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Edited Transcript of CADE.N earnings conference call or presentation 22-Jul-19 5:00pm GMT

Q2 2019 Cadence Bancorp Earnings Call

HOUSTON Jul 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Cadence Bancorp earnings conference call or presentation Monday, July 22, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Paul B. Murphy

Cadence Bancorporation - Chairman & CEO

* Rudolph H. Holmes

Cadence Bancorporation - EVP

* Samuel Michael Tortorici

Cadence Bancorporation - President

* Valerie C. Toalson

Cadence Bancorporation - Executive VP & CFO

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Conference Call Participants

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* Bradley Jason Milsaps

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

* Brady Matthew Gailey

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Brett D. Rabatin

Piper Jaffray Companies, Research Division - Senior Research Analyst

* Jennifer Haskew Demba

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Jon Glenn Arfstrom

RBC Capital Markets, LLC, Research Division - Analyst

* Kenneth Allen Zerbe

Morgan Stanley, Research Division - Executive Director

* Matthew Covington Olney

Stephens Inc., Research Division - MD

* Michael Edward Rose

Raymond James & Associates, Inc., Research Division - MD of Equity Research

* Steven A. Alexopoulos

JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks

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Presentation

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Operator [1]

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Welcome to the Cadence Bancorporation Second Quarter 2019 Earnings Conference Call. (Operator Instructions) The comments are subject to the forward-looking statement disclaimer, which can be found in the press release and on Page 2 of the financial results presentation. Both of those documents can be located in the Investor Relations section at cadencebancorporation.com. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

I would now like to turn the conference over to Paul Murphy, Chairman and CEO. Please go ahead.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [2]

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So thank you all for joining us, and welcome to our second quarter 2019 earnings conference call. Joining me today are Sam Tortorici, Valerie Toalson, and Hank Holmes. For the second quarter on an adjusted basis, we earned $51.5 million of net income. That's $0.40 per share, so right at a 13% adjusted return on tangible common and 1.2% on assets. It's a 50% adjusted efficiency ratio. And while these results are within peer averages, they obviously are disappointing to me, and the higher credit costs in the quarter does not meet with our top-level industry performance bar that we've set for ourselves.

So just in all honesty, open with saying it's not a great quarter. However, I think once you dig into the numbers and walk through with us, you're going to see it's not an awful quarter either. First and foremost, we are not in business to make bad loans and having charge-offs of almost $19 million resulting -- related to 4 credits is a disappointment for sure. The 4 credits, one of those credits was a restaurant, the other 3 were general C&I credits, one of the 4 was a SNC. There's no correlation on these 4 credits, and we don't view this as systemic.

If you look at our last 12 months trailing, total charge-offs were $22.5 million or 18 basis points on average loans, which is still higher than our past several years but within the acceptable ranges for a C&I-focused bank. We also reported increases in nonperformers of roughly $30 million, that's 3 loans: one energy, one restaurant and one C&I. Of these 3 loans, 2 are SNCs. We took targeted prudent steps in these credits as we reviewed updated information during the quarter that led to these accounting impairments.

C&I lending for us, of course, has historically been lumpy, but overall, our view on credit remains unchanged. We take action promptly when issues arise. And we had some issues this quarter. We do not believe that the second quarter credit problems are a result of a weakening economy, they are more episodic. We remain very diligent and very focused on every credit, every new credit, at renewal, every existing credit, just looking at all of the trends and properly underwriting on an ongoing basis.

And so while reporting credit losses stings, we still are fundamentally confident in our team, our discipline, our credit underwriting, our policies, our credit monitoring practices that have served us well in the past, and we're confident that, that will be the case going forward. But we also remain forever humble on credit.

Turning to some of the more positive developments in the quarter. Tangible book value increased $0.98 linked quarter, pretty spectacular, to $14.21. Our capital ratios continue to grow. Our tangible common equity ratio at 10.83% is over 100 basis points higher than a year ago.

Our well-timed interest rate collar from the first quarter increased in value significantly in the quarter and does give us nice protection against lower interest rates. We reduced our wholesale funding in the quarter. We had a $145 million in debt that matured, and we refinanced $85 million of that. So $60 million less debt, and it's a sub-debt issuance. So we get more favorable capital treatments, and at a rate that's a bit less than the previous issues. So really a lot of positives there.

We completed the exit of the Patriot Capital line of business, which came from the State Bank acquisition. That's about $130 million of equipment finance loans that were nonstrategic. This moderates our loan growth a bit, it moderates risk a bit, allows us to better fund with core deposits and is a positive for capital ratios. So we have intentionally moderated our growth, and I believe improved the risk profile of the loan portfolio this quarter, and are looking for a less aggressive growth in the future. And again, meaning for improved outlook for capital ratios, which increased nicely in the second quarter.

So let me ask you to turn your attention to Slide 4 of our presentation and comment on a few of the highlights there. Net income $48.3 million, $0.37 a share. While again, the higher credit costs are disappointing, we have not given up on our goal of top-level performance in the future.

