CapStar Financial Holdings, Inc. (NASDAQ:CSTR) Q2 2022 Earnings Conference Call July 22, 2022 10:00 AM ET
Company Participants
Tim Schools – President & CEO
Mike Fowler – CFO
Chris Tietz – Chief Credit Policy Officer
Conference Call Participants
Graham Dick – Piper Sandler
Kevin Fitzsimmons – D.A. Davidson
Brandon King – Truist Securities
Feddie Strickland – Janney
Taylor Brodarick – Hovde Group
Catherine Mealor – KBW
Operator
Good morning, everyone, and welcome to CapStar Financial Holdings Second Quarter 2022 Earnings Conference Call. Hosting the call today from CapStar are Tim Schools, President and Chief Executive Officer; Mike Fowler, Chief Financial Officer; and Chris Tietz, Chief Credit Policy Officer. Please note that today’s call is being recorded. A replay of the call and earnings release and presentation materials will be available on the Investor page of the company’s website at capstar.com.
During this presentation, we may make comments which constitute forward-looking statements within the meaning of the federal securities laws. All forward-looking statements are subject to risks and uncertainties, and other factors that may cause the actual results and the performance or achievements of CapStar to differ materially from those expressed or implied by such forward-looking statements.
Listeners are cautioned to not place undue reliance on forward-looking statements. A more detailed description of these and other risks, uncertainties, and factors are contained in CapStar’s public filings with the Securities and Exchange Commission. Except as otherwise required by applicable law. CapStar disclaims any obligation to update or revise any forward-looking statements made during this presentation.
We would also refer you to Page 2 of the presentation slides for disclaimers regarding forward-looking statements, non-GAAP financial measures, and other information.
With that, I will now turn the presentation over to Tim Schools, CapStar’s President and Chief Executive Officer.
Tim Schools
Good morning, and thank you for participating on our call. We appreciate your interest in CapStar and I ask you to bear with us this morning, the vendor Victor, here, we changed our software. And so this will be the first time, we’re using it this quarter. So be patient with us as we navigate this new software challenging to adopt it on earnings call.
Today, we’re excited to be speaking with you from Asheville, North Carolina, where it started off in the cool 60s this morning. I think it’s going to be 100 in Nashville today, so it’s nice to be here. And this is where we announced last week, we’ll be opening a new office. It’s an outstanding and healthy growing market. It also was one, we’re very familiar with. Its last 12 community banks since 2008 and is often served out of Charlotte. We feel it presents CapStar a tremendous opportunity as with Chattanooga and Knoxville investments. I’ll provide some highlights to be shortly.
In the second quarter, we reported $0.45 per share. Pre-tax pre-provisioned assets of 1.70% and a return on tangible common equity of 12.7%. I’m particularly proud of our results as they demonstrate the strengthening of the core bank, which for today’s purposes, I’m defining as excluding our mortgage SBA and TriNet businesses. Due to the headwinds, I communicated for these businesses last quarter in the sense rapidly changing market conditions, the second quarter net contribution of these three businesses was minimal.
This is meaningful as the core bank essentially earned about $1.80 per share annualized, which I believe would be a record. This positions CapStar very well when you incorporate the underlying growth opportunity of Nashville in our community markets, the expense we have embedded in our recent Chattanooga, Knoxville and now Asheville investments in what our mortgage and TriNet business historically have provided in a more stabilized market environment and the potential we believe is in our SBA business.
The underlying four key drivers of our company are performing very well. First, year-over-year revenue growth, excluding our Specialty Banking businesses and PPP increased 13% led by a healthy increase in loans. Our net interest margin expanded 44 basis points from the prior quarter, largely due to a favorable change in earning asset mix and an increase in market rates.
Third, our productivity management is outstanding, with core banking expenses down 1.5% year-over-year, aiding (ph) our overall efficiency ratio, which now stands at 56%. In combination with the revenue growth, I mentioned previously, year-over-year core bank pre-tax pre-provision growth was 38%. And lastly, credit quality remains outstanding where past dues reached their second consecutive record of 12 basis points and charge-offs remain low.
Importantly, you have seen thoughtful and balanced capital allocation discipline with the announcement of three De Novo expansion markets over the past two years to include Asheville and further expansion of Chattanooga this quarter. The paying of an increased dividend as well as share repurchases.
Before turning it over to Mike to cover the highlights of our key trends, I’d like to discuss the progress of our recent new market investments. If you’ll please turn to Page 5 of this morning’s presentation, you’ll see the targets we’ve established for each expansion market and the early results of Chattanooga and Knoxville. This is new for us, so we’re still learning and refining. Needless to say, we’re pleased with our progress to date.
I find Slide 6 and 7 to be the most meaningful in today’s deck. It shows the transformation that is occurring at CapStar, as well as the opportunity. Over the past three years, our team has significantly increased the franchise value of CapStar from a footprint and performance standpoint. We are now in four of the Southeast’s most dynamic markets, have improved efficiency, profitability and earnings. And our year-to-date, one year, three year, and five year total shareholder returns were greater than industry and local peer performance.
I’ll let you read through the commentary on Asheville and our continued Chattanooga investments and move forward to Pages 13 and 14. Here, we have attempted to provide some thought of what the potential of these recent investments could be. Obviously, there are many variables that could make these results better or worse. In second quarter, our current Chattanooga and Knoxville investments contributed a positive $0.01 per share.
On Page 13, we’ve listed what their future incremental contribution might be under stable market conditions and if we execute at the level we aspire.
Similarly, Page 14 shows the same for Asheville in our newest Chattanooga investments. As we all know, De Novo’s come with front end startup costs, but provide the opportunity for significant future accretion if successful. What is so exciting is, there are many other aspects of CapStar, which should also increase their contribution during these periods.
