SmartFinancial Inc (SMBK) 2017 Q2 法說會逐字稿

Good morning, and welcome to the SmartFinancial Second Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Frank Hughes, EVP of Investment and Institutional IR. Please go ahead.

Thank you, Phil. Good morning, and thank you for joining us today on our second quarter 2017 earnings call. With me this morning is Miller Welborn, Chairman of SmartFinancial Inc.; Billy Carroll, President and CEO; Bryan Johnson, our CFO. After our prepared remarks, we will take questions. Yesterday evening, we issued an earnings release discussing our second quarter results. We've also prepared a slide presentation which we will refer to during our remarks this morning. Both of these can be found on our website at smartbank.com in the Investor Relations section.

During the call, we may make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the safe harbor provisions of the federal securities law. Actual results and trends could differ materially from those set forth in these statements due to various risks, uncertainties and other factors. More detailed information about these and other risk factors can be found in our press release that preceded this call and in the risk factors and forward-looking statements sections of our annual report on Form 10-K. Statements are valid only as of today's date, and the company disclaims any obligation to update this information except as may be required by applicable law.

Additionally, today's presentation contains non-GAAP financial measures, the reconcilement of such measures to the -- to the most comparable GAAP figures are included in our earnings release -- our earnings press release at the end of our earnings call presentation. Please also note this event is being recorded.

I will now turn our call over to our Chairman of the Board, Miller Welborn.

Thanks, Frank, and welcome to everyone listening on the call. Today, I'm going to provide a brief review of the bank's strategic priorities and accomplishments. Afterwards, Billy and Bryan are going to give a review of the bank's operational priorities and financial performance.

If you will go to Slide 4, if you're looking at the deck. First, I want to thank Billy and his executive team as they continue to move this company forward. We have an incredibly experienced and talented executive team, and I have complete confidence in their ability to execute the next several phases of our journey. I'm also motivated by the extraordinary group of talented associates who have taken great pride in their work every day and demonstrate the entrepreneurial spirit that SmartFinancial continues to embrace.

If you want to move over to Slide 5. Last quarter, I laid out our focus on long-term shareholder value growth. This value is created by focus on both organic growth while pursuing an aggressive acquisition strategy to create enough scale to optimize our expense and revenue efficiencies. Our acquisition strategy has 3 priorities: first, certainly, earnings-accretive transactions with well-balanced loan portfolios and profitable branch systems would be #1; second, to fill voids in our current market coverage that will create dense geographic efficiencies; and third, finding partners that share similar culture who want a wow experience for our customers.

Moving on to Slide 6. I certainly believe we've accomplished all 3 of these priorities with our recently announced acquisition of Capstone Bancshares. The deal is immediately accretive and its location gives us more scale in Alabama and the Florida Panhandle. And to put icing on the cake, their primary market of Tuscaloosa is very similar to our primary markets, especially Chattanooga and Knoxville. All of these cities have state universities, and we've told you all before, this is a major priority for us. And each of these cities have major manufacturers with recent investments in their area and are considered cities that have strong momentum and are making impressions nationwide as the location to be.

Capstone's personnel are talented and excited about the energy of SmartBank and have a similar focus on their customer base and they'll blend easily into our Smart way and create wow experiences for our customers. We expect to close this transaction in the fourth quarter of this year, and you can be assured we will continue talking with potential partners and will continue to evaluate opportunities that we believe will be solid, strategic fits and meet our financial metrics.

Now I want to turn the call over to the architect of our plans, our President and CEO, Billy Carroll.

Thanks, Miller. Good morning, everyone on the call. I'm going to begin with highlights of the quarter and the year, year-to-date. I'm then going to turn it over to Bryan to review the financial details in a little bit greater depth. Then I'll pick back up, discuss the recently announced planned acquisition and some major financial metrics.

But if you're following along on the deck, let's take a look at Slides 7 and 8. Let's start on Slide 7, which has some of the second quarter highlights. For the quarter, we had very solid results, especially when you look under the surface as Bryan will do a little more detail on this in a moment. But I want to highlight just a few of those items. Our income available to common shareholders totaled $1.6 million for the second quarter 2017 or about -- right at $0.20 per diluted share, which was the highest quarter of net income available to common we've had since the merger, our combination with Cornerstone back in late '15. Specifically, net income available to common shareholders was up over 79% from a year ago as the company is capitalizing on the synergies of that merger and increasing net interest income by 7%, while limiting noninterest expense increases to a little over 4%. Impressively, when you look at net operating earnings year-to-year, the improvement is even greater.