NIM was 3.97% for the quarter and it's a bit complicated. Valerie is going to walk you through a lot going on with NIM here in a moment. Period end loans were $13.6 billion. Excluding the impact of the acquired loans, we've increased loans $1.5 billion or 16% from a year ago. And our update on 2019 organic loan growth estimates of 8% to 10%, we are now currently expecting that to come in on the lower end of that range or possibly maybe just a little shy of the low end of that range, as we're just moving towards a more conservative posture on overall loan growth.

Period end deposits were $14.5 billion, up $289 million, 2% linked quarter. Sam is going to go into more of an update on those initiatives. Adjusted efficiency ratio, as I mentioned, 50% compared to 45.7% last quarter. So the operating leverage in our model continues to be one of the key drivers of the, I think, attractive investment thesis here. And we still believe we'll see good expense discipline as we continue to manage to that 44% to 46% longer-term efficiency ratio target that we have previously reported. We don't see this changing that.

And so as I began to mention on these quarterly calls in the past, I just again have to take a moment to brag on our team. We've got a lot of great bankers that are really the engines that are driving our growth, and they're experienced and they're motivated and they're out making a lot of calls on really good customer prospects. And again, tip my hat to the hardworking Cadence bankers and thank them for their dedication. Feel really good about the retention rates. And top talent is hard to get and never take them for granted, but we've done a good job of hanging on to a great team.

So as we think about quality growth around our footprint, we still feel like we strengthened our customer service relationships, and feel like we are well-positioned for good future growth. As a public company for the last 2 years, we've generated a pretty decent track record, and we're still very focused on our long-range goal of consistently being among the top-performing regional banks in the country.

So with that, I'll turn it over to Sam for more on deposits.

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Samuel Michael Tortorici, Cadence Bancorporation - President [3]

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Thanks, Paul. I will be commenting on our deposit growth, starting on Slide 9 of our presentation. I am pleased to report that the combination with State Bank and Trust has enhanced our funding and deposit mix as we had projected. Core deposit growth was up $276 million or 2% linked quarter and up $5 billion from the prior year, driven by the State Bank acquisition, client retention and deposit growth initiatives.

The organic drivers of this growth continue to be the expansion of commercial, treasury management and consumer retail growth throughout our Texas and Southeastern markets. We also increased non-interest-bearing deposits by $87 million linked quarter, and $1.2 billion from a year ago. Non-interest-bearing deposits represent 23% of total deposits and are trending nicely. Our improved deposit mix is a priority for the company, and has been directly tied this year to management compensation.

We're confident that all these efforts will drive improved funding costs in the future. We're really pleased that Cadence Bank recently secured an investment grade credit rating from Standard & Poor's, which in addition to our Kroll investment grade rating, validates the bank's financial strength and stability.

We believe the ratings will contribute to furthering long-term client relationships and attract additional commercial, corporate and institutional deposits to the bank. Our brokered deposits were $868 million or 6% of total deposits at quarter end.

$228 million of brokered deposits matured following the end of the quarter, which we don't currently anticipate replacing until the latter half of 2019. Other borrowings and debt also declined by $349 million or 48% as a result of the quarter's deposit growth, and also due to the repayment of $145 million in senior debt in June. We replaced that debt with a lower amount, $85 million, of subordinated debt at a lower interest rate.

Now a quick update on our new Georgia franchise. Following our January 1 closing and subsequent rebranding and systems conversion of State Bank, we are quite pleased with our progress in the new Georgia market. A few highlights.

First, customer and associate retention, a key priority for us, has been solid. This has been evidenced by Georgia retail deposits being steady since conversion, and deposits in our community bank and commercial real estate group showing solid growth. Our Georgia community bank and commercial real estate teams also experienced one of their strongest loan production quarters in recent history.

As you know, commercial middle market has been one of Cadence's core strengths, and we added a top Atlanta middle-market sales leader during the quarter along with 2 seasoned bankers. We will continue to thoughtfully build out this important team.

We also recently announced the acquisition of an Atlanta-based wealth and pension services group, which has approximately $400 million in assets under management to combine with our Linscomb & Williams registered investment advisory platform, representing our initial wealth management offering in the Georgia market, and adding nicely to fee income. So we're encouraged by our prospects to grow our core businesses throughout Atlanta and the rest of the state.

With that, let me turn it over to Valerie to go through a little more of our quarterly performance.

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [4]

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Thanks, Sam. Slide 10 summarizes our net interest margin. There were a number of moving parts this quarter, but if you step back and look at it from a high level, we did experience some NIM compression from higher deposit costs, combined with the new deposit acquisitions that was partially offset by positive originated loan interest income from loan growth at slightly lower yields. Of course, the printed NIM was further impacted by a couple of additional items. One was the timing of hedge income between the first and second quarters that we've discussed previously and that would not be recurring. Year-to-date, the total impact from the hedges on NIM is a negative $3 million, which in a similar rate environment is a normalized level.

