Franklin Financial Network’s (FSB) CEO Richard Herrington on Q1 2018 Results – Earnings Call Transcript

Franklin Financial Network, Inc. (NYSE:FSB) Q1 2018 Results Earnings Conference Call April 26, 2018 9:00 AM ET

Executives

Richard Herrington – Chairman, President and CEO

Sarah Meyerrose – CFO

Myers Jones – Chief Credit Officer

Analysts

Stephen Scouten – Sandler O’Neill

Tyler Stafford – Stephens Incorporated

Laurie Hunsicker – Compass Point

Daniel Cardenas – Raymond James

Operator

Good morning, and welcome to the Franklin Financial Network Incorporated First Quarter 2018 Earnings Conference Call. Hosting the call today from Franklin Financial Network is Mr. Richard Herrington, Chairman, President and CEO of Franklin Financial Network, Inc. Please note the Franklin Financial Network earnings release and this morning’s presentation are available on the Investor Relations page of the bank’s website at www.franklinsynergybank.com. Today’s call is being recorded and will be available for replay on Franklin Synergy Bank’s website.

Before we begin, Franklin Financial Network does not provide earnings guidance or forecasts. During this presentation, we may make comments that may constitute forward-looking statements. All forward-looking statements are subject to risks and uncertainties and other facts that may cause the actual results, performance or achievements of Franklin Financial Network to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Franklin Financial Network’s ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements.

A more detailed description of these and other risks is contained in the Franklin Financial Network’s most recent annual report on Form 10-K. Franklin Financial Network disclaims any obligation to update or revise any forward-looking statements in this presentation, whether as a result of new information, future events or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G.

With that, I am now going to turn the conference call over to Mr. Richard Herrington, Franklin Financial Network’s Chairman and CEO. Sir, you may begin.

Richard Herrington

Thank you. Good morning, everyone, and thank you for joining the call. I’m here this morning with Sarah Meyerrose, our Chief Financial Officer; and Myers Jones, our Chief Credit Officer. I’d like to start our discussion with a brief overview of our franchise in the quarter and then Sarah will review the detailed financial results. Let’s start with Page 1. Since founding the bank 11 years ago, we have focused our management strategy on the often-competing and conflicting hallmark objectives of soundness, growth and profitability. This gives us a framework within which we have been executing a consistent long-term strategy focused on creating shareholder value through a franchise that is defined by vibrant growth, local real estate focus and a disciplined credit culture. The foundation upon which we continue to perform includes a highly experienced management team, our presence in the dynamic Middle Tennessee market, a solid capital base with pristine credit quality and scalable, efficient technology and systems.

Turning to Page 2, we list nine members of our senior management team who have an average of 35 years of banking experience in the industry. Many of the names you see have an important and varied experience at larger banks and deep connections, both personal and business, in our market. We have guided banks through a variety of economic, credit and interest rate cycles. We are proud of this leadership and even more proud of the larger team that executes our strategy every day through their deep customer relationships and dedicated service.

On Page 3 we provide an overview of the Middle Tennessee market, which has historically weathered national economic downturns with very little economic disruption. With the diversity of industry, commitment to education and a friendly business climate, job growth is high, unemployment is low and the outlook is positive. We believe this market will support the growth of our franchise for the foreseeable future.

If you’ll turn to Page 4, we note the first quarter 2018 was an outstanding quarter for our company in many areas. Let me touch on a few key points. First, we achieved record performance in net income, earnings per share and net interest income in the first quarter. Many banks have reported record profits in the first quarter 2018 because of tax law changes. We did benefit from tax law changes, but we also set a record level in pretax net income, which means that the tax rate change was not the only cause of our record earnings.

Secondly, as always, we look to soundness. Our asset quality continues to be pristine. We continue to be well capitalized and our balance sheet continues to be conservatively managed. Understanding the risk/reward nature of banking helps us take the most appropriate long-term risk.

Third point. Growth continued, with seasonal influences. Loan growth compared to the same period last year was 18.5%. But the annualized growth compared to year-end 2017 was only 9.5%. This slower growth is not characteristic of our franchise and reflects both record quarterly payoffs of $200 million and seasonal factors. We are managing loan growth to be more consistent with deposit growth. Compared to December 2017, retail deposit growth was actually higher than loan growth, a rarity for our bank. Deposit growth was aided by several large treasury management customers, a new branch in Murfreesboro and a continued focus on deposit customers.

