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Edited Transcript of HBMD earnings conference call or presentation 24-Oct-19 2:30pm GMT

Q3 2019 Howard Bancorp Inc Earnings Call

ELLICOTT CITY Oct 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Howard Bancorp Inc earnings conference call or presentation Thursday, October 24, 2019 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* George C. Coffman

Howard Bancorp, Inc. - Executive VP, Treasurer & CFO

* Mary Ann Scully

Howard Bancorp, Inc. - Chairman & CEO

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Conference Call Participants

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* Catherine Fitzhugh Summerson Mealor

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

* Joseph Gladue

J. Alden Associates, Inc., Research Division - Director of Research

* William Jefferson Wallace

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to Howard Bancorp, Inc. Third Quarter 2019 Financial Results Conference Call. My name is Omar, and I will be your operator for today. Please note this conference call is being recorded. (Operator Instructions) I will now turn it over to you, George Coffman, Executive Vice President and Chief Financial Officer of Howard Bancorp, Inc. Mr. Coffman, you may begin.

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George C. Coffman, Howard Bancorp, Inc. - Executive VP, Treasurer & CFO [2]

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Thank you. I'd like to begin this morning by thanking everybody for joining the call. As he stated, my name is George Coffman. I'm the Chief Financial Officer for Howard Bancorp.

Before we begin the presentation this morning, I'd like to remind everyone that some of the comments made during this call may be considered forward-looking statements. Our Form 10-K for the fiscal year 2018, our quarterly reports on Forms 10-Q and our current reports on Forms 8-K all identify certain factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements we make this morning. The company does not undertake the process to update any forward-looking statements as a result of new information or future events. Our periodic reports are available either through the company's website or via the SEC's website.

I'd like to remind everyone that while we think our prospects for continued growth and performance are good, it is our policy not to establish with the markets any earnings, margin or balance sheet guidance.

With that said, now I would like to introduce Mary Ann Scully, the CEO and Chairman of Howard Bancorp.

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [3]

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So good morning, everybody. I would add my thanks and thanks of our entire executive team to everybody who's taken the time to join us on this call.

You all have seen in the 8-K filing this morning the presentation that we published which would complement the earnings release that went out last night. So I will try not to duplicate but rather to highlight and then leave as much time as possible for questions.

We begin, as always, with the statement of what we believe the core strengths of the company are, and you will hear this recurring theme that we think that the company is exceptionally well positioned at this point in time. We made progress towards higher growth and higher return. We're especially pleased with the net loan growth in the quarter and most especially the growth in our core segment of commercial banking, which showed an 11% annualized growth rate.

The funding of those loans is critically important. We've highlighted a number of times our emphasis on transaction deposits and our strategic plans to grow those as a percentage of total funding sources. And the transaction deposits in that light increased by $11 million, which funded 38% of our net loan growth. So positive trends there.

We did see some pressure on the net interest margin but, as we'll discuss in more detail later, believe that we are insulated from some of those net interest margin pressures by virtue of both our loan mix and our funding mix, and the loan mix not only in terms of residential versus commercial but also fixed versus floating.

We continue to focus on efficiency as well as revenue growth and are, right now, very focused on the final execution of the branch optimization strategy that we've discussed in previous calls, most of which have not yet worked its way through the financials as those branches just closed late in the second quarter. Given the strong capital position of the company, we also have commenced the share buyback program that we announced.

So as the slide will show going forward, much of our positioning is based not only on the performance, the revenue growth, the expense management that I've just highlighted, the strong capital levels, but also the unique positioning because of our wave of consolidation and concurrent disruption in our market.

The financial highlights that are on Page 5 of the presentation are that we showed net income growth and showed a core EPS, after adjusting for the infrequent expense associated with a piece of litigation, to $0.27, so up about 9% from the last quarter.

Noninterest expenses continue to come down and, again, adjusting for infrequent expenses, was $14.7 million in the third quarter versus $15.2 million in the second quarter. And again, most of the branch optimization efficiencies are not yet showing in this quarter given the third quarter closings of the branches.

Loan originations, as noted, remain strong. From an origination standpoint, we've already highlighted the net loan growth. We had $46 million, almost $50 million, in commercial loan originations in the quarter.

And the NIM, as I noted, was down slightly at 3.46%, and that's despite 2 prime rate decreases and, again, is a function of both the commercial emphasis and the fixed-rate nature of much of our commercial loan portfolio. And our book value and tangible book value continue to increase.

What this leads to is the improving metrics shown on Page 6. We've made this presentation more concise than we've shown in the last couple of quarters. And what I would draw everyone's attention to while we show the reported is the core numbers over the last 4 quarters showing a consistent improvement in return on average common equity; return on average assets; and the one non-GAAP adjustment that we make, which is the return on average assets, net of the CDI expense, which remains significant, almost $750,000 per quarter. And that's the reason for that adjustment, which shows in the third quarter, after adjusting for that, a 1% adjusted ROA.