Mike, if you’d please now cover the financial highlights of the quarter.
Mike Fowler
All right. Thank you, Tim. Good morning, everyone. On Page 17, a few highlights. As Tim noticed, we feel we had a very strong performance in our core banking markets, offsetting near-term headwinds and our specialty key businesses. Our net interest margin of 3.41%, and the second quarter was up 44 basis points from the first quarter. Our efficiency ratio of 56.3% is an improvement of 2.4% versus last quarter. Our pre-tax pre-provision of 1.7% of assets is also an improvement of 9 basis points versus last quarter.
In terms of growth categories, our assets and we’ll talk more about this and discussing the margin in a minute. But despite very, very strong loan growth again this quarter, our assets are effectively unchanged as this was a continuation of deploying our excess liquidity into higher yielding loans. Tangible book value per share is down 2% from last year. However, an issue discussed throughout the industry, if you exclude the OCI impact of higher unrealized securities losses due to the general increase in market interest rates. Tangible book value per share is up 2.1% versus last quarter and is up 13.1% versus last year, reflecting ongoing solid profitability. And as Tim noted, credit metrics remain very strong and capital remains very strong. We continue to have capital above our peers.
On Page 18, you can see the drivers of the 44 basis point increase and net interest margin for the quarter. Essentially, as I noted a second ago, remixing the balance sheet deploying assets liquidity into loans; and number two, the benefit of the Fed’s rate hikes to date, 150 basis points since March. Net interest income was $24.4 million, an increase of $3.3 million versus last quarter again with no increase in earning assets. Our cash declined from 11.2% of assets last quarter and 14% year-ago to 3.7% on average for the current quarter.
In terms of the NIM and the net interest income outlook, we have seen as expected and consistent with past cycles of rising rates, as the Fed moves deeper into rate hiking cycle, deposit betas or pricing rates are increasing, and we have seen that to some extent in the last month. But our strong loan pipeline continues and our production provides opportunity for continued net interest income growth. Another thing you hear in the industry, we do expect some loan pricing tailwind as competitive pricing responds to the dramatic increases we had seen earlier this year when some of their competitors have lagged their increases in response to market rate increases. We’ve seen some evidence of that of some catching up and we do expect some tailwind on that front going forward.
From an interest rate risk perspective, as we said in the past, we are targeting to be positioned purely risk neutral. Our net interest margin could continue to benefit and we expect it will modestly from further rate hikes. However, a potential modest decline could occur in a flattening scenario, which is certainly not unlikely.
On Page 19, regarding deposit costs. Our deposits declined $40 million during the quarter, driven primarily by correspondent bank activity not surprisingly as our bank customers are deploying their excess liquidity into loans as well and they could be facing some deposit outflows. So not surprising to us that we’ve seen some modest decline in our correspondent bank balances.
Outside of correspondent banking, we certainly have seen some instances of deposits leaving, but in total our other deposits have been in the aggregate fairly stable. The deposit costs for this quarter was an average of 23 basis points or 4 basis points increase versus last quarter. As many of our peers are doing, we’re striving in this rate environment to maintain disciplined pricing on both sides of the balance sheet. But in turn to this slide, disciplined pricing on the deposit side, as the Fed continues to raise short term rates. We certainly focus on optimizing profitability, while ensuring we remain competitive through a combination of specials and new products, and competitive pricing on our standard products, designed to retain and attract core profitable relationships.
On Page 20, our average loan growth in terms of loans held for investments was 19.8% excluding PPP and a transfer of $106 million of TriNet loans, which we’ll talk more about in a minute, from held for sale to held for investment. End of period, the growth was 16.9%. PPP at this point has really gone. We’re down to less than a $1 million at the end of the quarter in terms of PPP loss. We continue to have very strong production. In the quarter, we had production of $217 million, which represents an annualized number of $870 million. And you can see the history there that represents a continuation of focus on consistent organic production. And as you’ve heard Tim say in the past, while we certainly focus on production, we’re focusing on profitable production.
Commercial loan pipeline remains very strong currently exceeds $500 million with strong contribution across all markets. In the quarter, our average loan yields increased 28 basis points versus last quarter, 22 basis points due to loan coupon, a 11 basis points actually due to a correction last quarter, which we discussed on the call of deferred costs, deferred loan origination costs, pricing achieved a match funded spread in a quarter at the time of funding of 170 basis points.
As you’ve heard us, say in the past, we target 200 and up, target an average of about 250 over a match funded federal home loan bank curve. This quarter, we have seen some pricing pressure, but some of that 1.70% represents well, A, originations lower than targeted spread given lag competitive response to market rates. As we said in the last quarter, we continue to have a lot of discussion with the line in our markets. We try to maintain discipline in our pricing. We certainly have some degree of flexibility for important relationships and important transactions.
The other thing in that number though is, where we do give rate locks (ph) and we have tightened those up. We’re giving them less often. We’re giving them for shorter periods of time. But the 1.70% represents the match spread between the rate on the loan, a fixed rate loan and match funded cost of funds as of the time of funding. In many cases that spread was wider when the rate was actually committed to the customer.
On Page 21, talk about non-interest income. As Tim said, this is an area where we certainly have some specialty fee businesses that have been very important in the past and we believe we will continue to be very important over time, but we’re seeing some headwinds. We continue to see growth in core bank deposit service charge and Internet and debit transaction fees. But we’re seeing headwinds in mortgage related to both volumes, obviously, with mortgage rates up sharply this year, refinance activity has dried up as it has for the industry.
We’re also seeing as a result of lower volumes consistent with prior cycles, we have seen some compression and spreads. And we are also facing in our markets, which are very strong housing markets, very strong demographics, as Tim touched on earlier. But we are seeing, which is not uncommon in the industry limited housing supply, which is also impacting our mortgage originations.