The fourth point. An earnings per share of $0.73, which was a 25.9% increase over the first quarter 2017, yielded a return of assets of 1.03% and a return on average tangible common equity of 14.1%. Fifth point. The performance in the metrics of soundness, growth and profitability were all consistent with our long-term vision of our company.

The sixth point. One key factor that adversely impacted the first quarter 2018 financial performance was net interest margin. Although net interest income set a quarterly record, the margin declined. While the trend in margin has been downward for several quarters, we have a clear understanding of its relevance to our overall long-term strategy.

The net interest margin declined in the last two quarters for three primary reasons. First is the flat Treasury yield curve. The second is that the reality in our market, deposit rates are priced off Treasury bond yields and loan rates are priced off prime rate and the Treasury’s rates have risen quicker and stronger than the prime rate. Third is our decision to reduce the risk of a flatter or inverted yield curve through shortening our bond portfolio duration. This also enhanced our balance sheet liquidity. While we’ve monitored net interest margin closely, our long-term focus creates an emphasis on broader profitability measures of return on assets and return on equity.

Now I’ll turn the program over to Sarah for a few minutes to review details for the quarter.

Sarah Meyerrose

Thank you, Richard, and good morning, everyone. Before we move on, I want to just make a comment on Page four about the Civic acquisition, just a couple of key numbers for you on that one. The new capital raised, well, the additive to it, is $34 million. We expect their net income for the first four quarters to be approximately $1.9 million. And that all adds up to slightly accretive to tangible book value and slightly dilutive to earnings per share during year one. So then if you will turn with me to Page five, we begin, as always, with soundness. And this slide is compared to our UBPR peer group for easy reference. Asset quality remains pristine and a hallmark of this franchise. Liquidity levels are in line and our balance sheet mix provides the opportunity to increase profitability, to raise our loan-to-deposit ratio while maintaining in-line capital levels.

Now if you’ll turn to Page six, you’ll see on the left side the historical growth in total loans. More importantly, we highlight on the right our continued commitment to diversified real estate lending. Fully 80% of our total loan portfolio continues to be real estate related and that is a level we consider appropriate for our market and level of expertise. We continue to focus on lower-risk areas of lending where we have deep experience and local knowledge and which provides us considerable diversification within the real estate segment.

If you’ll turn to Page seven, you’ll note that about 60% of the total portfolio is related to residential real estate, which has historically been one of the less risky market segments. That is made up of construction, which is fundamentally residential, as well as 1-to-4 family and warehouse mortgage. In addition, about 30% of the commercial real estate portfolio represents loans to owner-occupied CRE. Even the remaining 70%, or $504 million, of non-owner occupied loans represents the less risky market sectors, with only minimal exposure to hotels and apartment complexes. Acquisition and development loans, historically the most risky real estate sector, are consistently less than 2% of our total loan portfolio.

Page eight represents the growth and mix of our deposit sources from 2014 through the first quarter of 2018. Total deposits grew on a compound average basis of 39% from 2014 to 2017 and an additional 6% in the most recent quarter, with local government deposits an important part of our franchise. We include Page nine as a reminder that multiyear growth in EPS and tangible book value per share have been another key hallmark of this franchise.

And, finally, on Page 10 you’ll see a summary of our profitability metrics over time. All of the trends except one are very positive, including net income, growth year-over-year and quarter-over-quarter, net interest income and returns on average assets and tangible common equity, as Richard mentioned earlier. Our efficiency ratio has been consistently below 60% since 2015 and most recently has hovered in the mid- to low 50s. We spoke earlier about the critical role that credit quality plays in these profitability results and we have, I believe, demonstrated our continued commitment to be vigilant. So that brings me to the single performance metric that is under pressure, net interest margin at 2.71%, which is slightly below your estimates. You can find the NIM progression on the top-right chart on Page 10 in the grey ovals at the bottom. The 2.71% represents a decline of 21 basis points compared to the fourth quarter of 2017 as a result of three key drivers, including the Tax Cuts and Jobs Act passed in December 2017, specific actions we took to better position the balance sheet going forward and, third, the current general interest rate environment.

