front of us. We can certainly provide it. Happy to get you those estimates. If we can do it offline and if anybody else would like to get it, we're happy to send it to you. If you could just send us an email that, we'd happy to provide it.
Okay, great. If I look at the margin ex accretion, it was down about eight basis points. It looks like deposit costs were up about seven. How much of that came from just acquisition accounting and the impact on deposit costs versus just the core deposit pricing and being proactive and raising rates a bit?
You're spot on with the deposit cost. It was six basis points was just the cost of time deposits. That was the increase there. Really, there was little to no impact from what we deem as our more core deposits. There was also an impact from the accretion that was related to the time deposits on Ridgestone. That accounted for a good portion of it. As well, we had an uptick in the Federal Home Loan Bank advance expenses. That was the other component.
Okay. That was it on my list. Thank you.
Great. Thank you, Terry.
If you have a question, please press star then one. We'll pause momentarily. As we have no further questions, I would like to turn the conference back over to Mr. Paracchini for any closing remarks.
Well, thank you. I think I'll just end the call by thanking you all for your interest in Byline. We look forward to working with you in the quarters and years ahead and look forward to seeing you at some point in the fall and at our next call later on this year. Thank you. Operator, I guess I'll turn back the call to you.
Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.