Second, the total accretion for acquired portfolios was a little bit lower this quarter, we expect the year-to-date yields on these portfolios excluding recovery accretion to approximate the yield for the rest of the year. Recovery accretions, as you know, can be bumpy and is generally not significant for us.

These yields are laid out in Table 3 in the earnings release. We also included a couple of additional slides this quarter in the presentation appendix, Slides 14 and 16, to help clarify the quarterly movements for you, so you can really hone in on core margin facets more easily.

Based on the recent trends we're seeing, we believe our funding costs may have peaked mid quarter as wholesale funds and brokered deposits have declined. We have $60 million less debt on the balance sheet. We are seeing maturing CDs being replaced with lower rates. And we have over $2 billion of deposits that are linked to indices and would have 100% beta if rates were cut.

Our originated loan yields, excluding the hedge impacts, declined about 5 basis points, largely due to loan mix shifts and an average LIBOR decline of 5 basis points during the quarter. Close to 70% of our loans are variable rate with about 85% of those tied to LIBOR and about 85% of those tied to one-month LIBOR.

On an overall balance sheet basis, it's important to note that at a down 100 basis point scenario, our next 12 months net interest income is modeled to be down only 1% due to the positive impact of hedging activities on our otherwise asset-sensitive balance sheet. And we're very pleased with that dynamic as we look out towards the rest of the year.

Slide 11 highlights noninterest income that also had a nice increase in the quarter, 3.5% for the quarter and now up to 16.5% of our total operating revenues. Credit related fees grew an impressive 10% linked quarter and assets under management from our investment advisory and trust business lines grew 3%, both from asset acquisition as well as market performance. We also had a little over $900,000 in securities gains due to some portfolio rebalancing in the second quarter.

Moving on to Slide 12. This highlights the GAAP and adjusted measures of net income and efficiency, with the largest differences between GAAP and adjusted coming from merger-related expenses. Now 2 quarters since the State Bank merger and over a full quarter since systems integration, we believe the vast majority of these merger-related expenses are behind us.

We noted last quarter that the first quarter's adjusted expenses were unsustainably low, and the adjusted base this quarter essentially represents full run rate expenses for the larger combined organization. While we do anticipate some modest increase in expenses in the latter half of 2019, as we continue to invest in talent and technology, we remain confident in our ability to achieve further efficiencies based on scale. And also maintain our commitments to the longer-term mid 40s efficiency ratio target.

Operator, let's go ahead and turn it over for questions now. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today comes from Steven Alexopoulos with JPMorgan.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [2]

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To start, surprise, on credit, if we look at the increase in non-performers and net charge-offs, the market's clearly concerned this is systematic. Could you give us more color on these, the 3 NPAs and the 4 NCOs, maybe size the loans or reserves on there, just give us a little bit more color that these are truly one-offs?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [3]

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Yes. Steve, let me try to walk you through at a high level here. The first credit that we took a charge on in the quarter is a 40-year-old business. It's 2 well-known private equity firms sponsored the acquisition of this business several years ago. They went through a major expansion period that was not effective and had a management team change-out. Initially, the private equity firms were supportive and put some more money in, but couldn't get comfortable with the kind of go-forward projections from the new management team, and have elected to put the -- basically the business up for sale. And so -- it's not a SNC by the way, this first one. And so we kind of take a look at the operating performance of the company and the fact that they're going through a sales process, we thought the accounting treatment of taking a charge on that was appropriate.

Credit #2, different industry, great private equity firm, we've done 6 or 7 deals with, all successful, except this one. This is a SNC, the agent, by the way, has done a fantastic job. And this company went through some major margin contraction in their business, just due to new competition, and decided to sell the business. And that has been done, and the marks on this one are based on the final resolution of the sale of the business, which I think funds here just in the next 2 or 3 days. So really hats off to the agent on that one.

Company 3 is a supply chain management business. They lost their major vendor and sort of turned their business inside out several years ago. They have gone through a restructuring, hired a new management team. And this mark is a result of the ASC 310, just the accounting process that you go through looking at their operating performance. Again, they're showing some improvement within their results, but it's a very stressed company.

Credit #4 is a restaurant deal, and by the way, the first 2 are Houston deals, the third deal is a Birmingham deal, and deal #4 is an Atlanta deal, it's a restaurant company that is going through the sale of their business, and that may or may not be in or out of bankruptcy and mark seemed appropriate there.

Turning to the 3 new non-performers. The first one is just an orderly liquidation of an inventory of a company whose business line changed. And based on new appraisals, we believe we are adequately secure there. That will wind down over a period of several months, it will take some time.

Credit #2 is an energy credit. That is in bankruptcy because of the sub-debt. We believe our senior secure position is in a good collateral position. And then -- and that's a SNC, by the way.