To be specific, the effect on our fully taxable equivalent calculation reduced net interest margin by 6 basis points. Second, we repositioned approximately 20% of our securities portfolio into less-than-1-year maturities to better prepare for continued rise in short-term rates. We further increased our cash and due-from bank balances to improve balance sheet liquidity in anticipation of changing the mix of earning assets as we replace investment securities with higher-yielding loans. This repositioning affected margin negatively by approximately 8 basis points. For those of you who are counting, that’s approximately 14 of the 21 basis points, or 2/3 of the decline.

The remainder of the change in NIM is primarily attributable to a combination of a 14 basis point increase in loan yields, blunted by higher overall funding costs of 19 basis points. The increased loan yields resulted from the management-led strategic review of the loan portfolio based on relationship value and profitability that resulted in the decision to prune the portfolio to remove some lower-yielding term loans. These actions also contributed to a record high level of loan payoffs during the quarter of approximately $200 million.

Looking forward, we do not expect significant change in our deposit betas which are approximately 68% of the three-month T-bill for public funds, 75% for FHLB borrowings and broker deposits. And in terms of loan yields, I’ll remind you that our portfolio is approximately 46% variable rate, with about half of that tied to prime and the other half tied to LIBOR and other indices.

With that, I’ll turn it back to Richard for closing remarks.

Richard Herrington

Thank you, Sarah. I’d like to wrap up the prepared remarks with a quick overview starting on Page 11. These key developments position us for continued growth in the larger Middle Tennessee market.

On April 1 we welcomed Civic Bank & Trust into Franklin Synergy Bank family. Receiving final regulatory approval and closing the transaction is an important step. We expect the merger with Civic to be immediately accretive to tangible book value per share and, more importantly, we now have a premier location in the heart of Nashville. This gives us the opportunity to provide deposit and other services to our business customers in Nashville, as well as to grow our traditional banking services in Nashville, as well as wealth management, trust and mortgage banking.

We continue to actively seek potential acquisitions and will pursue those opportunistically in order to achieve a transaction that is both strategically compelling and additive to our balance sheet and funding mix.

On Page 12 you will see the expansion of our deposit market share as measured annually by the FDIC. We are the market share leader in Williamson County, with 25.3% of the market. In 2017 we rose to number two market share leader in Rutherford County, with 12.2% of the market. As impressive, in 10 years we have climbed to 4.8% of the Nashville MSA market, although we had branches in only 2 of the counties. Our market share position in the Nashville MSA is the sixth highest. The expansion of our physical footprint is important as we continue to grow through Middle Tennessee.

Thank you again, all, for spending time with us this morning. We look forward to the rest of 2018 and we feel that we have the team, the resources and the discipline and business model to continue to successfully execute our strategy.

Now I’ll turn it over to the operator for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Stephen Scouten of Sandler O’Neill.

Stephen Scouten

Question for you on the loan growth moving forward. Is this something that we’ll see rebound in the coming quarters? Or could there be some further impact from this strategic loan review process that you mentioned that will lead to continuation of some elevated pay-downs?

Myers Jones

I think the — my opinion is — Richard referenced seasonal factors. If you look at our construction book growth rate, the first quarter was 6%. We loaded a number of projects commensurate with our normal activity. And the issue with the construction book, first quarter here in Nashville was a very wet quarter. So construction activity was severely hampered by that. So we saw — we were loading projects but due to the fact that the construction had somewhat stalled because of the weather, the borrowers were not taking draws down as rapidly as they normally would. So I expect that to return, although it’s raining in Nashville this morning.

Richard Herrington

We continue to see strong loan demand. And the vast majority of the strong loan demand are very good loans. We’ll manage our loan growth to be consistent with deposit growth. We don’t see the slower growth in the first quarter as being an indication of what it’s going to look like for the rest of the year.

Stephen Scouten

Okay. But no plans for further kind of I guess strategic reductions and trying to move out more of these term loans. You feel like most of that’s already worked through the portfolio from how you’ve reviewed it.

Richard Herrington

Yes, without any additional activity that comes on. Now, to some degree that was a refi opportunity that we had that we just felt the rate was below our target. And we let that credit pass.