TriNet had a fair value mark of $185,000, due to the adverse impact of rapidly rising interest rates that was partially offset by modest gains on sale of other loans. Our other income was down for the quarter and that is primarily due to a one-time BOLI debt benefit last quarter of $860,000.
We go to the next Page 22. We wanted to give you a little more color on TriNet. TriNet, as many of you know is a business that generates interest and fee income by originating and selling high quality homogeneous fixed rate commercial real estate loans for properties on long-term triple net leases to national tenants. TriNet began more than 10 years ago at another institution. The leader of that business was recruited to CapStar in 2016. And since that business was launched at CapStar in late 2016, it has generated more than $25 million of cumulative revenue with no credit losses. Due to an average origination to sales cycle of about 10 weeks, TriNet has never operated with an interest rate risk program, it’s used business leverage to manage that market risk.
And it is not the materially impacted by rate movements in past rate cycles. However, recent events, we’ve seen a dramatic increase in market rates in the second quarter, causing TriNet originations, values to decline, the rapid increase in market rates, in addition to reducing the value of TriNet loans, it also caused a decline in the demand for these loans. So we have seen investors pause. We believe largely due to the uncertainty in terms of where longer term rates are headed. As I noted on the last slide, in the second quarter, we did transfer $107 million of TriNet loans from held for sale and to held for investment.
In terms of the outlook, we have paused further originations at this time. We have approximately $100 million of additional loans than process or loans that are held for sale that have a potential unrealized or realized loss. In combination with the recent reduction in demand, we are evaluating the market to sell these loans. We might consider placing them into held for investment, which could come to realize or unrealized loss. We are pursuing hedging strategies to mitigate market risk in the future and will only restart originations when we see clear indications of market stabilization and liquidity normalization.
On Page 23, non-interest expenses continue to have strong expense discipline with a productivity mindset across the organization. Total expenses are down $700,000 versus the last quarter. Our efficiency ratio as I noted earlier, 56.3% down more than 2% from last quarter. Significant part of that driver is salary and benefits, which were down $1.1 million for the quarter, due (ph) number one to increase deferred costs associated with loan growth with new loan originations, as well as the Q1 severance and retirement expense of $385,000; and number three, lower mortgage incentive accruals and benefit expense, reflecting lower mortgage revenue.
I’ll now turn it over to Chris to discuss risk management.
Chris Tietz
Thank you, Mike. Moving to Slide 25. As in the past, asset quality levels remained strong with continued improvement. Presented on this page, you see the evolution of the events that could ultimately result in credit loss. That is as losses emerge, the early warning indicators of loss are evidenced in increasing delinquency and adverse classification. Both of these early indicators are trending favorably for us and our losses are reflecting that trend over time.
Relating to delinquencies, last quarter, we told you that we were very pleased with record low pass dues, but aspired to continued improvement. We exceeded our expectations achieving 12 basis points for June 30, representing another new record low for us. Our credit and operations teams have done an outstanding job of bringing consistency to oversight and processing of payments and after elevated results in past quarters, we are seeing the improvement evidence in the results.
In addition, turning to criticized and classified asset levels, improvements from pandemic highs continue to be achieved. Our five year average for special mentioned loans is approximately 1.6% and we are currently at 0.77%. Our five year average for substandard loans is approximately 1.5% and we are currently at 1.35%. While we are near the five year average of substandard loans, it should be noted that this subset of loan requires the longest period for resolution. As a result, the range over this five year period is very narrow with a low of 90 basis points and a high early in the pandemic of 239 basis points. Therefore, we are pleased with the current level of 1.35%.
Needless to say, we are also proud of our continued low charge-off rate, which averages $81,000 over each of the last eight quarters. This reflects our strategic decision years ago to focus our attention on traditional community bank borrow profiles that are smaller and better secured. As a result, our losses, our net charge-offs this quarter are zero basis points, representing $15,000 net.
While our asset quality is outstanding, we remain diligent for uncertainty in the economy. This is represented by our commitment to robust independent external loan reviews, expectation that our own internal credit administration process continues to work diligently towards early identification of borrower stresses and the appropriate rating of credits. And we are also in the process of completing our external annual stress test from a trusted vendor to gauge our preparation for unserved economy.
One point of note, given the uncertainty of the current environment, and in preparation for potential economic downturn, Kevin Lambert and his credit teams have identified borrowers in cyclical industries for additional scrutiny and we are adjusting our underwriting guidelines and oversight accordingly in areas representing intrinsic risk profiles.
Finally, turning to Page 26, adhering to our methodology and balancing both loan growth and favorable asset quality trends, we closed the quarter with an allowance for loan losses of 109 basis points factoring in our fair value marks on acquired loans. We feel this is an appropriate level and we are satisfied with the performance of our portfolio.
With that, I will turn it over to Tim.
Tim Schools
Thank you, Chris. As you can see, our teammates are performing at a high level and we continue to enhance the value of our franchise. We’re striving to serve the financial needs of our customers in a more personal and responsive manner while managing our margins, expenses and capital prudently. The inflationary and rate environment bring unique challenges, which we are not immune to, but we do not believe them to be systemic and we remain focused on doing what we do well, and doing our best to be strong risk managers.
That concludes our presentation and we’re happy to answer any questions. Once again, thank you for your time and investing in CapStar. We appreciate your support.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from the line of Graham Dick from Piper Sandler. Your line is open.
Graham Dick
Hey. Good morning, gentlemen. Sounds like a nice day at Nashville. So I just wanted to start on TriNet. So I saw obviously our pause in production there and kind of just taking a step back to assess things, which obviously makes sense. But I’m just kind of wondering if you have any foresight into when or what kind of environment it might take in order to return to the market here? And then also trying to understand what the revenue cadence might look like in that case. I’m just wondering, if you guys might kind of like, ease back end of things a little bit rather than jumping in all back in at once.
