Good morning, and welcome to Peoples Bancorp Inc's conference call. My name is Nick, and I will be your conference facilitator. Please be advised that all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star then one on your telephone keypad, and questions will be taken in the order they are received. If you would like to withdraw your question, please press star then two. This call is also being recorded. If you object to the recording, please disconnect at this time. Please be advised that the commentary in this call will contain projections or other future forward-looking statements regarding Peoples' future financial performance or future events. These statements are based on management's current expectations.
The statements in this call, which are not historical fact, are forward-looking statements and involve a number of risks and uncertainties detailed in Peoples' Securities and Exchange Commission filings. Management believes the forward-looking statements made during this call are based on reasonable assumptions within the bounds of their knowledge of Peoples' business and operations. However, it is possible actual results may differ materially from these forward-looking statements. Peoples disclaims any responsibility to update these forward-looking statements after this call, except as may be required by applicable legal requirements. Peoples issues a press release this morning regarding the proposed merger with Capital Bancorp, Inc., and the press release and investor presentation are available at peoplesbancorp.com under investor relations. This call will include about 10- 15 minutes of prepared commentary, followed by a question-and-answer period, which I will facilitate.
An archived webcast of this call will be available on peoplesbancorp.com in the investor relations section for one year. Participants in today's call will be Tyler Wilcox, President and Chief Executive Officer, and Katie Bailey, Chief Financial Officer and Treasurer, and each will be available for questions following opening statements. Mr. Wilcox, you may begin your conference.
Thank you, Nick. Good morning, everyone, and thank you for joining our call today. We are excited to announce that we have entered into an agreement to acquire Rockville, Maryland-based Capital Bancorp, Inc. We view this as a transformational combination, not simply because of the additional scale, but because of what Capital adds to our franchise and the opportunities the combination creates going forward. Before I get into the transaction, I want to recognize Capital's management team, their board of directors, and the organization they have built. Ed Barry and his team have created a high-quality franchise with a differentiated set of businesses, a strong track record of growth and profitability, and a talented team across the company. Just as importantly, we have been very impressed with the way that they have approached this process.
Our interactions throughout the discussions and diligence have been thoughtful, collaborative, and constructive and have reinforced our confidence in both the cultural fit and the opportunity we see in bringing these organizations together. There are a few highlights I want to point out regarding the transaction. First, strategic fit. As I mentioned, Capital has built a differentiated and high-performing franchise anchored by a strong relationship-based commercial bank in Washington, D.C., in the metropolitan area, complemented by several established and profitable specialty businesses with national capabilities. Those businesses include OpenSky, a consumer credit card platform that provides secured, unsecured, and partially secured credit cards nationwide, which are digitally originated and served. Windsor Advantage, a loan service provider that offers community banks and credit unions a comprehensive outsourced SBA and USDA platform.
Capital Home Loans, which originates conventional and government-guaranteed residential mortgage loans primarily for sale into the secondary market, and a government-guaranteed lending platform with a particular expertise in areas including solar and renewable energy. These are established businesses with experienced leadership teams, and importantly, they add capabilities and sources of earnings that we do not have today. Capital has demonstrated an ability to translate their differentiated business model into consistently strong financial performance. The company has generated attractive profitability, including a last 12 months return on average assets of approximately 1.58% and return on average tangible common equity of approximately 16%, while also producing strong balance sheet growth. Over the last three years, Capital has grown assets, loans, and deposits at approximately 20% annually, well above peer averages. We believe that this combination of diversified capabilities, strong growth, and demonstrated profitability is particularly compelling.
We are acquiring a business that is performing well today. The merger will create additional opportunities to enhance that performance through the scale, products, and resources of our combined organization. Capital also brings an attractive deposit franchise, including specialized national deposit verticals that complement our traditional relationship-based funding base and provide additional avenues for growth. We believe our expanded product suite and expertise, including wealth management, insurance, equipment finance, premium finance, and other commercial capabilities, creates opportunities to deepen relationships across Capital's customer base. We also see opportunities to expand a number of Capital specialty businesses across our broader franchise. Notably, none of these revenue opportunities are reflected in our modeling assumptions. Our financial projections are based on the businesses largely as they operate today. We view successful execution against these opportunities as potential upside to the returns we included in our investor presentation.