Stephen Scouten

Got you. Okay. And then just as I think about the NIM moving forward here, has there been — I mean, you guys had mentioned a couple of potential opportunities last quarter in terms of being able to maybe reduce some of the pressure from the public funds deposits. Has there been any progress on that front? And I guess more so, the trends of the NIM from here, do you think we’ll start to see that ramp higher? Or could we see another quarter of lag before we start to see it move, hopefully higher from there?

Richard Herrington

We always like to start, when we talk about public funds, is to recognize the strong seasonal factors. Our local government deposits reach a peak at the end of February, early March and begin to decline. In the last quarter those were some of our more costly funds and we’ll see a significant drop in those funds. We’ve already seen over $100 million drop in the level of those funds just since the end of February. That will be accretive to our net interest margin to some degree. The biggest challenge of looking at the net interest margin is we don’t know where the yield curve is going to go. If the yield curve gets flatter we could have some additional changes. If the yield curve begins to return to anything normal, we think the net interest margin could stabilize or improve. Not only do we have that, we also have, as Myers mentioned, a mix of loans coming on, going off. So we have lots of different factors. But we don’t really perceive a continued significant drop in the net interest margin.

Stephen Scouten

And then just last question for me — on the FDIC expense in the quarter, is that reduction something that should hold moving forward? And was there any — what was the specific driver for that nice reduction you saw in the FDIC expense?

Sarah Meyerrose

No, that’s a recalculation. They review all of our statistics and our reports and our ratings and everything else every year. And so because of that review we have a lower rate and that should continue through the rest of this year — will continue through the rest of this year.

Operator

The next question comes from Tyler Stafford of Stephens Incorporated.

Tyler Stafford

Maybe just to start also on the loan portfolio and the pruning that you did during the first quarter. I know you mentioned there was, call it, $200 million of pay-downs. How much of those pay-downs were related to the pruning that you did during the quarter or just the normal cash flow of that portfolio? And any additional commentary on the characteristics of what you decided to prune?

Myers Jones

My take on that, Tyler, is — this is Myers — there was about $30 million of that that was, let’s call it, unanticipated due to our decision not to go forward with a particular credit. The rest of it was derived from normal cash flow coming off the portfolio.

Sarah Meyerrose

Tyler, just to add a little bit to that, I took a look at what paid off during the quarter at what coupon and what came back on. It was pretty close to both — pretty close to the $200 million. But we paid off at a 5.03% and reloaded at a 5.30%. So we picked up 27 basis points on the coupon on those.

Tyler Stafford

Maybe just sticking with the loan growth topic, you mentioned funding loan growth with deposit growth this year. And as you think about that, does that include the brokered and the public funds as you think about the matching deposit growth with loan growth, or is that more I guess kind of core retail deposit growth?

Richard Herrington

We’re talking more about core retail deposit growth. We’re blessed in this economy with a strong, strong loan demand. As we’ve grown the bank we’ve used institutional funds, brokered deposits, et cetera. We think we’re now at the point that we need to make sure that we have adequate sources of retail or local deposits to fund our loan growth going forward. Again, this is part of managing loan growth. As we’ve talked about, we are building a participation network where we can manage our loan growth to the levels that are appropriate, not only manage the levels but manage the concentration. And, again, the idea is we want to fund this with local retail deposit growth.

Myers Jones

Due to the pledging requirements we cannot loan the public deposits.

Tyler Stafford

So to the extent that you grow the retail deposits this year, is what you will allow within the loan portfolio to stay on the balance sheet. The rest you will sell off.

Richard Herrington

Big picture, yes.

Tyler Stafford

Yes, big picture. Yes. Okay. And then, do you..

Richard Herrington

And, again, we have seasonal influences. As we mentioned, we had unusual amount of payoffs right at the end of the quarter. We’ll just manage through that. Again, the participation network gives us the ability to manage that growth. So broad picture, you were correct.

Tyler Stafford

Okay. And how much of a benefit was the increase in the value of the held-for-sale mortgages this quarter that the press release called out?

Sarah Meyerrose

Tyler I don’t have that in my brain, but I’ve got it somewhere. So if you want to ask your next question, let me grab it here.