And then credit #3, a restaurant SNC, is a company that management team is continuing to support the business, including putting cash in. But they have multiple concepts, one of which is doing really great, and they're going through a sale process. And a mark on that one seemed to be prudent. So as you might expect, I'd much rather talk about the best loans we've ever made, but it is my view that these are not correlated, unique sets of facts. Just a little bit of bad luck coming on the heels of the Investor Day, but my view of credit really unchanged. Our credit underwriting at Cadence is good. We've got a bad quarter here, but all in, still pretty confident with where we are.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [4]

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Well, I guess what I'm trying to figure out, so these do appear to be one-offs, if you will. But I'm trying to connect that to the commentary that loan growth expectations are being reduced, maybe even below the low end of the range. Have you decided to exit segments, reduce exposure to segments? Not really clear to me why we're all simultaneously lowering the loan growth outlook?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [5]

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The only thing we've decided to exit was the Patriot Capital business, and so that's part of it. What we're seeing is the loan pipelines look good, it's the payoffs are running a little bit higher. It's what sort of yield -- gets me to maybe the lower end of the range. And we debated here internally. I mean, we are open for business in all lines. There is no business line that we are actively deciding to exit. But we, of course, have an ongoing review of everything we're doing. And as we've reported previously, restaurant is not slated for growth. So we see those numbers coming down there. So that impacts our totals just a bit. But overall, we're steady in the boat. It's the paydowns that lead me to think more about lower net growth in the future.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [6]

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Okay. Maybe just one final one for Valerie. There's obviously, many moving parts to the NIM this quarter, how should we think about the starting point for NIM? And then from that level, where do you see NIM trending, assuming the Fed does cut rates in July?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [7]

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Yes. Sure. So basically, if we -- there are a number of moving parts. And I can go through those, if you like. But basically, if we get a rate cut next week, we do expect some modest margin pressure in the latter half of the year from the current level. But probably in the range of 8 to 12 basis points or so on average for the -- the latter half. Said another way, for the full year of 2019, we're looking at a NIM probably near what we saw this quarter, give or take 1 basis point or 2. That being said, based on the anticipated growth for the rest of the year, we do expect net interest income in dollars to be up, even with a little bit softer margin. So and of course, LIBOR movement and betas and all of that can change a great environment. But that's what we're expecting currently.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [8]

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So full year NIM, 3.97%, is that what you're saying?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [9]

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Within that range.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [10]

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Within that range. Okay.

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Operator [11]

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The next question comes from Brady Gailey with KBW.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [12]

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Brady. Thanks for joining us.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [13]

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Paul, I know another thing you all talked about is your guidance on expense growth this year. I think you talked about kind of that 5% to 6% level, is that still an appropriate way to think about expense growth this year?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [14]

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Brady, yes, we talked about that based on the first quarter run rate expenses. As we look out the latter half of the year, materially within line to that expectation, we might see an extra $1 million or so per quarter in the third and fourth quarter. But overall, fairly consistent, maybe slightly higher.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [15]

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All right. And then if you look at capital levels, they grew pretty nicely in the quarter. I think some of it was related to the mark-to-market of the hedge, but your TC is now kind of approaching 11%, yet your stock is now trading around $16. I know you have a buyback in place. It doesn't look like you repurchased any stock this quarter. But with the stock trading how it's trading, with your capital going up pretty nicely this quarter, maybe just talk about your thoughts around the buyback for the back half of this year?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [16]

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Yes. Brady, so the buyback that we had in place previously has been fully satisfied. So there's not any current buyback authorized by the Board or approved by the Fed. And our position on additional buybacks in the future is -- really remains unchanged from the first quarter. We've got CECL coming up, really understanding that as our first priority. I get your point on the stock price, that's kind of new information to bake into the equation here. But I think in the future, we'll be looking at it every quarter and making a decision based on facts and circumstances at the time. But -- so no additional buyback is imminent, but something we'll consider.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [17]

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All right. And then finally for me, Paul, when you were walking us through the problematic credits out of second quarter, I heard you mention a lot of these were private equity sponsored deals. Are some of these loans considered levered lending loans?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [18]

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Yes. When you look at that at origination are they considered levered? If they have poor operating results, then they typically trip leverage covenants, and they become levered by definition. And so -- oh gosh, help me with that at origination...

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Rudolph H. Holmes, Cadence Bancorporation - EVP [19]

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At origination, none of them were levered, under the levered designation.

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Operator [20]

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The next question comes from Brad Milsaps with Sandler O'Neill.

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [21]

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Paul, I'm curious if you could add maybe some additional color on the also -- the bump in criticized loans? I think, according to the release, they went from about 260 basis points at March 31 up to 3% at June 30. Is all that driven by the NPA categories or were there other loans in there as well?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [22]

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It would be mostly the NPAs. Some of the -- there were a few other downgrades. I consider it to be really pretty flat, all things considered. I wouldn't call that a big increase. But yes, mostly for things that were identified.