This transaction gives us meaningful scale and a more diversified financial profile. On a pro forma basis, we expect to have approximately $14 billion of assets, $10 billion of loans, and $11 billion of deposits. Just as importantly, the combination creates a more balanced earnings mix. We retain a predominantly relationship-based community banking franchise while adding multiple national lending, deposit, and fee-generating businesses. On a pro forma basis, approximately 23% of revenue would come from fee income, providing greater diversification in our sources of earnings, which we see as key to our future. An important part of that scale is the $10 billion asset threshold. We have been preparing for this threshold for a number of years, investing in our systems, infrastructure, talent, risk management, and governance. During due diligence, we thoroughly reviewed the existing infrastructure of Capital to ensure it conformed to our needs for passing the threshold.
This transaction allows us to cross $10 billion with meaningful scale and earnings capacity rather than simply growing incrementally over the threshold. Our standalone projections already contemplate the approximately $11 million of Durbin-related revenue impact associated with our existing business, including the pending Citizens merger, while Capital adds very little incremental debit card exposure. We believe this is a financially efficient way to move through that threshold and position us for our next phase of growth. We believe the financial returns are very compelling. We have spent significant time understanding Capital and each of its businesses. Our diligence process was broad and cross-functional, with a particular focus on credit and the specialty businesses, including an extensive review of OpenSky. The work we completed gives us confidence in both the quality of what we are acquiring and our ability to successfully integrate the organizations.
Ultimately, we believe this combination accelerates the strategy we have been pursuing for a number of years and validates our watchwords of strategic patience that we have repeated with our investors for the past few years. This transaction gives us greater scale and significantly amplifies our current business in the D.C., Maryland, and Virginia markets. It also adds attractive and complementary businesses, improves and diversifies our earnings power while creating meaningful opportunities for continued growth and shareholder value. I will now turn the call over to Katie for some additional background on performance metrics of the proposed deal.
Thank you, Tyler. The proposed transaction is for full stock consideration with a fixed exchange ratio of 1.11 shares of Peoples for each share of Capital. Based on our 20-day average price, that represents an aggregate transaction value of approximately $728 million. Following the close, we expect our existing shareholders will own around 2/3 of the combined company, and Capital shareholders will comprise the remaining third on a diluted basis. Additionally, three current directors from Capital will join our board. We anticipate completing the transaction during the first half of 2027, subject to shareholder and regulatory approvals along with customary closing conditions. As Tyler mentioned, we believe the financial characteristics are attractive. Based on our current assumptions, we expect fully phased in 2027 EPS accretion of approximately 19%.
Initial tangible book value dilution is approximately 10.8%, with an earn back period of less than three years, and the modeled IRR is greater than 25%. We will continue to maintain a strong capital profile after the transaction and are estimating a CET1 ratio of approximately 11.9%, providing meaningful capital capacity as we integrate the businesses and continue to grow the combined franchise. I would like to highlight some of the assumptions used within our projections. We are modeling cost savings equal to approximately 30% of Capital's non-interest expense, with approximately 70% phased in during 2027 and the full amount realized in 2028. Again, we have not modeled any revenue synergies despite the opportunities that Tyler discussed.
We are currently estimating approximately $56.5 million of pre-tax transaction expenses and have incorporated a 3% gross credit mark on Capital's loan portfolio, along with the other purchase accounting adjustments outlined in the presentation. We believe those assumptions appropriately reflect the diligence completed thus far and provide a sound basis for the financial returns we have included in the presentation. We expect that our interest rate risk profile will be relatively unchanged after the merger and will be consistent with our position for the last few quarters. I will now turn the call back over to Tyler for his closing comments.