We had gross loan growth for the quarter of approximately $58 million. That was assisted by the closing of our Cleveland, Tennessee branch purchase. The primary driver of loan growth outside of that, however, was organic with over $35 million organic dollars in loan growth during the quarter. Our margin remains strong at over 4.15%, and asset quality is outstanding with nonperforming assets to total assets dropping to just 0.31%.

Turning to Slide 8. You can see a summary of our key metrics for the last 5 quarters. Our ROA ticked down a few basis points due to those merger-related expenses that we'll discuss for the quarter, and those were not tax deductible. But absent those expenses, ROA would have been north of 75 basis points. You see that over the 3 quarters, we've held net interest income to average assets around 3.8%, thanks to our success in maintaining margin and efficient balance sheet management.

Looking to noninterest income. You can see this was our best quarter of the last 5 relative to average assets at 0.47% as well as in absolute terms of $1.3 million. I mentioned that noninterest expense was elevated primarily due to merger-related expenses during the quarter, which we expect to be lower going forward. So excluding merger expenses, our EPS was right at $0.25 a share. So all in all, I feel very good about the solid performance we had in Q2.

I'm now going to turn it over to our CFO, Bryan Johnson, and let Bryan jump in and go over financials in a little greater depth.

Thanks, Billy, and good morning, everyone. As Billy said, we're very pleased with the results for the second quarter of 2017. There are some areas in our results, as Billy mentioned, that are worth noting. So let's begin by turning to Slide 9, which is the earnings profile for the quarter.

Net income for the quarter was $1.6 million compared to $1.2 million a year ago. As Billy mentioned, a key driver for that improvement was the growth in net interest income by 7%, which is primarily due to average loan balances up 11% compared to the prior year.

Turning over to Slide 10. Net interest income totaled $10.2 million in the quarter compared to $9.6 million in the second quarter of 2016. Key drivers leading to the increase in net interest income were the loan growth we mentioned previously, plus the increase in yields on the securities portfolio. We did have some slight increases in deposits, but so far that's been primarily isolated to specific clients and select markets on few account types. We believe we can continue to lag increases on the rates on our deposits as a whole.

Finally, you can see on the chart that our net interest margin taxable equivalent compared to what it would have been without any purchase accounting adjustments. While there is some variability due to the adjustments, on average, purchase accounting adjustments have increased our margin by about 22 basis points the last 5 quarters.

Turning to Slide 11. You can see the improvement in noninterest income that Billy mentioned earlier. The fact it was our best quarter in the last 5 is impressive. What is really telling is the trend we've had in what we refer to as core noninterest income. Last quarter was the largest -- the largest improvement was due to gains and higher volumes in sales of SBA and mortgage loans. While there is some seasonality in mortgage and SBA loans do take a while to process, close and sell, we do believe the second half of the year will be more like the second quarter as opposed to the first. In addition, we'll continue to forecast increases to service charges on deposit accounts as we roll out our overdraft products to the Chattanooga and Cleveland markets.

Turning to Slide 12. Noninterest expenses were up primarily due to the $420,000 of merger expenses we mentioned earlier. Excluding those, our efficiency ratio would have been about 73% for the quarter. You can see, looking at the bottom 2 sections of the columns, we continue to keep our biggest cost of salary and EB and occupancy fairly steady. In fact, they're up less than $100,000 year-to-year. And what increases we do have are primarily due to the addition of new revenue-producing personnel. Data processing was down slightly from a year ago, up slightly from the prior quarter, but we think what we had this quarter was what will be an average run rate for us barring any merger or conversion expenses.

Turning it over to Slide 13. On the balance sheet, loan growth is the first thing that jumps out at you. As Billy mentioned, $58 million for the quarter. And as we've noted, about 60% of $35 million of that growth was organic. So while the Cleveland branch acquisition was material, we were going to have a great quarter with or without it. Also on the asset side, we did end up a little cash heavy and securities light. Part of that is due to the nature and the timing on some of our larger noninterest bearing accounts, and part of it is due to the fact that we had our reinvestment rates drop on us towards the end of the quarter. On the liability side, the only deposit type which did increase both in [period end and] average balances was on the interest-bearing demand deposits. So everything else, very nice, strong core growth.

Moving on to our loan portfolio on Slide 14. We've already touched on the fact that loan growth was up 12% over last year. In the chart, you can see the growth has been broad based. The only area where we went down was in C&D, which luckily, as it would have, it helps us drop even further in those 100 and 300 guidance ratios.