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [23]

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Okay. And then Valerie, I appreciate the color on the margin and accretion. I think in the release, noticed that you adjusted some of your assumptions with the accretion from January 1 when the deal closed. Does the guidance still hold in terms of some of the recovery accretion as it relates to CECL heading into next year? And then, I think if I heard you correctly, you said that the yields on the acquired book, which sort of approximate kind of first half yields in the second half of the year, is that correct?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [24]

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Yes. That's correct. And that was kind of a pretty easy way to look at that. And if you look at Table 3 in the press release, we've got those year-to-date yields there for you. That would be on the ANCI accretion and then the ACI accretion. But the recovery accretion, as you know, is kind of bumpy. So I wouldn't expect materially higher levels than that as we go forward. And then on the guidance for CECL, yes, the recovery accretion is treated differently under CECL, nothing else changed than that.

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Bradley Jason Milsaps, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [25]

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Okay. And how much do you have left in that bucket?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [26]

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Well, the recovery accretion, the accretable difference is ballpark around $75 million at the end of the quarter. And most of that comes in through a scheduled accretion time line, where cash flows changes, there are payoffs, et cetera, that's where you see recovery accretion come in.

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Operator [27]

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Our next question is from Brett Rabatin with Piper Jaffray.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [28]

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Wanted to just go back to growth for a second. If you look at the quarter, restaurant and health care were a little lower, can you talk maybe a little bit about where the growth comes from in the back half of the year? And will there be efforts to reduce any of the portfolios that you have that might somewhat stymie that growth?

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Rudolph H. Holmes, Cadence Bancorporation - EVP [29]

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Sure. I'll take that -- answer that one. This is Hank. So we're seeing, as Paul mentioned, the pipelines are pretty good at this point, and we are seeing some nice growth throughout the footprint. Specifically, we do see real estate, that's had some good movement or should have some good movement. The C&I teams are really seeing nice portfolios and pipelines in place. And so it's hard to specifically give one area. Our midstream group continues to have a pretty strong robust pipeline. And it's when you look at our Atlanta group that Sam has put together, nice pipeline there and then obviously, we have a new group in Dallas that is seeing some growth as well. So pretty balanced in the pipelines.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [30]

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Okay. Does the restaurant and health care book shrink from here? Or can you give us any thoughts on those portfolios?

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Samuel Michael Tortorici, Cadence Bancorporation - President [31]

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I think we're actually...

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Rudolph H. Holmes, Cadence Bancorporation - EVP [32]

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There were not...

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Samuel Michael Tortorici, Cadence Bancorporation - President [33]

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I'm sorry. Hank, go ahead.

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Rudolph H. Holmes, Cadence Bancorporation - EVP [34]

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No. No. Go ahead, Sam. I am sorry. Go ahead.

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Samuel Michael Tortorici, Cadence Bancorporation - President [35]

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Yes. Brett, Sam here. So yes, as Paul noted earlier, we noted in the first quarter call and in Investor Day, we're intentionally kind of slowing growth in the restaurant space, just due to the handful of pressures facing that industry. So we would expect that to be kind of flat to slightly down. On the health care side, we have had a really solid production year and a great pipeline that is being partially offset by some unexpected payoffs. That's the good news, our customers are doing really well and their owners are monetizing. Good for them, not so great for us. So we do expect to see possibly a little bit of growth in health care, but definitely not in the restaurant space.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [36]

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Okay. And then last one on -- back on credit. Just thinking about the linked quarter increase in criticized loans and these lumpy credits that you're having that are not related. Can you give us some color on how you're thinking about provisioning the back half of the year and then what -- basically if you've taken the provision you needed for all the stuff that happened in terms of 2Q? I know there's 1 credit that's in a liquidation type status.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [37]

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Yes. Brett, so this is Paul. I mean, I think the accounting methodology works the way it works. You go through and do the ASC 310s, and if additional provision is required, then it gets made at that time. So predicting that with certainty is a little bit of a challenge. But I mean, I think that based on what we know today, all of the appropriate provisions that should have been taken have been taken. And hopefully, we get more good news than bad news from here. But if we see additional deterioration, then we'll rack it up. But I think it's unusual that we have sort of this much in 1 quarter, and I would not expect that to be ongoing.

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Operator [38]

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Our next question comes from Kenneth Zerbe with Morgan Stanley.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [39]

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Great. I guess just staying with credits. You had a comment in your press release that basically said you increased your provision expense due to general credit migration in your C&I portfolio. Now Paul, you are very clear that these credits were very unique and not systematic. But I guess I'm just, love some clarity around the "general credit migration" comment that you had?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [40]

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Yes. Ken, I think it just goes back to we did see some additional downgrades in the quarter and that is taken into consideration when we're doing our reserve allocation.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [41]

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And these additional downgrades, were they in addition to the 3 non-performers and the 4 charge-offs? This is extra or additional stuff?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [42]

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Ken, this is Valerie. Yes. Basically, the majority of the reserves that we took relates to the specific analyses, ASC 310s, that would include the loans that are categorized as nonperforming. That's probably $20 million of it right there. The rest is really just related to a combination of loan growth, loan payoffs, migration, with the majority of that difference, really over 2/3 of that, being migration within the pass category versus downgrades significantly.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [43]

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So if the credit goes from a 5 to a 6, it's going to take a lot more provision.