Tim Schools
Yeah. This is Tim and I’ll start first and then I’ll ask Mike and/or Chris to add anything they’d like to. It’s obviously a great business. It’s existed for some 10 to 15 years at a couple of banks with the same gentleman. And he’s been here for eight years and the number actually is closer to $30 million of total revenue that is generated with no losses. Now obviously, there’s been operating expenses, but been very profitable in a capital generator for CapStar. And it’s common sense, right? You’re booking seven year maturity loans that have maybe a 20 year amortization. And so those loans have always work through in a 10 week period. Well, when rates move that fast in a short period, unexpectedly on a seven year duration, the value goes down. So that’s sort of the current situation, hasn’t really been an impact in the 12 to 15 years this business has been a business. So at this point, we believe in the business.
And if you look at the history of CapStar, I certainly think the last two years are not the beacon to look to because it was the opposite, right? We really over earned. But if you go back to 2018 and ’19, like, I said in the first quarter, we believe in a more traditional rate environment, which there is not such a thing, but an environment unlike second quarter, we believe that the business development capabilities we have in our historical spreads that we could earn on or about $750,000 a quarter that it could be a $3 million contributor. So we don’t foresee that in this market. I’ll let them expand more, but it’s largely, I don’t want to say that this necessarily caught us off guard. I mean, I guess you could say that, but the program has not had an interest rate risk management program. So we certainly do not want to expose or create any more exposure that could be subject to rapid rates between now to the end of the year, where they’re still calling for maybe another 150 basis points even though these are valued more on the longer end of the curve.
I think we just want to [Technical Difficulty] see rates stabilize some. And then the second issue is even if rates were stable, I think just with the uncertainty of the rates, the inflation, the potential recession, we’ve seen the traditional buyers pause a little bit and step back some. So even if we even – even if rates stabilized and we booked them that we thought were margins that could be sold for a profit this is really meant to be a gain on sale. It’s the inflation, the potential recession. We’ve seen the traditional buyers pause a little bit and step back some. So even if we — even if rates stabilized and we booked them, we thought we’re were margins that could be sold for a profit. This is really meant to be a gain on sale off balance sheet business for CapStar. We don’t want to, while we view it as valuable, we don’t at the same time want to use up valuable liquidity. We’ve got great growth in Nashville and Chattanooga and Knoxville and Asheville and we want to make sure we reserve our balance sheet for that.
So I’m throwing a lot at you, but maybe I’ll stop there and see if you have a further question or Chris or Mike could add anything.
Graham Dick
No, that answered several of my questions altogether. My next one is really going to be on [indiscernible] on balance sheet, but makes sense with the growth you’re seeing elsewhere. So I guess just moving on to deposits, looked like they were down a little bit this quarter obviously with the correspondent bank activity picking up a bit. Can you talk just a bit about your strategy on the side of things and how the newly added teams in Chattanooga and Asheville might play into that? And then also just generally what direction you see total balances heading in the near term?
Tim Schools
Yeah. Great question. I think that’s exciting for us. When I came in, we were growing the loan side. When I came in ’19, the five years before I got here, If you took out all shared national credits and all participations, we had grown loans 3% a year for the five years before and now we’re growing them 20% a year with no participations. So on the rights side of the balance sheet, we need to crack that same code. And we’re now 14 years old. When I came, we were 10 or 11 and loan capabilities come first. So this summer, we’ve had an active deposit structure.
First of all, we started in the fall of ’19 when I came, we changed the incentive plans. We did our products. We really got started and then the pandemic came and we had an inflow of deposits. So you sort of got comfortable and actually, we changed the tone, and we said we need loans. We need to lend all those deposits out. And so I don’t want you to think we’re just starting. We really started in the fall of ’19, but then we paused. And so we’re back at it. We had — I can’t remember April or May, we formed a deposit strategy committee and came up with a full five or six point plan on relooking at incentive plans, communication, products. We spoke to a lot of banks across the country that are high performing banks on what products are they doing and so forth.
And at the end of the day, it’s just got to be execution. And we’re really focusing on and we don’t want it to become talk or the quarter of the month, how do we become a deposit first bank? I mean that in capital is the backbone of any bank. And so traditionally a lot of banks don’t go after deposit only customers. They go after borrowers and see if they can get some deposits. Well, you’re always going to be net looking for deposits. So I’d say that’s the biggest thing, Graham. And we’re just — we’re excited about it. Obviously, when you bring on new markets, it’s also easier for them to get loans. I’m friends with [indiscernible] and Justin Strickland formally of Southern First, and they’ve done a great job of organically going to new markets and emphasizing that they need to fund their own market. And that’s our mantra. Now we’ve got to hold them to it and we’ve got to execute.
Graham Dick
Okay. I guess, so would you say that deposits you would see them growing here in the back half of the year or do you think that there might be some more of that correspondent bank activity that brings balances a little bit lower in the near term?
Tim Schools
I think the whole industry, you’re going to see some sideways to maybe down the next six months. I mean, it’s going to be interesting. I looked at first thing, Pinnacle and ServisFirst. I think all three of them deposits were down — ServisFirst down $800 million. I think 15% annualized is what Mr. [indiscernible] said. So we feel real pleased with our success. It’s challenging. And not for CapStar, you’ve got depositors who have been getting zero to 5 basis points over the last several years and really a lot of the period back to 2008. So if they can get 1% to 2% that’s a lot.
And so you finally have people shopping and moving money around and wiring around. You’ve got some people investing in treasury bonds. You can get a one year treasury bonds today. It’s 3.15 in one year CD that banks are 1.50. So you see — so it’s an interesting market right now. again, is it systemic and is it long term? I don’t think so. It is really a highly unusual. We’ve gone from an unusual pandemic environment where we were all wondering what’s going on and now this inflationary environment.