Thanks, Katie. While we are in the process of completing our merger with Citizens, we have an established record of being able to close and convert multiple mergers within a short period of time. We announced this Monday that regulatory approvals have been received, and we are on schedule to close Citizens on October 30th. We are confident that we have the capabilities and workforce to successfully complete both mergers and begin realizing their benefits in the near future. We are focusing on a streamlined close and conversion process for both of our mergers while working to bring our collective clients together with our expert associates to provide products and services that not only meet but exceed their needs. Our culture is relationship-based at its core and will continue to be the primary driver of our day-to-day interactions with our clients.
We believe the proposed merger will drive meaningful shareholder results with improved long-term financial performance, and will further establish our long-term strategy to be a unique, diversified financial services company that provides quality returns for our shareholders. We are looking forward to discussing our quarterly results at our next call on Tuesday, October 20th. This concludes our commentary, and we will open the call for questions. Once again, this is Tyler Wilcox, and joining me for the Q&A session is Katie Bailey, our Chief Financial Officer. I will now turn the call back into the hands of our call facilitator.
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble the roster. The first question will come from Jeff Rulis with D.A. Davidson. Please go ahead.
Thanks. Good morning.
Morning, Jeff.
Morning, Jeff.
I guess on the niche business lines, I guess just the strategy going forward. Is it kind of run those as is? Do you potentially extend that to Peoples platform? I just want to see your thoughts on how those businesses are run post-close.
Sure. Thanks for the question, Jeff. Those businesses are a key part of why this transaction is so attractive to us. We have had a chance to obviously review the financial results, but also to be introduced and spend time with the leadership of those groups to see the operational excellence and see the returns that those add to Capital. As we have done that, we have a high degree of confidence that they will fit in well with Peoples. We have a track record of integrating differentiated businesses across the scope of the entire country with our national business platforms. Our expectation is bringing over the leadership and the infrastructure of those additional businesses is going to enhance Peoples going forward.
They certainly will have their own systems, their own operational excellence and, obviously, quality leadership, and all of those things will enhance Peoples. That is what we see as one of the main upsides of this opportunity.
Got you. Tyler, you mentioned a couple of times the leadership. The expectation is that the key heads of those business units would be expected to be retained or staying on?
That's right.
Okay. Got you. Maybe Katie, if I could just jumping over to the margin projection of 5% +, is that inclusive of purchase accounting accretion? If not, if you could just outline what you think that expectation is from an annual contribution. Thanks.
It is inclusive of accretion, albeit I would note that is a relatively small and short-term benefit that will be received. So it is not heavily influencing that number.
Okay. Katie , I guess the pro forma balance sheet would lean incrementally asset sensitive, but the rate profile is largely unimpacted?
That is correct. Exactly.
Okay. Great. I will step back. Thanks.
Thanks, Jeff.
Thank you.
The next question will come from Brendan Nosal with Hovde Group. Please go ahead.
Hey, good morning, folks. Hope you are doing well.
Morning, Brendan.
Morning, Brendan.
Just kind of starting off here on Durbin, just want to make sure I am perfectly clear. You are providing accretion kind of outlook for fully phase in 2027, but Durbin does not start until the middle of 2028. Just want to make sure that $11 million drag from Durbin is fully factored into that 19% EPS accretion figure that you provide.
Yes.
Okay. All right. Perfect. Maybe pivoting to the cost savings, the 30% outlook you have there. Can you just walk us through where you see most of those savings coming from, just particularly given the expense load of some of Capital's specialty or niche offerings?
Sure. No problem. As with every transaction, there's some corporate overlap. There's technology and data processing overlap, key vendor overlap. Obviously, what we don't have, but we never really have in many of our deals, is significant kind of branch infrastructure overlap. But that hasn't been the case in most of our deals. We have a high degree of confidence in historically always hitting our cost-saving estimates and ensuring the capabilities of the perpetuation of those businesses, as I mentioned in the first question, is built into those assumptions, Brendan.
Okay, perfect. Thanks for taking my questions.
Thank you.
Thank you.
The next question will come from Tim Switzer with KBW. Please go ahead.