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [44]

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Right.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [45]

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Every quarter. So that -- there would be...

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [46]

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Got it. Understood. I just want to clarify because you -- as far as I recall, I think you're the only bank that's actually mentioned general credit migration in their portfolio. So I just wanted to make sure we understood what that was about. I guess just a small question. Just back on, in terms of the loan growth, you mentioned the payoffs were running higher than expected. What kind of assumptions are you making about future payoffs, and how does that tie into your lower end of 8% to 10% loan growth?

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Rudolph H. Holmes, Cadence Bancorporation - EVP [47]

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We certainly watch the payoffs. And just kind of anecdotally, we're seeing a few of the non-banks come in and look at some higher leverage points than we're willing to look at, at this point. So we're seeing a few payoffs. It's been fairly consistent. It's a little lumpy as well. And so we recognize kind of a consistent level of payoffs and as we kind of reposition the balance sheet and look to continue to grow, we just feel like that the lower end of the range is more in line with our expectations.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [48]

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It's really hard to budget for.

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Rudolph H. Holmes, Cadence Bancorporation - EVP [49]

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It really is.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [50]

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We know there will be some unexpected payoffs, but we have numbers in that. And then sometimes we're close, and sometimes it fluctuates more dramatically quarter-to-quarter.

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Rudolph H. Holmes, Cadence Bancorporation - EVP [51]

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It was a little higher this quarter than it has been. So one other point -- and I'm sorry, I'm going to correct myself from earlier in the call. I'm sorry, we did have one of the loans that Paul discussed earlier that is -- that was leveraged at origination.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [52]

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One of the 4 charge-offs this quarter was leveraged on at origination.

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Rudolph H. Holmes, Cadence Bancorporation - EVP [53]

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So just to clarify that.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [54]

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Ken, maybe just to -- kind of -- I am sorry, Ken, coming back to your -- going from 2.6% to 3% criticized, classified, does that concern me as an indication of beginning of a trend that would be noteworthy? I would say I consider that to be a normal, ordinary fluctuation in the loan grading of a portfolio and from a pretty low level.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [55]

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Understood. And I guess we're just -- you can imagine from our side of the table, we're just trying to take into consideration the increase in criticized plus the charge-offs, plus the NPAs, plus the reserve build. I mean, it's all kind of tied together. We're just trying to make sure we understand where to go from here.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [56]

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Yes. That's fair. Certainly.

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Operator [57]

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And our next question comes from Michael Rose with Raymond James.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [58]

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Just going back to the margin, Valerie. I think you said, 8 to 12 basis points, but I think that was just for one rate cut. If we were to get a second one sometime later in the year, and I guess can you just lay out the expectations? And then if you can remind us when the hedge really or the interest rate collar really kicks in? And is it plausible that with deposit costs essentially having peaked from what you said, that we can actually start to see the margin stabilize, perhaps increase as we move into 2020, on a core basis?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [59]

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Yes. So basically, the guidance I gave on the margin incorporates the forward rate curve from June, and I believe that incorporates a couple of rate cuts during the year. So it already includes a couple of those. So that's factored in there. If it was less, it would be less. On the collar, basically, if you look at it on a full year-to-date basis, there's 0 income coming from that collar specifically. And that's because rates, LIBOR, hasn't materially changed since we put it on in the first quarter. And so basically, if nothing else changed, then that is what we would be expecting going forward. But obviously, since we put the collar on, the forward rate curve and the expectations for a rate cut are lower. And so assuming we have a rate cut next week, that would, of course, impact our LIBOR-based loan yields negatively, and it would impact our collar positively. Based on that forward rate curve, we would actually expect the collar income to go from 0 to approximately $4.3 million in the next quarter. And I think it's just important on an overall basis, our modeling indicates that in a down 100 basis point scenario, our net interest income would be impacted by only 1% on the downside.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [60]

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Okay. That's very helpful. And then, if I can just go back to the comment around the efficiency ratio and the target there, the 44% to 46%. I guess just given a more challenging rate backdrop here and maybe a little bit higher expense build, I guess over what time frame do you think you can get back there? And is it plausible that you could be back there by the end of next year?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [61]

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You're right. I mean, it's going to take [the low] several quarters for us to see the movement. I mean, what I'm encouraged about is our 3-year trend line or really anyway you look at it, we've seen the operating leverage in the model almost every quarter practically. So this is a setback for that, just from operating leverage standpoint. Interest rate pressure, margin pressure would also further challenge our ability to get there quickly. So I don't know, give me some time. I mean, overall, I think that still is a trend that we'll see resume, but it's going to definitely be a setback.