So I can’t give you an answer because I don’t know, but I can tell you we’re working hard on it. I can tell you everything we’ve worked hard on, we’ve made progress like the loans, like the past dues, like anything. And so we’re going to work real hard. But I think for the industry, is probably — I’ve seen some banks report, hey, we think we’ll be up next quarter. We think we’ll be up next six months. We hope we are, but I think that’s going to be a challenge. I think that at least through the end of the year with rates going up and a lot of shopping, they could be flat to slightly down.
Graham Dick
Okay, cool. And I just got one more, if you don’t mind. Just on the expense side of things. So I guess that bank on the expense guide excludes mortgage, SBA and TriNet. Just trying to get to the total expense number going forward. Do you mind just outlining what the typical efficiency ratios are on each of those specialty businesses like, maybe just SBA and TriNet more so than anything on mortgages?
Tim Schools
So we’re growing a lot of things that you are — our consolidated efficiency ratio was 56% this quarter. Somewhere in our materials, I think we report a bank only efficiency ratio. That’s what we historically report that only excludes mortgage on that slide. Today in my verbal comments, when I was talking about the core bank earnings, I went ahead and took out TriNet and SBA in my comments. But on that expense slide, you’re looking at that bank only efficiency ratio would only exclude mortgage, if you would have everything in it. On our looking forward slide at the back where we say bank only approximately 16% to 16.5% per quarter, that is everything but mortgage and it includes the new investments in Chattanooga two or what we call Chattanooga two and Asheville.
Graham Dick
Okay. Great. That answers the question perfectly. Thanks, Tim.
Tim Schools
Okay. Thank you.
Operator
Thank you. And one movement for our next question. Our next question comes from the line Kevin Fitzsimmons from D.A. Davidson. Your line is open.
Kevin Fitzsimmons
Hey. Good morning, everyone. I guess on the subject of deposits and margins, so it’s a pretty interesting shift in environment. And Tim, I guess you’ve covered some of this already, but maybe from the angle of ability to grow NII and what the drivers are going to be for that? So, I mean, I think we’ve been coming off the past few years of an environment where it’s been all balance sheet and the margin has been compressing and now we’re shifting to the margins higher, but maybe the average balance sheet doesn’t grow all that much because you guys with your markets you probably continue to grow loans, but you got to fund that and cash is going down and deposit given what we’ve been talking about with deposits. Maybe securities is used to fund some of that loan growth.
So I’m just curious like how you view that ability and what those drivers are going to be to grow NII and particularly like, you seem like you went out of your way to make the point that the margin had a real outsized expansion this quarter and not — so on that front is the mix shift mostly played out? Like maybe your cash is getting to a point where that’s — we probably shouldn’t be expecting 44 basis points next quarter, but I know that’s a lot, but just that kind of angle if you can address? Thanks.
Tim Schools
No, I think that’s get all (ph). We had — we did a great job. And so we certainly benefited from a modest amount of asset sensitivity and then we benefited from a mix shift. And so you’re very observant that when you measured our sensitivity before, cash would have been in that measurement, right, which has a good beta and now that’s been put into a mix of variable and fixed rate loans. So you would anticipate lesser upside in the future on the margin. As far as growing, we’re calibrating what I think was already a terrific franchise. We got our loan capability side. We’ve gotten our expenses in line. We’re managing our capital.
And so again, as I just said, we identified early in 2019 that need to develop deposit strategy and all of them coming in, we didn’t really continue working on that. So we’ve got this earning asset engine that is growing 20% a year. Actually, it would have been higher. We had a $10 million payoff or pay down the last day of the quarter and we had a $5 million loan that funded the next day, the first day of July. So it would have been $15 million higher which the end of period would have been 20% some. So the last three quarters, we’ve done 20% annualized each quarter. So I answered sort of the margin expansion. We’re going to work on deposit capabilities. I think we have a tremendous opportunity there.
But how do you grow in the meantime? And I think it’s going to be a balance of deposit capabilities coming online, maybe a modest reduction in securities. I don’t know that they can go down that much more. And then I think you’ll see as we build deposit capabilities, some introduction of CDs or brokered CDs or some wholesale funding sources like, FHLB, which if you get to the end game, my ideal bank, I’d love to have customer funded loans and customer funded deposits. We didn’t start there on either side. We at one point had 32% shared national credits and total participations were probably 45%.
And on the other side, we had correspondent banking and we had really a lot, not a lot. I hate to say that, but we had a fair amount of hot money and so we’re transforming a balance sheet. So I see the funding coming from increasing deposit capabilities. We’re actually — we’ve got a correspondent banking division just like Mr. Broton does at ServisFirst. We’re looking at expanding that. Even though some of those banks are using their liquidity, we could take share. There are some banks that are in the middle of selling right now that are correspondent banking departments. And some of those employees we’re talking to. And then I think the introduction of some wholesale sources.
Kevin Fitzsimmons
Okay. Thank you. And then on the new markets, particularly as Asheville, I’m just — I know it’s early, but that — there’s a lot of overlap in that market between TD and FHN. And I know that’s where one of those is where you got your leader and then ServisFirst also stepped in recently to that market and got their leader from the other player. So I’m wondering on one hand, could that market ramp up faster given the overlap. But on the other hand, you got a player like ServisFirst stepping in the same time. Does that almost, is that a serious headwind?
And then separately, I’m just curious what your thoughts are on now that you got those three markets in place, which if you include Knoxville in terms of new market expansions, where is your appetite for adding new ones. And I know in past conversations, you’ve said in theory, why not do these all day long? On the other hand, if we’re going into an uncertain environment, you have to watch what inning each of these are in. So I’m just curious your updated thoughts on that? Thanks.