Hey, good morning. Thank you for taking my questions.
Good morning, Tim.
A follow-up on the kind of niche verticals you are acquiring here. You guys now have, I guess, nine at least national business lines. As you have your portfolio of businesses here, are there any that will be a particular focus for you and a primary larger driver of growth going forward than any of the others? And are there any that, now that you have a lot of different business lines, that are kind of less of a focus for Peoples going forward?
Yeah, Tim, I am going to give you the answer you probably don't want to hear, which is that they are all a focus. We are intentional with all of those businesses. We got into them for a reason. They all provide different risk and return profiles for us. And so take insurance premium finance, which we are happy to grow and have been growing, that carries a significantly lower credit risk, but carries some operational risk versus anticipating OpenSky and the different profile they have with the diverse customer base. And so we look at them as a portfolio of businesses. And just like all of us should be diversifying our portfolio, we believe that it gives us differentiated returns for that reason.
I am not trying to dodge your question by saying all of them will be a focus, but we are particularly interested in continuing to invest in all of them as we have been. And as we look at the investments that are anticipated in Capital's strategic plan, the investments they have been making in Windsor and OpenSky and in all those verticals that they have, that is also attractive to us, and we plan to continue to make those investments that they have anticipated making and are making.
Okay. Yeah, no, I get it. It helps differentiate the business quite a bit. You mentioned OpenSky. If I look at Capital's historical net charge-off rates, they have been a little bit higher for the consolidated bank the last few years. I assume a lot of that is OpenSky. Can you kind of talk about your comfortability with that business and maybe what the risk-adjusted yield on that business line, what it looks like?
Absolutely. We certainly have had our experience and with our diversity of businesses, having businesses that we are comfortable with a higher risk-adjusted return. OpenSky is certainly in that range. They are in kind of a 20% range, and so highly profitable. Again, very granular. They have hundreds of thousands of clients with very small balances, particularly in the secured credit, and they have been met in a very measured way, growing the unsecured piece of that business. We expect to continue to grow both of those pieces of business. At the end of the day as well, the pro forma company is a $10 billion in loans operation, and OpenSky, as it sits today, is about $150 million, driving oversized returns and punching above its weight.
But certainly also screening like we have historically, a little bit higher relative to peers who don't have those higher returns in terms of net charge-offs. We view that as a positive and an intentional investment.
Okay. All right. Very helpful. Sorry if I missed this when you were talking about retaining some of the management team, but will Ed Barry have a role with the combined company?
Yeah, Ed and I are absolutely aligned on our goals for kind of a successful merger, and he's committed to making the transaction a success today and beyond. We'll talk more about that in the future, but very committed to the mutual success here.
All right. Great. Thank you.
Thank you.
Thanks, Tim.
The next question will come from Tyler Cacciatori with Stephens. Please go ahead.
Hey, good morning. This is Tyler on for Matt Breese.
Morning, Tyler.
Good morning. With the Citizens deal still underway and the associated balance sheet actions related to securities, can you just update us on if there's any changes there? Is there anything on the CBNK balance sheet that we should contemplate being in run-off mode?
As it relates to the Citizens transaction, that's trending as expected. As we noted in the second quarter results, we did a meaningful securities restructuring in advance of the closing of Citizens, which has proven beneficial to us based on the yield curve as it stands today versus when that was executed. You might see a little bit more, but I think the most meaningful portion of that was done in the second quarter. As it relates to Capital and any balance sheet, I think we're committed to the businesses they have and the structure that they are today and don't have any plans for meaningful change.
Okay, great. Just a quick one from me. I was just wondering what are the anticipated impacts to 2028 EPS from the deal?
Sorry.
2028 impact?
Yeah.
We just 2027 to give you an indication of what we would expect, and we would expect 2028 to be in line with the 2027 full year phased-in accretion.
Okay, great. Thank you very much. That'll be it for me.
Thanks, Tyler.
The next question will come from Nathan Race with Piper Sandler. Please go ahead.
Hey, Katie, Tyler.
Hey, Nate.
