Brooklyn | In this issue of The Institutional Risk Analyst, we speak to Paul Murphy, Chairman, Chief Executive Officer and Director, Cadence Bancorporation (NYSE:CADE) and also Chairman of its main business unit, Cadence Bank, N.A. Paul formerly spent nearly 20 years at Amegy Bank of Texas, helping grow that institution from just double digit millions in assets and a single location to a bank with assets of $11 billion, offices across Texas and a growing book of business with a focus on energy. Amegy was sold to Zions Bancorp (NASDAQ:ZION) in 2005. Cadence was created five years later to invest in the US banking sector, starting in 2011 with the purchase of $1.6 billion asset Cadence Bank of Starkville, Mississippi. Today, Cadence is $10 billion in total assets and is rated “BBB” and “stable” by Kroll Bond Rating Agency.
The IRA: So Paul, tell us your perspective on the hurricane and its aftermath for the City of Houston, which is an important part of your bank’s footprint.
Murphy: Harvey has truly been an unprecedented weather event. Throughout the storm, our banking services remained fully functional and contingency capabilities were activated to ensure ongoing customer service was not impacted, despite local office closures. As challenging as it was, it served to validate the effectiveness of our contingency planning and preparedness protocols, which withstood this test well.
The IRA: That is good news. What did you do early on in the storm’s aftermath?
Murphy: Employee safety was our #1 concern. We are happy to report that all our team members are safe and secure, for which we are grateful. Sadly, a number of our staff and their families reported water damage to their homes, and many were subjected to mandatory evacuation orders in the Houston area and forced to seek shelter in alternate locations.
The IRA: What is the situation in Houston today?
Murphy: First responders did an incredible job supporting those impacted by the storm, as did thousands of volunteers. It’s often in trying times like these when we see the best in others. Managing the follow-up to this natural disaster will take a monumental and city-wide effort, and we are committed to helping our clients and communities rebuild and continue to prosper.
The IRA: Apart from the tragedy of last week, how are you feeling about the world? We’ve been through the great oil credit bust that wasn’t in 2015, then the election of Donald Trump and related euphoria, and now the long, tormented disappointment?
Murphy: We had a really good second quarter. Made $29 million, core deposits are up nicely, a whole 9 basis points of charge offs. Efficiency ratio at 53%. Return on assets is 1.19% and tangible capital is 12%, so we are feeling pretty good. These are pretty decent numbers.
The IRA: You are a solid performer in the small regional category. We got to find you another bank to buy. We have a long list of non-bank mortgage firms that need to get married to a double-digit asset regional bank, of note. Create a whole bunch of Flagstar (NYSE:FBC) clones to bolster the profitability and stability of the mortgage sector, especially the FHA market. But we digress. Talk to us about the focus of Cadence since we first got to know you and there was a real focus on banking the energy business.
Murphy: At the peak we were almost 19% energy exposure. Today we are closer to 11%. Going into the oil price downturn, we had about $1.1 billion in loans and about 100 energy clients banking with us. We had one disaster in the portfolio with a really tough set of facts. A couple of others got beat up pretty badly and were severely stressed, but just one out of a hundred was a huge disappointment. These were pretty good results, in part because more than half our exposures were in midstream companies where we’ve had zero charge-offs. We’re still in the business.
The IRA: These are very good results and beg the question, why? You and the industry as a whole were preparing for the apocalypse in energy coming up to 2015, but the credit losses simply did not materialize as expected. Provisions were way, way too high vs the actual losses. What happened? Is this another impact of the secular rise in the value of financial assets? As with other asset classes, it suggests that credit events have no cost.
Murphy: Equity markets have been wide-open for oil field services and E&P. Some of these deals that are getting done are priced against a 2018 EBITDA growth J curve that is just stunning. I don’t think it is going to happen. There is not so much of an expectation of an oil price increase but rather an assumption that there will be an increase in activity. We’ll see. The Permian is still red hot with people paying high prices for acreage. The Permian works at $49 per barrel all day every day.
The IRA: So when we see these breathless articles about oil producers operating at a loss, in part because investors are funding the operations, is this accurate? What is the big picture from your perspective as a lender in the energy belt?
Murphy: As with most things, you have to be careful with generalizations. The Energy business is still stressed given the prolonged low price environment. Costs have come down and producers are surviving but returns for investors have declined. In the right area, some operators are reporting 20% IRRs. Our portfolio is appropriately 55% Midstream, and that business is doing well. Natural gas prices are going to remain low for some time to come, but this is spurring an industrial renaissance along the Gulf Coast that is not widely understood. Cheap gas is a huge boost for industry and the economy.
The IRA: We’re waiting for somebody to invent a teeny gas turbine that can go in a car and then maybe Elon Musk will have something with Tesla (NSADAQ:TSLA). In addition to energy, talk about the rest of your credit book. Cadence has a good amount of C&I loan exposure and also some residential. Talk about how you view the rest of the business. Have you participated in the great Texas real estate boom over the past few years?
Murphy: We are heavy on commercial lending. Our residential portfolio is about $1.1 billion and we like the single family asset. Over the past couple of years, we’ve originated over $2.3 billion in residential loans and have charged off $220,000. We sell about half of our new residential originations, the longer-term fixed rate paper. We tend to keep the floating rate jumbos, the private banking paper.
The IRA: And this sounds like well-underwritten production with a 50% risk weight presumably.
Murphy: Correct. Its granular and diverse from a risk perspective. Great paper really.
The IRA: Do you retain the servicing on the residential loans that are sold?
Murphy: We do retain the servicing on some of the fixed rate paper. Over time I expect that we will retain servicing on more of our production.
The IRA: Well, the large banks tend to overpay for loans and servicing, then have to play games with the average life to justify their earlier acts of optimism. But skyrocketing prices have choked off the move-up home purchase market thanks to the Federal Open Market Committee. Dan Perl at Citadel Servicing taught us years ago that the real average life of a mortgage is generally about four years, which is the decision cycle for most families. But maybe that is changing. How has Houston real estate come through the decline in oil prices?
Murphy: Texas, in particular, is growing nicely. If you had asked me three years ago if we’d be adding new jobs every year, I would have said no way. But we have. But to the point about the duration of new production mortgage loans, if you account conservatively for the mortgage servicing rights created when the loan is sold, it is not a problem and can be a very nice busine