Turning over to Slide 15. You can see our asset quality is outstanding, as Billy mentioned. Nonperforming assets, down over 50% year-over-year, just 31 basis points of total assets. Our allowance continues to increase as originated loans make up a larger percentage of our portfolio. Allowance was $5.5 million or 64 basis points of the portfolio compared to $4.7 million or 61 basis points a year ago. Also worth noting, as you can see, that we have another $9.1 million in additional discounts on those $186 million of purchased loans.

Finally, turning over to Slide 16. That shows the deposit composition for the last 5 quarters. Over the last year, mix has changed for the better. We've increased core noninterest demand deposits, interest-bearing demand deposits, money market and savings and reduced higher-cost wholesale and in some cases, higher-cost local deposits. Change in the mix is the large reason why we've been able to keep the increase in cost of funds to just 8 basis points while the Fed has increased the target rate by 75 basis points over the same period.

So wrapping this up, we're really pleased with our performance in the second quarter of 2017. We look forward to the remainder of the year. I hope this has been helpful. Billy, with that, I'll turn it back to you.

All right. Thank you, Bryan. Again, as Bryan said, I feel really good about the progress we continue to make on a quarter-on-quarter basis. I'm going to pick up and talk a little bit about a few other items. If you want to flip in the deck to Slide 17 through 19. We are extremely excited about our upcoming acquisition of Tuscaloosa, Alabama-based Capstone Bancshares, as Miller had mentioned in his opening remarks. We are moving forward in all planning aspects of this integration, and all of that has gone really smooth so far. Capstone shareholders will receive a mix of 20% cash, 80% stock and a deal valued at about $85 million.

As you can see in the deck, we've got the summary transaction terms there. We feel like this is a very fair deal, and I'm very excited to add the 2 new board members from Capstone. That will increase the total number of directors in our company to 13 when complete. And we anticipate, after our cost saves, an expected 25% annual earnings accretion. So outstanding earnings accretive deal where we think -- we anticipate tangible book dilution being earned back in approximately 3 years.

As Miller said earlier, this is a fantastic acquisition that meets all of our priorities. We're really excited about their markets and the synergies that we're going to achieve, specifically, the ability to tie in our Florida branches and lines of business with Capstone's teams. We believe there's a tremendous upside in this Tuscaloosa market, which is led by the University of Alabama and several large manufacturers, such as Mercedes-Benz, that will be great economic engines for the next couple of decades. We anticipate a Q4 closing of the transaction and a Q1 2018 conversion and a rebrand.

Flipping over to Slide 21, something that we're very, very proud of that we've announced in our markets. As we continue to build on our culture, it's sure nice to get recognized for that, get some validation on what we are doing on that hard work and that is that we've continued to succeed in building -- laying the foundation to build something very special with this company. This has been demonstrated by our recent award that names SmartBank a 2017 Top Workplace in Knoxville. The award proves that our culture is working, and that SmartBank is a great work environment that will attract and retain top talent now and in the future.

Let me sum everything up. As you can see, solid quarter highlighted by 90% growth in our quarterly core net operating earnings year-over-year. We also had strong loan production with a more balanced mix of origination, specifically high-quality C&I, while construction and development loans decreased as a percentage of the loan portfolio. In the supporting slides, you'll also note that we are now well below our regulatory guidance on the 100% and 300% CRE capital ratios. Excited to see that trend moving in a great direction as we shifted our mix to non- -- a little more non-CRE production over the last couple of quarters.

We closed our Cleveland, Tennessee branch purchase, acquiring over $24 million in loans and $24 million in deposits in one of the fastest-growing markets in Tennessee, Bradley County. To leverage this acquisition, we lifted a team of producers to lead the market, and it seemed this deal will be immediately accretive.

In addition, we've added several new producers in existing markets that we will continue -- and we will continue our recent record of strong organic loan growth as we continue to add those producers as we've had out in Q1 and Q2. The key to that is just finding talent that aligns with our company, and so far this year, we've had great success in doing that. We are continuing to shift our employee mix to a higher percentage of revenue-producing team members. That's been one of the big tenets that we've worked hard on this year. That has been one of the factors that's kept our efficiency ratio a little bit elevated, but we've expected this. But we also expect to see that continuing to tick down in the coming quarters.

Another area of success is our mix of core deposits that migrated away from noncore funding to noninterest-bearing and interest-bearing transaction accounts. You'll see that in slide -- in the supplemental piece of the deck as well. This has allowed us to keep our funding cost fairly level even in a rising rate environment.

We believe these actions have positioned us well for solid growth over the next several quarters and anticipate we will meet or exceed the results expected by our investors. As Miller said earlier, we are laser focused on long-term shareholder value and exploring opportunities that will take us in that direction.