The loan growth trends that we show on Page 7 are over a longer period of time. I think the important thing to note here is not only the annualized loan growth of 6.7%, the commercial annualized growth of 11%, but the strong annualized loan originations, $197 million, which is 16% of the base portfolio.

We've seen net loan growth of $80 million year-to-date, and that organic growth always is focused on full relationships. The long-term organic CAGR for Howard since 2013, I will note, is over 20%.

I've highlighted the strong capital ratios on Page 8 and again, would simply note here that given the strength of these ratios, we did commence our share buyback program in the third quarter.

Much of the focus, I know, is going to be in the questions on our net interest margin. So the margin was 3.46% for the third quarter, down from 3.53%. The primary driver was the impact of decreases in primary. But again, there was a certain insulation because of the mix of fixed-rate loan assets almost 70% of the commercial loan portfolio. It does provide us with some protection. Now as some of those loans prepay, it puts a certain amount of pressure on that fixed-rate portfolio. But that mix is the reason why we're seeing a smaller compression in the net interest margin, along with the focus on transaction deposits.

If you look at asset quality on Page 10, this continues to come down. Contextually, I will note again that at the time of the merger with First Mariner, we had a higher-than-normal NPA as a result of the legacy pre-recapitalization loan portfolio of First Mariner. That has worked down dramatically, and we see that in terms of the NPA to total assets of 1.04% in the third quarter.

I've referenced the loan mix, but I think it's important to highlight that again, the strong emphasis on commercial, constituting about 69% -- or 68% of the total portfolio. I would also note that from a portfolio perspective, while we do maintain a residential mortgage origination division, that the majority of our mortgage portfolio is related to the serial acquisition activity of the bank, FDIC transactions, whole bank acquisitions and the merger with First Mariner.

The funding mix also continues to be very strong. Our overall cost of deposits was 0.96% for the third quarter, one of the lowest in our regions. And the funding mix should improve more over time given the experience level and the well-known nature of our commercial team; the very competitive treasury management product set that we have; the reconfigured branch network that has allowed us to decrease the number of branches in our system 46% since the date of the merger in 2018, giving us an average branch size of over $100 million but still allowing us to fully cover our footprint.

Page 13 is a slide that I've used to quantify the repeated references that we've made over the last couple of quarters to in-market deposit disruption. And what this shows is that starting in the fall of 2018, we've had a series of acquisitions of local banks acquired by out-of-state banks and in-market banks or banks that are either owned by out-of-state banks but are now merging, as the case of SunTrust and BB&T and the in-market consolidation of Revere and Old Line.

If you look at the acceleration of that line from May of 2019, I think that all of us familiar with the industry would recognize that this sort of disruption, the attended changes in branch structures and in systems conversions provide us with a huge opportunity. But over and above the opportunity, I would remind everybody we are the largest locally headquartered bank in the Greater Baltimore area. We're now at #7 in deposit market share. All 6 banks above us are out-of-state banks. And upon the completion of the Old Line and Revere Bank acquisitions, we'll actually be the third largest local bank in Maryland behind Sandy Spring and Eagle.

We have a commercially focused loan origination engine that is performing well and shows continued momentum. We're continuing to optimize our franchise, both to acknowledge different customer behaviors and also to provide us with a more efficient platform that allows us to leverage the scale we've achieved with the First Mariner merger. And once again, a word that I think cannot normally be used in a banking industry context, we're not just well positioned, but we're uniquely positioned as the largest locally headquartered bank.

With that, I'll turn it over to you for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from William Wallace at Raymond James.

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William Jefferson Wallace, Raymond James & Associates, Inc., Research Division - Research Analyst [2]

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Mary Ann, maybe just we'll start with the expense, the branch rationalization efforts that you completed in the third quarter. Are we going to see a full run rate of all the efforts that you've taken in the fourth quarter? Or will we not see that until the first quarter?

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [3]

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You won't see it until the first quarter, Wally. You'll see a significant percentage of it in the fourth quarter. But part of the branch optimization was closing 2 branches and consolidating them into 1 new branch in the northern area of our footprint. That new branch is not scheduled to open until this fourth quarter, and as a result, we're going to keep those other 2 branches open. And my colleagues are reminding me, it's probably very late in the fourth quarter or early in the first quarter. But given that we'll have 2 of those branches still open for most of the fourth quarter, you won't see the full effect until the first quarter.

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William Jefferson Wallace, Raymond James & Associates, Inc., Research Division - Research Analyst [4]

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Okay. And so if I look at $15 million as a baseline of expense when I back out the legal accrual and the benefit for the FDIC reimbursement, can you remind us how much of expense should be coming out so that we can kind of gauge what we'll see in the first quarter as a run rate?

