TBK investors had a very good year in 2017. Our stock price returned over 20% (and has continued to significantly appreciate in early 2018). There are many factors that affect our stock price, but the only one that we can control is our execution of the business plan. To that end, we did many things right and a few things wrong last year. Overall, it was a very strong performance. We have put ourselves on a favorable trajectory for 2018 and beyond. Our future is bright!
The first quarter was noisy…
We did some things really well in the first quarter of 2017, but those good results were clouded by a couple of issues. Those included a spike in chargeoffs in our healthcare asset based lending business (which we have now exited) and related to three loans inherited via the acquisition of Colorado East Bank & Trust. In any M&A deal, there are a few surprises. The leadership team at TBK has completed several M&A deals — both as part of our current team and in previous employments. We have experience evaluating, acquiring and turning around distressed banks. While we find most of the surprises in our diligence efforts prior to signing a deal, we found a few after closing on this transaction.
Whenever we have a loss or a surprise, we target to learn from it. Several years ago, our chairman, Carlos Sepulveda, told me, “Aaron, let’s always turn our losses into tuition by learning from them.” That is precisely what we have done and will continue to do. Our M&A playbook, loan policy, and operating procedures are evolving programs that improve as a result of our experience. We have a formal process to review lessons learned whenever we experience a loss so that we get the full value of the “tuition” we paid.
We also sold Triumph Capital Advisors, our asset management business, in the first quarter. We made this decision in light of “risk retention” and other regulatory headwinds to operating a CLO manager inside of a bank. This sale resulted in a substantial gain for TBK.
…but the rest of the year was a symphony.
“Noise” in reported financial results due to M&A is not bad per se, but it causes confusion for investors trying to comprehend TBK’s trajectory. Underneath the noise in our financials, the trends are very good for our business. Here are a few examples:
So where do we go from here?
Our goal is simple: we want to be the most valuable bank we can be. Not the biggest or the fastest growing. Not the one that makes the most money in a single year. We want to be the most valuable according to the following metrics:
When it comes to creating shareholder value, we know that it is highly correlated to generating consistent financial returns. We are very specific on what we are aiming for in this regard, which we illustrate on the following page. Astute investors will note that we have made subtle adjustments over time to the components of our return on average assets (ROAA) target. Those changes reflect our expectation that the more cost-intensive areas of our business (e.g., commercial finance) will grow faster than the more traditional areas. By cost-intensive, I mean lines of business that require more overhead per asset but also generate higher returns. For example, it takes far more team members to generate and service $50 million in net funds employed in our factoring business than it does to generate and service $50 million in real estate loans, but we also generate higher risk adjusted returns on that same dollar amount of assets in factoring versus real estate lending.
We have also increased our long term ROAA target to 1.8%. This is largely due to the benefits we will realize from tax reform passed late in 2017. Our expected tax rate will decrease by double digits in 2018 vs. 2017. A smaller tax bill will improve shareholder returns.
Building blocks for value.
Last year, I talked about three building blocks for value: (i) maintain credit discipline, (ii) maximize operating leverage, and (iii) focus on core deposits. I wrote at length about why we believe those are the key metrics last year, so I will just touch on our progress on these fronts here.
Our credit challenges in the first quarter were a painful reminder of the vigilance and discipline we have to exercise in maintaining credit quality. This obviously applies to loans we originate and loans we inherit through bank acquisitions. Our emphasis on this discipline increased significantly in 2017, which contributed to the favorable asset quality trends we created throughout the balance of the year. Maintaining this focus will serve us well in the future.
Healthy growth will lead to greater operating leverage for TBK. This is evident if you compare our current efficiency metrics to those when we became a public company in 2014. We are making investments in 2018 related to new technologies, new products, staff development and operating processes to become “future ready.” These investments are necessary to achieve long term improvement in operating leverage. We expect meaningful improvement in operating leverage as we move past the $5 billion mark in assets.
On the deposit front, TBK will be launching 12 new retail products in 2018. These products will add sophisticated feature sets to our product line in our branch and digital channels. Additionally, TBK will launch seven products to aid in the sophistication of our back office operations, including fraud and anti-money laundering protections, pricing tools, analytics and the identification of cross-selling opportunities. Together with a more visible brand presence, we expect these tools, in the hands of our dedicated and joyful retail team members, will lead to greater core deposit growth.
A deeper dive various segments.
Community Banking. With the acquisition of nine Colorado branches from Independent Bank in October and the purchase of Valley Bank & Trust in December, we increased our presence in Colorado to 32 branches. We now have 53 branch locations overall. Many of our Colorado branches are located in prime growth areas, which positions us for future organic growth.
In our Midwest division, we have already announced that we are rebranding our branches from “Triumph Community Bank” to “TBK Bank” at the end of the second quarter of 2018. In advance of the physical rebranding of our branches, we will roll out the TBK Bank brand in this market with cobranding opportunities, including the TBK Bank Quad Cities Marathon. We have also acquired the naming rights for what will be one of the nation’s largest youth sports facilities, which is currently under construction in Bettendorf, Iowa. We are confident that our rebranding will be well received in these markets and that we will continue to deepen our presence in our Midwestern markets.