Thanks for the presentation. I was wondering if you could just touch on how the deal came together. Was this a more negotiated or shop process that Capital ran, and just how you got comfortable from a perspective on pricing?
Yeah, sure. Thanks, Nate. I've known Ed and had conversations with Ed for a number of years now. We've certainly kind of admired them from afar. As recently, I think both companies came together and had some discussions of what could be. I think Capital would say that they really appreciated our mutually entrepreneurial spirit and looking at us as a partner that had significant upside, that had the scale to integrate them and perpetuate the businesses that they have. Seeing the track record that we have of our diversity of revenue sources as we've talked about a lot here on the call today. I think they saw a mutually beneficial arrangement and the conversations blossomed from there, and here we are today.
Okay, great. If you could just touch on capital priorities leading up to and following the deal closing. As you guys outlined on slide 14 of the deck, the stock will be trading at a discount to peers on core former EPS and tangible book. Your capital ratios remain quite strong. Just curious in terms of where share repurchases may stack up in terms of your capital priorities, and if you guys would be entertaining any additional acquisition opportunities, whether it be income or otherwise.
Yeah. I think we stand committed to the organic growth that's illustrated in the model and in the investor presentation. As you're aware, our dividend, we've stayed committed to that, and I think this helps rightsize our dividend to the lower end of the range we've guided. That is our goal thereof. Buybacks are the next avenue that we would explore in line with acquisitions, just being opportunistic there. You may see us become a little more aggressive on both of those fronts as the capital continues to build on a go-forward.
Yeah. Nate, I would just add as to our appetite for acquisition, obviously we are hyper-focused on success here, and this is a little bit larger than the Citizens deal. But we will maintain our efforts to see what is in the market and what is compelling and remain opportunistic on that front as well.
Okay, great. Then if I could just sneak one last one in going back to the credit and charge-off discussion. Could you just help us in terms of what is kind of embedded in your forecast around EPS accretion and provision in terms of what you expect in terms of charge-offs and to what degree provision would cover that?
Yeah. I think we would expect our charge-offs, as we have said historically, to continue to trend favorably as North Star continues to do what we say it will do in the last couple of quarters. I think we anticipate their charge-off levels remaining consistent with where they have been. So the combined organization will look a little better than we do on a standalone because of the improvement we have, but then also adding in their charge-off history. The allowance, I think, does allow for that level of charge-off on a go forward.
Okay, great. I appreciate all the color. Thanks, everyone.
Thank you.
Congratulations.
Thank you.
The next question will come from Daniel Tamayo with Raymond James. Please go ahead.
Thank you. Good morning, guys.
Morning, Dani.
Yeah. Most of my questions have been asked and answered, but on the pro forma growth of the bank that CBNK was doing good growth. As you mentioned with the 20% annual for the last three years, is that kind of what you are assuming continues? You mentioned committing to staying in all these businesses and continuing to grow the card on both sides of that. Just curious how you guys are looking at maybe growth opportunities for Capital and how that fits into the overall growth for the bank.
Yeah. I would say on the pro forma basis, obviously the growth will be lower. We have, I think, measured expectations. The more the company grows, the more the percentage growth shrinks a bit. But that is in no way an indication that we are looking to pump the brakes on anything that they're doing. But that commitment that we have to each of those businesses, I think is clear. And we're using, essentially in our modeling, the forward-looking consensus as to where they are going and where they've been. And I think that makes a lot of sense with respect to the forward expectations of the pro forma and that their contribution to our obviously somewhat lower growth and larger size.
Okay. Thanks, Tyler. I guess you had mentioned in the deck here that the deal allows you guys to operate at better scale for their businesses as well. Does that imply that their kind of standalone growth opportunities are accelerated under you guys with the larger balance sheet?
I think some of that is a reference to the potential synergies which are not modeled. Some of that is the opportunity to combine and scale each of our businesses. Obviously our funding base provides an engine to help continue to grow, particularly their lending businesses. So we view it as kind of a big picture opportunity to scale up their businesses. I think one of the reasons that they were attracted to us as a combination in the future is that high quality deposit base, which is the kind of core of our bank, and deploying that into those businesses to drive profitability and growth, I think is really the core of the strategy.