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George C. Coffman, Howard Bancorp, Inc. - Executive VP, Treasurer & CFO [5]

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Yes. When we talked about -- hey, Wally, this is George. When we talked about this before, again, we were closing 5 locations. Three of them, as Mary Ann mentioned, closed in September. The other 2 will close late this year, early next year. All-in, we expected between $1.8 million and $2 million in overall cost savings. We're starting to see -- for the 3 that have already closed, starting to see those reductions, but we'll see the rest of it in -- starting in January.

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [6]

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And the other thing that I would note, Wally, and I think we noted this in the press release itself, is that we've recently renegotiated our core processing contract. And in addition to it allowing us to provide some enhancements to some of our cash management products, it also provides us with some significant savings, about $700,000 a year. And you will start to see those roll through in the fourth quarter. And essentially, you'll see the full effect of those on a quarterly basis roll through the fourth quarter.

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William Jefferson Wallace, Raymond James & Associates, Inc., Research Division - Research Analyst [7]

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Okay. Are there other opportunities on the cost side?

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [8]

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I think the big opportunity is probably the one that we've referenced before, and that's not just a noninterest expense savings but is an opportunity to just deliver a more focused franchise. And that is the fact that we continue to look at the mortgage operation and what we want to do with the mortgage operation. It's an operation that we've determined and publicly stated on a number of occasions we don't want to see significantly grow. If we reach some sort of final resolution on that, it will obviously affect, if nothing else, the efficiency ratio given the higher efficiency ratio associated with any mortgage operation. We've seen improvement in the profitability levels there, but it continues to be an area of non-focus. And for that reason, we're still evaluating a variety of alternatives on the mortgage company. But that would affect the noninterest expense level and the overall efficiency ratios.

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William Jefferson Wallace, Raymond James & Associates, Inc., Research Division - Research Analyst [9]

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Okay, okay. And then I would like to maybe just ask about net interest margin. So we obviously had the September cut, which will impact the fourth quarter. Can you give us a sense as to what you anticipate the impacts from the September cut and, assuming we get another cut next week, what the margin should look like?

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George C. Coffman, Howard Bancorp, Inc. - Executive VP, Treasurer & CFO [10]

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Yes, Wally, this is George. I'll answer that as best as I can. When you look -- and I'm going to start talking about the loan portfolio. Mary Ann mentioned that earlier. If you look at the percentage of our loan portfolio that is subject to changes in rates, either prime or LIBOR, about 28% of our portfolio is subject to changing rates that I just mentioned. So just taking that -- what I would say is after prime changes, the immediate impact is about a 7 basis point impact on our overall loan yields and, therefore, our margins, just from a drop in prime. However, if you look at the composition of our funding and, obviously, the September numbers, we had $273 million of FHLB advances. The vast majority of those reprice within 90 days. And then you look at the CDs that are scheduled to mature within 90 days and -- where the day 1 impact of a prime rate is about 7 basis points. Within 90 days, it's down to only 1 or 2 basis points because of the ability to shift the funding mix around.

So overall, the way we're looking at this, given the composition of both our loan portfolio and funding mix at the end of September, is that within 90 days, we would expect there'll be a 1 or 2 basis point impact per 25 basis point change in prime.

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William Jefferson Wallace, Raymond James & Associates, Inc., Research Division - Research Analyst [11]

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Okay. And then with new loans that you're putting on the balance sheet today, how are they coming in on average versus the portfolio yield?

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George C. Coffman, Howard Bancorp, Inc. - Executive VP, Treasurer & CFO [12]

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Unfortunately, lower. The market is competitive. The rate environment, in order to achieve the goal, is driving some of the new loan yields lower than what we're seeing. For example, in the third quarter, the weighted average yield of loans that we originated was 4.45%. That's down from where we were even in the second quarter. And the payoffs that we're achieving because of those that have been on the books for a little while, the weighted average rate, so what paid off in that third quarter was around 5%. So we're seeing some churn in the differential between the new books sold (inaudible) versus what's being paid down.

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William Jefferson Wallace, Raymond James & Associates, Inc., Research Division - Research Analyst [13]

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So presumably, that adds additional pressure to net interest margin. Or do you feel like you've got enough room on the deposit costs to fight that?

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George C. Coffman, Howard Bancorp, Inc. - Executive VP, Treasurer & CFO [14]

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I don't know that we can fully offset it. We're expecting another basis point or 2 just because of the good churn in the loan yield. We can offset most of that through lower funding. But unfortunately, we have to -- most of it is dependent on the timing of the maturities of our CDs and our FHLB. As I mentioned, FHLB is relatively short. But we have to look at the timing of the maturities in the CD portfolio to fully mitigate the loan reductions.

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William Jefferson Wallace, Raymond James & Associates, Inc., Research Division - Research Analyst [15]

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Okay. So putting it all together, it sounds like we're probably seeing 2 to 3 basis points of pressure every time the Fed cuts.