Tyler Stafford

Sure. And then just the brokered deposit costs, what those were this quarter, just the actual average cost of those during the quarter?

Richard Herrington

Of course it varies. The actual cost is somewhere around 150 million to 175 million. Again, sometimes we use brokered to specifically offset a loan or a government security. So it could be a higher — one particular brokered could be at a higher rate, but overall somewhere about 175 million would be a good estimate.

Myers Jones

Depending on the duration.

Tyler Stafford

Yes. Okay.

Sarah Meyerrose

Yes, Tyler, on the net gain on sales there was, from 4Q to first Q there was about a 67% increase in that, which was from about 800,000, 1.4 million. And a couple of things the production was about the same in first quarter as it was in fourth quarter. But we had a larger fair value mark as the rates recovered. You’ll recall we had an increase in rates during the quarter in the longer — in the mortgage-backed. And the rate loss pipeline was also larger at the end of the first quarter. So it was a combination of all of those things.

Tyler Stafford

Yes. But do you know, Sarah, do you have handy how much of that, call it 600,000 quarter-over-quarter increase was related to the fair value? I’m just trying to get a sense of do we stay around this level. Do we grow from a seasonal perspective here? Or does with the lack of that fair value for 2Q do we go back down?

Sarah Meyerrose

I’d say almost all of it was a result of the fair value, because the volumes were approximately the same.

Operator

The next question comes from Laurie Hunsicker of Compass Point. Please go ahead.

Laurie Hunsicker

I just wanted to go back to where Tyler was just in terms of matched loan growth with retail deposit growth. Can you just help us quantify in terms of a round number what we could potentially see with loan growth for the duration? I mean, if we’re mid-teens, is that a good number?

Richard Herrington

Yes. We’re sticking, Laurie, with our perspective that 15% to 20% loan growth is our objective this year. And we’re not talking about loan originations. We’re talking about loans that are actually on our books, so 15% to 20%…

Laurie Hunsicker

Loans on the books, correct.

Richard Herrington

Yes, is a fairly appropriate number.

Laurie Hunsicker

Okay. Great. And then can you give us an update on where the health care piece stood at quarter-end?

Richard Herrington

Myers.

Sarah Meyerrose

Yes, I’ve got it for you, Laurie. Hang on one second.

Myers Jones

Laurie, the health care change at the end of the quarter was responsible for $302 million. And $247 million actually was in the health care sector. The rest of that total they were responsible for, but it was booked in other sectors other than health care. But $247 million is that number. We had 46 relationships out of that portfolio.

Sarah Meyerrose

And, Laurie, that would relate back to the C&I number on Page seven. It has a total C&I of $465 million. $247 million of that is health care and the $217 million is other C&I.

Laurie Hunsicker

Okay, great. And then the $247 million, just so I’m apples to apples, compares to last quarter’s $251 million. Is that correct?

Sarah Meyerrose

Correct. Yes.

Laurie Hunsicker

And how do you think about growing that further? Is there an emphasis on that or is that somewhere near the plateau? Or how do you think about that?

Myers Jones

We continue to see opportunities, Laurie, out of that portfolio. And one of the large credits that we discussed earlier that was paid off came out of that portfolio. So that’s why I did not see the growth rate in the quarter that I would have anticipated being normal.

Laurie Hunsicker

Okay, got it. That makes sense.

Richard Herrington

Laurie, we continue to see a lot of opportunities. We are very careful in our underwriting. We have every — we have several different groups look at our underwriting standards for the health care world. So far we have had no significant issues in the health care. I know that other banks are experiencing those problems, but I think because of our strong underwriting we’ve been able to avoid those problems.

Myers Jones

I read a lot about health care portfolio — Laurie, this is Myers. And I guess due to some of that and some of the questions I get from you guys, we have bumped our reserve ratio to that sector from 1.44 to 1.59 at the end of the first quarter. Not anticipating any losses but, again, just adding a little reserve.

Laurie Hunsicker

Okay, great. That’s helpful. Okay. And then just going back over the funding, as I’m looking on Page 8 of your slide deck I want to make sure I’m reading this right. Your government deposits are $992 million compared to $1 billion last quarter at quarter end.