Tim Schools
Yeah. Outstanding questions. First of all, ServisFirst is not in this market. ServisFirst hired someone from First Horizon in Charlotte, which is an hour and half a way. So they are not operating in Nashville. So that doesn’t mean they may not come call up here, but they’re not here.
On the other question, I think that, in light and you could always do a capital raise, which we’re not going to do. But give limited capital and give limited deposits. So as far as all day long, you can’t get to do that within constraints of your balance sheet. I’m real pleased with our four markets right now. I would — you never say never, but I would say the next 18 to 24 months CapStar, I’m really excited about Page 13 and 14 in our slides.
And I don’t think that is hocus pocus stuff. I think that’s reality. And so if we execute hard, I’m really focused on how do we bring that into earnings and how do we mature these four markets now. Pinnacle has done such an outstanding job and it’s just a terrific company and they are definitely the leader in Nashville. And so how would can we continue to improve our positioning against them and do a little better.
And then in these other markets, somebody called us, I don’t want to say who, but one of the top three market share banks in Knoxville actually called us, when we hired the team in Chattanooga in October and said, you just hired the number one team all at Chattanooga and I was a competitor. Well, the team we just hired as friends of theirs, that’s also viewed as All Stars. So I think it’s without question. We’ve got the top sheet in Chattanooga. We’ve got 10 commercial bankers there, that are outstanding team in Knoxville and now Asheville. So I think we have more than we need and we will work the next 18 to 24 months to make those better.
Kevin Fitzsimmons
Got it. Thanks, Tim.
Tim Schools
Yeah. Thank you.
Operator
Thank you. One movement for our next question. Our next question comes from the line of Jennifer Demba from Truist. Your line is open.
Brandon King
Hey. This is Brandon King on for Jenny. How are you doing?
Tim Schools
Hey. Good morning.
Brandon King
Good morning. I had a question on the correspondent banking. I know you mentioned as far as participants take market share there and that was kind of the source of the decline in deposits. But I’m wondering what percentage of deposits you’ve corresponding banking today?
Tim Schools
I don’t have it right in front of me, but they generally run about give or take $250 million give or take, plus the balance, Mike?
Mike Fowler
Let me pull that out very quickly. I think the percent, let me check, I believe is about 15% but hold on just a second. So they’re at 340, 270.
Tim Schools
So they’re about $300 million right now.
Brandon King
Okay. Yes.
Mike Fowler
13%.
Brandon King
Okay. That’s helpful. And then, I saw that there was some share repurchases in the quarter. I know obviously the priorities of internal investment and dividends and share repurchase and M&A But with the incremental investment in the Nashville market, could we see a similar pace of share repurchases in 3Q or kind of in the back half of this year?
Tim Schools
I think that’s an excellent question. And I certainly, we were trying to buy, I don’t know if we have our average price we purchased that in there, but we were buying in the $19 range or something. And again, I want to do balanced and disciplined allocation. And I certainly thank our price as attractive here, if you look at $20.50, especially in light of, if you look at the earnings trajectory. But I want to use that capital to grow my balance sheet. And I think if you look at an IRR that’s more valuable. So I wouldn’t model really that same pace.
We’ll be opportunistic if we feel that it’s just such an attractive price that we ought to toe in. But as we’ve been communicating, our priorities and this is consistent with most investors, I speak with that own our stock is investing in our business, growing the company, dividend increases and then buybacks at the right price. And as you know, we increased the dividend this past quarter from $0.06 to $0.10 and we paid that out for the first time. So great question, but I don’t think that’s something I would model on.
Brandon King
Okay. Thank you very much. That’s all I had.
Tim Schools
Okay. Have a great day.
Operator
Thank you. One moment for questions. Our next question comes from the line of Feddie Strickland from Janney. Your line is open.
Feddie Strickland
Hey. Good morning, guys. Just wanted to get a clarification on your guidance for SBA fees. Is it saying that the quarterly rate going forward should equal the first half of 22 total, meaning around 500,000-ish a quarter? Or do you mean that the rate in each quarter in the first half of 2022 is a good go forward meeting around 250,000?
Tim Schools
Can you say it one more time?
Feddie Strickland
Sure. So I just want to get clarification on the SBA fee. So as the guide saying that the quarterly rate going forward should equal the first half total, which is around $500,000 in revenue or do you mean that the rate in each quarter in the second half should equal around 250 basically?
Tim Schools
No. On SBA and that’s one, we just — we have some such high prospects and I know we’ve talked about it before, we’re — we’ve demonstrated in a couple of quarters we can do it. We’re challenged on getting the consistency. And in speaking with our team, we thought last quarter, second quarter was going to be higher and some of the transactions flowed over this quarter. But they have communicated that they feel that this quarter will equal the total of the first half. So I don’t have that right in front of me, but I believe that was $600,000 or so. So they believe that this quarter will be that and if they can continue that going forward.
Now that’s not guidance, but that’s the best information they’re providing. And really have been communicating and working with them and that they feel they can do it really communicating them, we feel we’ve got the capabilities to do $750,000 to $1 million a quarter we just haven’t been able to consistently do that. I also want to stay in corrected. One of my teammates just showed me, I have not been aware of it. No one has mentioned it. but someone did show that I guess ServisFirst in July also announced Asheville. So I’ll look into that. I know I’d seen their Charlotte one, but did not see Nashville.
Feddie Strickland
Got you. And that was exactly what I was looking for in the SBA fees. Thanks. And then I know the potential for a special dividend was discussed at one point just given your strong capital levels. I didn’t see it in the deck this time. Is that still on the table or have you decided to save that capital just with all these list out opportunities and potential regular dividend hikes?