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George C. Coffman, Howard Bancorp, Inc. - Executive VP, Treasurer & CFO [16]

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Yes. I would say 1 to 2 because of a Fed cut and 1 to 2 because of the current market rates on loans.

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Operator [17]

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Our next question is from Catherine Mealor, KBW.

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Catherine Fitzhugh Summerson Mealor, Keefe, Bruyette, & Woods, Inc., Research Division - MD and SVP [18]

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I want to ask about loan growth. I feel like we came out of the First Mariner acquisition, and we're pretty positive for kind of, I'd say, double-digit loan growth, and then we pulled that back just given the competition and what I think, Mary Ann, you called some silly pricing and silly structure in the market. But this quarter had really great growth. And it feels like your outlook for growth feels better just given some of the market dislocation. So can you just kind of put that all together and give us an outlook for what you think loan growth should be as we move into next year?

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [19]

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Catherine, what we're still committing to ourselves and when we look at the budget for next year is, barring any sort of unusual activity, that we still think that we'll average out something in the high single digits rather than the low double digits. This was a good quarter. The second quarter was an amazingly good quarter. The pipeline looks good right now, but it's a little softer, frankly, than it was in the last quarter. So I think what we're feeling very comfortable with is that high single digit and in part because of what I want to call irrational pricing and irrational structure, especially on the commercial real estate side.

Now when we talk about the disruption in the market, again, we believe that this disruption in the market in the short term leads to customer activity. And that customer activity is factored into those pipeline numbers, factored into those growth projections. That at some point, it will begin to translate to personnel opportunities. And we are in discussions with a couple of people who could bring teams on board, and that would clearly have a very different effect because then when you acquire people, you're acquiring whole portfolios. And it's not 1 customer at a time but 3 or 4 customers at a time. But barring that, since we don't have any of that in place right now, I'd say that we're, right now, budgeting for high single digits.

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Catherine Fitzhugh Summerson Mealor, Keefe, Bruyette, & Woods, Inc., Research Division - MD and SVP [20]

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Okay. That's a bit helpful. And then on CECL, if I'm right, you're a smaller reporting company. So are you eligible for the CECL delay? And do you plan to take that?

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George C. Coffman, Howard Bancorp, Inc. - Executive VP, Treasurer & CFO [21]

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No. We are eligible for the deferral, and we are very happy about that.

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Operator [22]

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(Operator Instructions) Our next question is from Joe Gladue, Alden Securities.

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Joseph Gladue, J. Alden Associates, Inc., Research Division - Director of Research [23]

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I just wondered if you could touch on the buyback program, sort of what's your criteria for when you'll be active and when you'll hold back.

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [24]

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So we are presently active in the market. As you can imagine, we don't want to disclose the target price, although we've recently adjusted the target price to ensure ourselves of the ability to do a pickup there. But we are presently albeit, to date, modestly active in the market. So the buyback program is active.

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Joseph Gladue, J. Alden Associates, Inc., Research Division - Director of Research [25]

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Okay. All right. And just a question on the new core system. Can you give us a little color on, I guess, when is that conversion or when was it? And are there some expected additional costs associated with that?

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [26]

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All right. So it's a renegotiation of a contract with our existing core provider, Joe. So very fortuitously, no need at all to go through any sort of conversion with any of our customers. It's a chart that I focused on earlier would show we might be the only bank in the market not going through a systems conversion, but we will not be going through a systems conversion. And we expect there to be savings. If you assume present volumes right now, we expect there to be savings. As we grow, the cost increase will be much less than it would have been otherwise. So it's pretty much a win-win-win in that we will not have a systems conversion need. We will have decreased cost rather than increased cost. Again, it has been negotiated. It's been signed. You'll start to see that in the fourth quarter. And there will be some enhancements, product enhancements to some of our commercial TM product sets. So all positive.

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Operator [27]

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We have reached the end of the question-and-answer session. I will now turn the call back over to Mary Ann Scully for closing remarks.

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Mary Ann Scully, Howard Bancorp, Inc. - Chairman & CEO [28]

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So I'll thank everybody again for being on the call, thank everybody for the quality of the questions, remind everybody that we are always here, George and I, in particular, to answer any more detailed questions that you might have as you look at modeling or you think about valuation.

As I think you could probably gather from the tone of the call, we're very optimistic. We don't see necessarily a rapidly growing economy, we also don't see any imminent signs in our marketplace of a recession, but we are very confident about our ability to grow our market share because of the focus that we have on small and medium-sized businesses who tend to be very well served by banks that can make all the decisions, including policy decisions, in their local marketplace.

So thanks, everybody, for your support. And if you have other questions, please do not hesitate to reach out, and we'll walk you through any more details that you might need.

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Operator [29]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.