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [62]

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Yes. In a period of declining rates, that will be a headwind to it. But when you look at our overall business model, that's where over the long term, we are confident in the lower efficiency. And in the meantime, if we're at 50%, where we are this quarter, that's pretty good efficiency.

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Operator [63]

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The next question comes from Matt Olney with Stephens.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [64]

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Just wanted to go back to the sale of the equipment finance loans. Can you tell me at what point of the quarter did that sale take place? And what's the average yield of those loans?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [65]

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Yes. Matt, this is Paul. It closed very late in the quarter. And does anybody have the yield?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [66]

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Yes. It's just a little over 7% average yield on those loans.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [67]

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Did recognize a modest gain on it.

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [68]

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Yes.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [69]

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And then Valerie, any impact of interest reversals on the NII from some of the credit deterioration in 2Q?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [70]

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Yes, there was a couple hundred thousand or so, but it was actually pretty consistent with what it was in the first quarter. So not too much variation between them.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [71]

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Okay. And then I guess lastly, going back to credit. And Paul, you gave us some good details around the problem loans. But as far as the timing, it seems unusual to see all 7 of these credit issues experience deterioration over the last 50 days or so since the Investor Day. Is this what you're saying, that it all happened in the last 50 days? Or was there any kind of regulatory exam that could've also resulted in some of these downgrades?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [72]

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The downgrades are -- have no result as of regulatory exams. And I guess if at Investor Day, if I left you with the impression that there would not ever be any downgrades, then I've created the wrong impression. I mean, these are, for the most part, credits that have been nonperforming or are on the watch list or have been things that we've been watching for some time. And so they were on my mind at Investor Day. And I still believe what I believed at Investor Day, that our credit story is a good one, but albeit, we have had some migration and some reserves as the results of the credits that we walked through.

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [73]

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I would just follow up, there wasn't any specific portfolio focus analysis, et cetera. It was -- it's really our normal course of business that, where we, every quarter do a diligent assessment of our credits and the reserving process.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [74]

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It's episodic. It's kind of like payoffs. It's episodic, you just never know when you'll have more of that in one quarter or not. So I wish the timing were different, however, but it is what it is.

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Operator [75]

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Our next question is from Jennifer Demba with SunTrust.

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [76]

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I have 2 questions. First, can you give us a little bit more color on the technology investments you're making right now? And my second question is back to credit. Paul, given that you think these credit trends this quarter were episodic, what kind of net charge-off range do you think makes sense for Cadence at this point in the cycle?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [77]

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Yes. So Jennifer, first on technology. We are, on an ongoing basis, looking at routine upgrades to applications, so a little bit of delay in some of that as a result of the conversion. But like our wire transfer system is set for upgrade later this year, new ACH system, things like that, cost of which are very manageable. I think the wire transfer system is $800,000, and should get a lot of efficiencies from that. So routine ongoing investment in IT, in line with prior years would be, I think, the way to think about it. And we do continue to look down the road at the future. What are platforms and other models and we're comparing notes with peer banks. And our work through the MBCA just always thinking about technology and where should we go and where do we have. But we're sort of steady in the boat, I guess, for technology. So from a -- back to credit, I would say our long-term goal would be for charge-offs to be under 25 basis points on the C&I portfolio through a down cycle, year in and year out. And so we're at 18 basis points, so based on the last 4 quarters, that still seems like a reasonable goal to me.

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Operator [78]

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The next question will be from Jon Arfstrom with RBC Capital Markets.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [79]

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Just back to Matt Olney's question. When these issues started to come up, did it cause you to do anything different, any kind of a deep dive or look deeper at some of your other credits?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [80]

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Well, I mean, Jon, we are always looking at the portfolio and thinking about how to -- what's the optimum level. I mean I will tell you this, we at Investor Day, we said, "Hey, Paul's view is the most concentrated -- the area of risk in the bank that everyone should be aware of would be the leverage lending portfolio." And so since Investor Day, we are running really, really thin on new capacity for new leveraged lending loans. We've got an adequate sized book. It's performing much in line with what we thought. But with the potential recession on the horizon, increasing that is something that we've decided we don't want to do. So we are not closed to new business, but we have kind of raised the bar, if you will, on anything that would be considered leverage without moderators. And a very high bar you must clear to be open there. But for many of these long-term relationships, we are still entertaining requests, but we have moved to a more conservative place on the risk spectrum with respect to leveraged lending.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [81]

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Okay. You said -- you made the comment about potential recession on the horizon. I just want to be clear that you're not saying you're seeing signs of that, you still feel like the general health of the economy and the sectors you are lending into is strong?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [82]