In Dallas, we are in the process of building our first standalone branch, which should open in the fourth quarter. Our vision is for something very “epic” when compared to the typical bank branch experience. In addition to the cool factor — and it will be very cool — this branch will allow us to service and grow banking relationships in Dallas, which will be a significant contributor to our organic deposit growth strategy. Check out http://epicbanking.com/ to stay informed
Commercial Real Estate. In most community banks, commercial real estate (CRE) is the primary income driver and the greatest risk concentration. Because individual loans are relatively large, have a longer tenure than most other types of lending and require minimal monitoring after origination, community banks typically gravitate to this asset class. When the market cycles, CRE values can move around substantially. While we don’t believe that we can time the market, we do choose when, where and on what basis we become active participants. In 2017 we made CRE loans to experienced and well capitalized sponsors and developers. These loans were principally in multi-family, office, and self-storage across the country. We finished the year with commercial real estate exposure equal to 204% of capital, which is a conservative concentration relative to our peer group.
Mortgage Warehouse. Our mortgage warehouse strategy is to provide liquidity to medium to large independent mortgage bankers through purchase/repurchase agreements, whereby we purchase mortgage loans they originate at closing and they repurchase the loans upon selling them to long term investors a few weeks later. We focus on a small group of customers and endeavor to provide best-in-class service levels to achieve higher line utilization and increased efficiency. This strategy led to a 63% increase in loan balances compared to 2016.
Commercial Finance. For TBK, commercial finance includes the following disciplines: factoring, asset-based lending (“ABL”), equipment finance, and premium finance. This group achieved exceptional organic loan growth of 46.2% in 2017. We drove our success by serving small- to middle-market companies in a wide range of industries through an expanding national presence. With our sixth year of this unit now in the books, our experience and research tell us that our customers value our uniqueness. Customer surveys and market research reflect a view of most financial companies as “standardized” and “slow” (a reputation the banking industry has unfortunately earned) and as not having their best interest in mind (e.g. many merchant cash advance lenders). With TBK, they have found a financial partner that delivers custom-tailored solutions at the speed of business.
They have also found a partner that cares about seeing them grow. Our customers know that TBK wins when they win. It’s the best way to build a sustainable and valuable business that is appreciated in the market.
Our equipment finance unit continues to deliver solid growth and credit quality due to its focus on specific industries: transportation, construction, and waste/refuse. Our strategy is to stick with what we know. Due to our expertise and brand recognition in these industries, our team is able to deliver tailored solutions that create value for, and gain loyalty from, our customers. This focused strategy also creates a natural underwriting discipline that generally protects us from unpleasant surprises. The secret to our success is our team and their ability to create financial partnerships with our clients rather than depending on an equipment dealer network for referrals, which usually comes with greater credit risk.
Triumph Business Capital (TBC) provides financing to small businesses by purchasing accounts receivable from our customers. TBC operates in several industry verticals. Our largest and most dominant vertical is in the transportation industry. We are one of the nation’s leading providers of discount factoring to for-hire truckers and freight intermediaries. For our smaller trucking customers, we function as their back office — from generating invoices on their behalf to collections to negotiating fuel discounts. This past year was a record year for TBC. We purchased 1.8 million invoices, representing $2.8 billion in trade volume, from over 3,100 clients. We benefitted from a strong trucking market in which the average invoice size increased 16%, fee revenues grew 37% and profit contribution grew 46% from 2016. We invested over $2 million in proprietary technologies and expanded our geographic presence by opening a new Chicago office in November. I am a huge fan of this business. I have seen customers start out with one truck and grow their business into fleets approaching 100. Many of our customers are first generation immigrant achieving the American dream and we are honored to support them.
An epic bundle of potential.
After two years of development, we launched TriumphPay, a technology and payment portal, on an enterprise scale in late 2017. Now serving over 70 transportation intermediaries, TriumphPay provides supply chain financing to freight brokers and other service buyers through vendor-selectable “QuickPay” options. Our early experience confirms both substantive expense savings for buyers and cost-effective liquidity for service suppliers.
In addition, we are developing a funding solution for the transportation industry’s blockchain initiative. TBK is a charter member of the Blockchain in Transportation Alliance (BiTA), and is currently serving on its board of directors. BiTA is a recently formed trade association whose membership now represents 85% of domestic freight tonnage. It is important to distinguish between blockchain technology and cryptocurrencies, such as Bitcoin. While cryptocurrencies are generally based upon blockchain technology, we are not sure if they are the next gold rush or the next bubble to burst or both. TBK is not currently involved with cryptocurrencies, but we steadfastly believe that a distributed ledger technology (which is built upon blockchain infrastructure) has enormous potential to create speed and transparency in the supply chain. This will be disruptive to the least efficient market segments, including some in which we’re highly positioned, such as transportation factoring. Thus, we are investing to become an innovator rather than waiting and hoping for the disruptive forces to go away.
Our opportunity with TriumphPay and its blockchain integration is truly epic in potential scale. The size of these markets and our advantage as a first mover could create value for our shareholders that is exponential and asymmetric to the growth of our core banking business. We will continue to invest and lean forward into technology based opportunities in these areas with great excitement. In closing, I want to thank our shareholders and customers for placing your trust in us and thank our team members for your unwavering commitment and hard work. Your leadership team holds our responsibility to you with the utmost regard. I wish you all the best for an epic 2018!
Aaron P. Graft
Vice Chairman and Chief Executive Officer