Great. Maybe just one on those deposit businesses. I am looking at slide nine here. It talks about the deposit franchise of Capital, and you have got the four national specialty deposit verticals. Maybe just give us a sense for the type of costs that those four businesses you are able to bring deposits in at, and how those businesses, if there is an ability to scale those further, kind of like I was talking about with the loan book.
Yeah.
If there is any kind of rate sensitivity on those deposits as well.
Dani, as to kind of most recent quarter cost of deposits for those deposit verticals for them is about $2.28. As we think about the attractiveness of those deposit capabilities, we do think they are scalable across our footprint. It is interesting. They as a bank that do not have the kind of consumer deposit base in low-cost markets like we have grown the muscles of diversified deposit gathering capabilities. That is an addition that we have been working to grow ourselves over the last couple of years as we have expanded. We view this as highly synergistic in that, again, we have that historic core deposit base, the desire to grow some of these specialty deposits. They do not have that, and they do not have the low-cost historic rural deposit base that we do, but they have those capabilities.
It is kind of a match made in heaven in that regard. Both sides will enhance each other.
Terrific. All right. Well, thanks for all the color, Tyler.
Thank you.
Thanks, Dani.
The next question will come from Michael Hess with Hess Investments. Please go ahead.
Congratulations on the transaction.
Thank you.
Thank you.
I was just calling to find out how this transaction would affect the acquisition of Citizens National. When that transaction is expected to close, do the terms remain the same? Any other effect it might have on that upcoming acquisition?
Michael, thanks for the question. I would say there is no impact other than increased capabilities for all of our mutual customers. We have been actively and aggressively engaged with the closing, the training, the integration, and as we just said, we got the closing approval from the Federal Reserve and from the regulators, and we are ready to go October 30th. Nothing changes there. That is right on schedule of what we originally announced. We are very excited about our Eastern Kentucky franchise. We have our associates who are all over that every day. No change other than, again, a more addition to the whole as both of these fine organizations are going to be part of the future of Peoples.
Thank you very much.
Thank you for the question.
Thank you.
Again, if you have a question, please press star and then one. The next question will come from Daniel Cardenas with Brean Capital. Please go ahead.
Hey, good morning, guys.
Morning, Dan.
Congrats on the deal. Just couple questions here. In terms of additional M&A transactions on a go-forward basis, I mean, a nice move into a major metropolitan area. Is expectations that additional deals, future deals are going to be more geared towards major growth markets? Or is it going to really be kind of more opportunistic as you think about future transactions?
Yeah. Thanks, Dan. I would say no change to our stated strategy. As we've demonstrated, I'd love to have more in Kentucky. I'd love to have more in Ohio. I'd love to have more in West Virginia. We continue to believe that Virginia and kind of the Mid-Atlantic has been viable. Pennsylvania, Indiana, Michigan, Tennessee, kind of these states we've talked about. But we certainly continue with the thesis that overlap and market density would be a real strength. And so we will be actively engaged throughout all those markets and be opportunistic about what is the right opportunity. But I will just say, because I haven't said it this clearly, when you have an opportunity to buy a high performer like Capital that has demonstrated just significant history of profitable growth, you do it without a question, and we're very excited about this one.
But that isn't an indication that we are moving away from any of the other strategy that we've talked about.
Okay, good. Then, just in terms of timing, if you can answer this. When do you think the systems conversion is going to take place on this deal?
Systems conversion probably kind of mid or late third quarter, early fourth quarter of next year.
All right. All my other questions have been asked and answered. Thank you, guys.
Thank you.
Thank you.
At this time, there are no further questions. Sir, do you have any closing remarks?
Yes. I want to thank everyone for joining our call this morning and your interest. Please remember that the webcast of this call, including our investor presentation, will be archived at peoplesbancorp.com under the investor relations section. Thank you for your time, and have a great day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.