Sarah Meyerrose

Yes. And, Laurie, both of those totals include public fund CDs, so State of Tennessee CDs, at about $200 million. The rate remainder of that would be — of each of those totals would be the local — the county government funds that we talk about that are so seasonal.

Laurie Hunsicker

Okay. And so just so that I’m clear, if I’m going back from a December standpoint, the $778 million is the public fund money that basically is really, really vacillating, going up and down out of the $1.003 billion.

Sarah Meyerrose

That’s correct.

Laurie Hunsicker

Okay. And then what is the corresponding number to that $778 million for the March quarter? Is it just $992 million less $200 million?

Sarah Meyerrose

Approximately, yes. It’s $797 million. So, yes.

Laurie Hunsicker

$797 million. Okay. And then you mentioned obviously that’s going down. I understand there’s the seasonality there with respect to drop-offs in 2Q and 3Q. Can you help us think about potentially where those balances are, respectively, for 2Q and 3Q?

Richard Herrington

They should be down. And, Laurie, we’re forecasting should be down about $250 million each quarter.

Sarah Meyerrose

If the peak is the $800 million to $900 million, because we have two counties now, and then the low point is, as Richard says, $200 million, $250 million per quarter, so the low is about half of that. It’s about $400 million in the third quarter.

Laurie Hunsicker

Okay, got it. Okay. And then just when I think about your total local government, I know that last quarter we had talked the rate being roughly the three-month T-bill plus 30 basis points. Is that for all of the $992 million or just more specifically that subset, that $797 million?

Sarah Meyerrose

The $797 million subset.

Laurie Hunsicker

Got it. Okay. And then what is approximately the rate on the other?

Sarah Meyerrose

It would be a CD rate, a market CD rate, for probably three months.

Richard Herrington

Yes, 1.50% to 1.75.% is probably a good estimate there.

Laurie Hunsicker

1.75%. Okay, great, that’s helpful. And then just on margin, if you could just go back and clarify something for me, Sarah. So the press release had stated that the repositioning of your bond portfolio dinged your margin 4 basis points. And then you had mentioned 8 basis points on the call, unless maybe I misheard. Or perhaps there’s something else in that calculation. Can you just step me through that?

Sarah Meyerrose

Yes. The thing that — we specifically focused on just the securities portfolio. And in my remarks I also included that we were more liquid at the end of the quarter. If you’ll notice, our cash balances were pretty high and we were positioning for coming into the end of the first quarter on that. So the combination of the repositioning and increased cash and different bank balances for liquidity purposes kicked that up a little bit higher.

Laurie Hunsicker

Okay, got it. Okay.

Richard Herrington

Keep in mind that we did a capital leverage program in the first quarter 2017. We raised $70-plus-million of capital in the fourth quarter 2016. First quarter of 2017 we leveraged that through the bond portfolio as we have traditionally done. As we continue to grow we’ll see the bond portfolio shrink a little bit. And we’ll be moving those — that cash coming out of the bond portfolio into the loan portfolio, which will go at a higher rate and should help our net interest margin.

Laurie Hunsicker

Okay, good. And then just last question on Civic, as we’re thinking about the effects of that, which obviously closed in early April. It’s approximately 1 million shares that you issued. Is that correct —

Sarah Meyerrose

That’s correct.

Laurie Hunsicker

Or do you have an exact number? Okay. And then intangibles, do you have a pro forma intangible number for what that’s looking like?

Sarah Meyerrose

Yes. The pro forma intangible, $9.7 million. The core deposit intangible will be 510. CD portfolio and loan mark is right at $800,000. Total good will $9.7 million.

Richard Herrington

Shares issued was 970,000.

Laurie Hunsicker

970,000, okay. So that puts your total pro forma intangibles right around $20 million from what’s now $10 million, round numbers.

Sarah Meyerrose

Yes, Laurie.

Laurie Hunsicker

Okay. And then just last question, merger charges —

Richard Herrington

Laurie…

Laurie Hunsicker

Oh, sure. Go ahead.