Tim Schools
No. That was just mentioned as hypothetical about how all the different options that the bank has. And I really was just talking about, I think at the point I mentioned that, I was trying to explain that our core — if you look at like I study ServisFirst a lot in this quarter, I think their tangible common equity was 8.3% or something and our is 10.2%. If we theoretically did a one-time dividend, [indiscernible] 8.2% think what our, our return on tangible equity was already 12.7%. Think what it would be if we were at ServisFirst capital levels. So that was really sort of hypothetical that it’s one of the many options, but we’d like to get there by actually investing in our business.
Feddie Strickland
Got it. That makes sense. And then just one last one from me. Appreciate the details from Chris on the proactive approach to the cyclical industries. The slides on classifieds declining and everything else. But I was just curious anecdotally, are you seeing anything new from competitors things they’re doing that concerns you in terms of doing deals that don’t make sense, maybe some strange terms of pricing. Just curious what’s out there in your markets?
Tim Schools
Well, like, Chris said, I’d say first of all, we’ve got great competitors. And I’m one that I was always talking, you wish everybody to win so I don’t want to talk to you about any competitor. And I’d just say that in a rising rate environment, the main thing I’d say is, we’re seeing a lack of pricing discipline. And when I say that, I don’t know — I don’t want to expect to come across it. I think they’re being aggressive, but if you use any kind of funds transfer pricing methodology, to understand your true cost of funds. If you go — most banks would use the FHLB curve. If you go look at what a matched term funding is, your base rate has gone up.
So just like if you look at the inflation in the world, just like people are passing along inflation costs, disciplined banks, if we all work together, should look at our base costs are going up and borrower should pay more. And we’re not necessarily seeing that from all banks, which makes it hard for you to maintain paying your discipline and you could totally turn your growth off. We heard yesterday, I don’t want to say what bank, but a very high performing reputable bank is doing — at least five or seven years. Five year, 20 year amortization, commercial real estate loans at 4.25%. I don’t have the FHLB curve pulled up. But I think if you pull that up, what’s that going to be, Mike, around 315?
Mike Fowler
Five years, you have about 340.
Tim Schools
So the base rate would be 340. That mean that bank is doing loans at 100 basis point spread. We target a minimum of 200 and an average of 250 and have always gotten that. So I’ll let Chris or Kevin speak about credit, without mentioning specific banks, but I haven’t really heard that. I think we’ve got good competitors with good underwriters right now, the biggest challenge is a lack of discipline on pricing. But Kevin or Chris, any comments on.
Chris Tietz
Yeah. I mean, clearly pricing is the first thing and foremost, to a lesser extent, we will generally require more cash equity in transactions, particularly in the commercial real estate area than some competitors. But we’re finding that generally in our markets, there’s discipline in the equity requirements and the underwriting of many of these transactions. So pricing is number one. It’s just absolutely number one but we’re still seeing rational competition at least on structure and underwriting.
Feddie Strickland
Got it. That’s good to hear. Appreciate the color everybody and thanks for taking my questions.
Operator
Thank you. One moment for our next question. Your next question will come from the line of Brett Rabatin from Hovde Group. Your line is open.
Taylor Brodarick
Hey. This is Taylor in place for Brett. Thanks for the comprehensive discussion so far and all the candor surrounding TriNet. For the pipeline, I see plus $500 million for commercial. What about the other loan segments? And also sort of how does — it’s obviously been strong and the trajectory is good. Like does this line up with what you thought maybe a quarter or two ago or has it exceeded or been below expectations in your view?
Tim Schools
Yeah. Great question. I would say it has exceeded it. It surprised us. We all thought, hey, rates are going up is that going to really slow loan demand. And it’s actually their growing and expanding. So I would say surprise. That is what we call our commercial pipeline. So that’s our on balance sheet, core bank market lending, obviously does not consider business banking or consumer that comes through our branches because that’s more instantaneous
And then, the three units that I can think of that would have any material other pipelines would be the specialty businesses I’m referencing. So our mortgage divisions pipeline wouldn’t be in there. TriNet’s pipeline wouldn’t be in there, nor our SBA unit, which we’re really trying to increase their funnel so we can get that up to $750,000 a quarter. I’ll let Chris comment on TriNet as we just said we paused. So their pipeline is going to be zero but maybe Chris could talk about the residential mortgage and the SBA pipelines.
Chris Tietz
Yeah. So first of all, Taylor, relating to the mortgage environment, we’re very proud of our mortgage operations which are primarily focused in Middle Tennessee and the Nashville market. It’s a strong residential market. And I will say that the challenges that we’ve had there this year have not been volume. The market is a little bit frothy in terms of activity levels. There is a limited supply that is tending to calm down just a bit as it is in other markets. But we had similar volumes as we had budgeted, which are close to 2019 levels. But where we’re challenged right now is in the interest rate environment fees are way down on the mortgage sales. So volume is good. We are postured as a top five underwriter and originator in the Middle Tennessee marketplace. And we think we’re postured because our business model is primarily focused on purchase money transactions and not on refi transactions, we’re posture to continue to perform well there despite the crosswinds that we have on the gain on sale premium.
In our government guaranteed world, we added to our business development team early in the year and that is starting to yield benefits to us. And so that’s part of where we see the accelerating contribution from that area and we continue to be focused on looking for additions to the business development unit as well. One of the things that’s interesting to me is that the servicing income, which we don’t report separately has basically doubled each of the last three years and we look at that trend to continue. But we also have the crosswind right now that on our gain on sale for the guaranteed portions those gains are down 30% this year over where they were last year. So we’re getting much less return on the same volume output. But we’re going to stay as a steady producer in that, trying to increase that invest in business development and look forward to when the rates stabilize and the premiums return to previous levels.