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Main Street looks fantastic. Our loan committee, our customers are successful, they're profitable, they're growing their businesses. Finding people is oftentimes the biggest problem they cite. And so yes, I'm -- you summed it up nicely. Yes, we -- I'm not calling for a recession. But I know that the longer we are in a cycle, the possibility of a recession is something that we have to look at. And so what we know is that companies that have low leverage can manage recessions well. And if you have high leverage, a recession can be a bigger problem, not necessarily 100%, but so -- yes, just moving towards a more conservative place on the portfolio risk level with leverage is the direction we have chosen to go.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [83]

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Yes. Okay. And then maybe Valerie, back on the provision outlook. Can you help us a little more on that? Do you feel, other than just for growth, do you feel like you need to continue building reserves? Or do you feel like the next quarter's provision will come back down to the range it's been in the past?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [84]

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Yes. So again, just kind of reiterating what Paul noted earlier, it's very much a quarter-to-quarter assessment process. And careful evaluation of the individual credits for impairment, and when you do the valuations of those, look at the grading movements within the quarter, positive or negative, it's volumes. I mean, it's -- it's -- we're very consistent, I would say, in the application of our -- on balance, and so it will be treated on a consistent basis. Probably that's not what you're looking for, but that's...

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [85]

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Not at all, really. We're just trying -- you understand what's going on here. Your stock isn't doing well on the call either. So we're just trying to figure out if 7 credits went sideways in one quarter, and it's going to clear up in the next quarter is what we're trying to figure out.

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [86]

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Well, and I think Paul mentioned that we wouldn't expect to have this level of charge-offs in the near future, by any means.

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Jon Glenn Arfstrom, RBC Capital Markets, LLC, Research Division - Analyst [87]

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Right. Okay. Okay. And then just last thing, message to your bankers, you use the term selectively growing in the release, but it sounds like it's more of a payoff issue, so the message isn't any different?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [88]

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Yes. I mean, we're open for business. We are out looking for good loans to good borrowers and cross-selling for deposit opportunities and doing what we always do.

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Operator [89]

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The next question is a follow-up from Brett Rabatin with Piper Jaffray.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [90]

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I just have one follow-up. I wanted to see if you guys might have the total amount of loan portfolio that's tied to PE?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [91]

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I don't think that...

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Rudolph H. Holmes, Cadence Bancorporation - EVP [92]

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That's not a number that we've given guidance on a regular basis.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [93]

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Okay. And then I'm just curious, there was discussion earlier just about some of these credits, they weren't leveraged when they were made, but they could have become levered by the time they became an issue. Would you guys not have any covenants that would restrict junior debt? Or can you just talk about how these loans sort of act once they've been made or not levered, but with these PE firms, like what happens to them as they sort of mature?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [94]

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Yes, sure. So when -- if EBITDA drops, we do have covenants in place and typically they would violate the covenant. At that point, the bank has the ability to not fund any additional monies under the line of credit, it can -- has actions that we can take, foreclosure, et cetera. And so -- but if a company's EBITDA goes from $15 million to $5 million, I mean, they're going to bust the covenant. But then just you're sort of in a workout mode and you -- if you have good sponsors, we have seen them come to the table, put in additional equity, clear the defaults and upsize the company, and get the business going in the right direction again, or in some cases, it doesn't always work that way.

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Operator [95]

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Our next question is also a follow-up from Steven Alexopoulos with JPMorgan.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [96]

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So just a follow-up on all of the questions you've had around provision and charge-offs. I hear you that credit can be choppy, right? Who knows what the future is going to have, you could see volatility quarter-over-quarter. But I guess, Valerie, what we're trying to understand, so if you look at your internal budget for net charge-offs and provision for the second half, did that change because of what we're seeing this quarter?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [97]

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No. No material changes. No. No material changes at all. I mean, we see it's bumpy.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [98]

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You didn't see any changes?

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Valerie C. Toalson, Cadence Bancorporation - Executive VP & CFO [99]

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We think this was a bump. We think this quarter was a bump.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [100]

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Right. But internally, this was not an inflection point for you, where you guys are now expecting a higher level of charge-offs and provision versus your assumptions before the quarter, correct?

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [101]

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That's a -- Steve, I mean, I'll say it this way. I think our provision will return to a normalized level. Just being on the record, could it ever -- could we ever have another credit that requires an ASC 310 mark, of course, we could. So I'm not trying to give a carte blanche, but I think that this quarter is unusual, that this spike is not likely to be repeated, and that we'll return to more normal levels over time.

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Operator [102]

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Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn it back to management for any closing remarks.

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Paul B. Murphy, Cadence Bancorporation - Chairman & CEO [103]

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Well, thank you, Chad, and thank all of you. First off, my apologies for the disappointment in the results on credit. We're continuing to work that very hard, and look closely at every credit. And to summarize the point that Steve just made, is that I don't think this is likely to recur. And I feel like we've got a great team of professionals that are doing a good job managing risk and avoiding risk, and we're going to do much better for you in the future. So with that, we stand adjourned.

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Operator [104]

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