Richard Herrington

One of the things that we want to always say about Civic, the Civic is more than just adding two balance sheets together, two income statements. Civic is a big move for us because it gives us a branch in a very good part of Nashville. It also allows us to gather deposits from our existing customers in Nashville. We do a lot of lending in Nashville. But it’s been difficult for those customers to move their deposits to us. So as we get the Civic deal completed we’ll have some opportunities to pick up considerable amount of deposits, which in the big picture is very important to us. So when we look at Civic, it’s not just adding of 2 balance sheets. It’s to increase opportunities we have in Nashville.

Laurie Hunsicker

Sure. That makes sense. And then just lastly, can you remind us how we should think about one-time charges going forward? I mean, I assume the bulk were taken — or just how we should think about it. Thanks.

Sarah Meyerrose

I will have to get back to you on that one.

Operator

The next question comes from Daniel Cardenas of Raymond James.

Daniel Cardenas

Just a couple quick questions here, following up on the M&A side. Maybe some color, now that Civic is done, maybe some color on the outlook here going forward. What’s the environment like? Is there a lot of chatter going on and how are your pipelines looking on the M&A side?

Richard Herrington

Big picture, Dan, is we see that there are going to be a lot of opportunities for us to look at potential acquisitions. There’s just a lot going on in the Tennessee market. We are being very careful as we go down this path. We’re more interested in doing the right type of acquisition than simply doing an acquisition. We’ve looked at a couple that we passed on just because we didn’t feel it was the right combination. What we’re looking for are banks that are headquartered in markets where there are more deposit potential than loan potential. You don’t have to go far from Franklin or Nashville to find a lot of those opportunities. What we’re looking for is somebody who can help us construct a town-and-country strategy. This has worked very well in banks in the past and we feel like it’s something that is very meaningful to us. So it’s important for us to find the right partner going forward. We’re looking at a bank that has good asset quality. We don’t want to buy a problem bank. We also want to look at a bank that has good capital levels. We can treat it as somewhat of a capital raise. But most importantly, we’re looking for opportunity to grow low-cost deposits.

Daniel Cardenas

Thank you. And then just jumping over to on the credit side of the equation, the numbers look good. And historically your charge-off levels have been extremely well behaved. As we kind of look forward, I mean, how sustainable do you think charge-off levels at current levels are on a go-forward basis?

Myers Jones

This is Myers. I don’t see a dramatic change in that level. Our delinquency ratio at the end of the quarter was 0.14%. Normally that’s kind of a leading indicator of problem loans. So I think, as you pointed out, the behavior aspect, hopefully it will remain well behaved.

Daniel Cardenas

We’ll knock on wood. I hope so as well. And then I guess as I think about provisioning for you guys, is it mostly then just to kind of take care of growth on a go-forward basis?

Myers Jones

Yes. And if you look at the PCI side still remaining from the Murfreesboro acquisition, we were — we’re right at 0.97% overall if you include that PCI number in the reserve.

Daniel Cardenas

And then, how should we be thinking about your efficiency ratio? Where do you kind of see that number jelling out by the end of the year?

Richard Herrington

It finished the first quarter at 54%. You know, Dan, there’s a tradeoff between deposit costs and efficiency ratio. If we had more branches we’d probably have a lower deposit cost and a better net interest margin, but we’d have a higher efficiency ratio. Our objective on efficiency ratio is to keep below 55%, somewhere in that range. We think that’s doable. We don’t see anything on the horizon that will make it increase significantly. We spent a lot of money in the last — in 2017 building new systems, creating the right type of risk identification systems, et cetera. These have been built now and we feel like we’ll be able to enjoy some economies of scale in 2018.

Daniel Cardenas

Then, as I look at your operating expense number that we saw in Q1, is that pretty sustainable? Or should we kind of expect to see some increases related to the acquisition and just normal cost of going to business?

Richard Herrington

You’ll see some small amount of increases. You can’t continue to grow as we have without adding additional resources and continue to build our team. That’s an important part of our continuing growth. But you won’t see a significant amount of increases in the last three quarters of this year from an operating perspective. It will be some increases but they’re very manageable and they will be offset by increase in net interest income and noninterest income.

Operator

This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Herrington for closing remarks.

Richard Herrington

Again, we want to thank everyone for calling in this morning. We’re very appreciative of your interest. And we certainly hope that we’ve answered your questions. We had an outstanding quarter. We’re very excited about our future and we thank you for your interest.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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