Taylor Brodarick
Great. Thank you for all the detail. I guess maybe one more for me. Obviously, credit quality is in great shape and not a surprise especially given the markets you operate in. Looking, I was just curious about the $0.5 million qualitative reserve for the current economic environment. Maybe you can educate me on like maybe the thinking there of if that’s just a model telling you to do so or just looking at just general macro factors and being prudent there?
Tim Schools
Yeah. We try to tie those few factors to as quantitative a view or measurement point as we can. And yes, there are some things that are out there that would start going the other direction and that’s reflected in those considerations.
Taylor Brodarick
Okay. Well, thank you very much. Appreciate it.
Operator
Thank you. One moment for questions. Our next question comes from the line of Catherine Mealor from KBW. Your line is open. Catherine, your line is open.
Catherine Mealor
Thanks. Can you hear me now?
Tim Schools
Yeah.
Catherine Mealor
Okay. Great. Just wanted to follow-up on the loan growth. I mean, you’ve grown at a really nice pace the past couple of quarters of a 30% that your guide is still low to mid double-digit. Just with all these new hires, is there any reason that the growth is pulling back or you just kind of be conservative?
Tim Schools
I’d say being conservative and make sure we could fund it. If anything, I think it could be 30%. I mean it’s amazing. I mean we’re doing the legacy bank, I’ll call — I’ll just — when I got here, you heard me say the 3% and I sort of asked what’s everybody’s goal and there was no goal. And so just to be honest, we sort of got out of napkin and said, okay, our loans are at this number, we’re not doing any more participations. We wanted to grow 10%. If you take that number times 10% and you say the starting number is going to have principal pay down and amortization of 15%. What is that total dollar we need to do divided by 4? And Chris, that number was what?
Chris Tietz
$45 million.
Tim Schools
Everybody in the bank knows it was $45 million Catherine. And so you could have gotten an elevator, everybody would have said $45 million and so we got the legacy bank to $45 million which I would say, was Nashville in Athens. And then we’ve added Chattanooga and Knoxville and they’re doing their own $45 million or $50 million a quarter. So that’s where we’ve sort of gotten to the $100 million a quarter. And then you put Chattanooga two that we’re calling it and Asheville along it. So I think it certainly could be 20% plus, but the most ideal situation is for your deposit line and your loan line to grow in parity over time if you want to build a real high quality bank.
So I think what we’re talking about right now is our pipeline is so big. We now are at a position of strength. Let’s be disciplined on what we do and we don’t want to run customers off. So let’s really focus on the 200 basis point spreads and higher on the loan side. That may make it 15% instead of 20%, or 15% instead of 22% and then work on the deposit side and we think that will build a better bank. But I certainly think we have the capabilities that we could post in the 20% range plus of quality loans if we wanted to.
Catherine Mealor
Great. And then on the expense side too, it was interesting to me that your bank level expenses are still the $16.5 million guide, which is what you had last quarter, we’re adding on Asheville. So is it just safe to say that your Asheville was savings from other places or as that market builds, we could see that expense growth kind of move into next year?
Tim Schools
Well, keep in mind, Asheville at this point is going to be two employees. So that’s what that is. If we built a team like Chattanooga, there will be more expenses coming. But that’s 16% to 16.5% does have the four new people in Chattanooga and the two people in Nashville. So that does have the six new people. It’s a balance. I mean, it’s growing revenue, but we’re looking, I mean, just — and again, it’s not anything with cash or every bank I’ve been in. I could do a presentation on expense management at banks. It would blow your mind. And banks in general are not, there are some obviously ServisFirst their efficiency ratio is very mindful of expenses, National Commerce, where I was taught was.
I mean, I’ve been in banks with people who had a multi-function printer device, every size, feet from a cube. when you can walk 15 feet and get rid of a third of them. You’ve got software systems that people never use that are still in the books. It’s amazing when you get to the banks. And so there’s a system right now we have. I’m not going to say which one that is coming to end of life and the vendor said we’ll give you a great special if you sign within 48 hours and pay us a quarter of one million dollars I’m not joking. $250,000 we’ll let you go on our new system. Well, we have options. We can go on somebody else’s system for free. So you know what we told them. And so we — I gave Mike Fowler 10 banks that I think very highly. Lake City Bank in Indiana, Five Star bank in San Francisco, City Holdings, [indiscernible] in West Virginia.
I gave him 10 banks and I said call these 10 CFOs and ask what system they use on that system. And we got the name of five or six different systems and have interviewed them all and we actually have found a system that we actually like better that is price better. And the salesperson that was at the first company that asked us to pay $250,000 and now at this new company and wants us to come there without paying the $250,000. So my point in sharing all that is not to get on that. You got to manage it every day. And you’ve got to manage your expenses like you manage a pipeline in [indiscernible]. And the message internally and everybody has to believe me, we don’t want to be cheap. We don’t want to work with the lights out and run on the rims. It’s work frugal and run a company like you would your house.
And so I’ll just stop right there, but we’re just doing a good job. Now that ends right. You can’t cut yourself to prosperity. But I do think there are opportunities to operate smarter and better and hire more productive people and that is allowing us to add some people without having to add expense.
Catherine Mealor
Got it. That’s very helpful. All right. Thanks so much for all the commentary this quarter.
Tim Schools
Go generals.
Operator
Thank you. I’ll turn the call over to Tim Schools for any closing remarks.
Tim Schools
So we just appreciate you calling in and we appreciate you following our company and hopefully you hear that we’re actively managing and trying to make it better every day and increase the prospects for our employees and our shareholders and when there’s challenging times during the pandemic with credit or we’re facing right now in the interim with TriNet that we’re on it and we’re actively managing it and we’re transparent in our communication. So we hope everybody has a great weekend and then you have as much fun as we’re going to have in Asheville. Have a good day.
Operator
And this concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone have a good day.
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