So that really concludes our group's prepared remarks, and we will open it up for any questions.

(Operator Instructions) The first question comes from Joe Fenech with the Hovde Group.

Billy and Miller, just with -- quick question on future plans. Capstone projected to close by year-end. Can you update us on your M&A strategy, how we should be thinking about geography, I guess, in light of the market expansion here with Capstone, your size parameters? Just wanted to get an updated sense of where you go from here post Capstone and then timing of when you'd be comfortable in making your next move. Do you wait for Capstone to close and convert? Or would you be willing to sort of run a parallel path on other opportunities?

Great question, Joe. I don't think our strategy has changed any. We're continuing to look at good Tier 2 markets. We feel like we keep 6 or 8 different folks in the pipeline, in the queue. They might change in their order of prioritization from quarter-to-quarter or month-to-month, but we are actively meeting and visiting with folks on a weekly basis, both to do fill-ins or to get a little more dense in areas where we already are and to do new markets that would be complementary to where we are. It's interesting that for the first year or so when we were doing this, Billy and I were having to make the outbound calls to convince people to sit down and tell our story. We have been excited over the last -- it's really since we announced this Capstone. We are still making those outbound calls, but we are starting to feel some inbound calls with folks saying, "Hey, I'd sure like a visit with you." So we feel pretty dadgum optimistic and boy -- and as far as when you might see the next one, I wouldn't say I'm impatient. Gosh, I'd love to go ahead and do another one, but there's no way to tell. I'm not going to speculate on when that might be.

Yes, and Joe, I'll just add, when you look at the pro forma branch map, and I think you all have probably seen, we've got one in the deck, the great thing about this Tuscaloosa opportunity is it really -- again, it helps solidify that southern component of our franchise. And so it really -- when you look at east Tennessee and you look at -- middle to east Tennessee, you look at Alabama, you look at the northern Atlanta arc, there's so many opportunities now. And I think as Miller said, I think that's what's opened us up to being able to explore a number of opportunities. And you guys know there's a lot of -- everybody is out trying to check and see what's going on and putting some feelers out and continuing to grow, but it's exciting for us. And so we think middle to east Tennessee, the Alabama market, north Atlanta, all could be great opportunities. I don't think strategically, we're looking to really move outside of those zones. So we'd like to probably stay in those. But as you know, we're a pretty entrepreneurial group. And if the right opportunity presents itself, we could pivot a little if needed. But we think those are good, and as Miller said, timing -- the great thing that we've been able to do, we've done a lot of work over the last year getting our team ready to do an acquisition like the Capstone. So we're working hard building out some experience in those operational areas where we need to. We'll be ready to go when that next opportunity arises. But obviously, we don't want to get out too far over our skis from the operation side. So we'll make sure that we've got it buttoned up first.

Okay. No, that's helpful color. And I guess I was just wondering, in an ideal world, do you have a strong preference, not for a particular bank you'd like to acquire, but just one of those different opportunities? Or you -- it sounds though to me like you're agnostic about whether it's new market entry, filling in some other newer markets or bolstering around the home base and that you just go for the best deal from here. Is that fair to say?

I think obviously density. You've heard us talk about building density is really important, and so we'd want to build density in markets where we are. But we also kind of look at this, and as you've heard Miller and I talk about, we've got a good strategy to build out a great southeastern franchise. And so if the next best opportunity is maybe one where we're not going to go outside of our -- too far outside of the scope of where we're looking, but we really want to at least stay within our region, obviously density is important. We want to do that. Or if we know -- if it's not that, we want to make sure we're going into markets where we've got great upside.

Yes, our 3 priorities haven't change and don't see them changing in the foreseeable future.

Okay. And then any update on longer-term profitability targets, guys? I'm assuming you think Capstone gets you closer and accelerates the time line to those targets you had identified publicly with the capital raise, but again, just sort of looking for an update in light of the deal and the opportunities you see in front of you. And when -- also, I guess more specifically, have you had a chance to fine tune maybe what you think Capstone does for you specifically from an earnings accretion standpoint 12 to 18 months out?

And we have -- Bryan, do you want to hit that or touch that? Or do you want me to jump on in?

Yes, I'll -- as we said, we're anticipating a 25% earnings accretion on what we think would probably be our target somewhere about -- as I said, this quarter we did about $0.25 when you take the merger expense out. So we're on a -- we can look at, Joe, if we're on $1 a share run rate today from a core standpoint, we think that this thing is going to pick us up into the, probably, in the $1.25 going into next year, potentially more. I think we've modeled it out potentially a little more than that. So I think we're going to get to this $1.25 to $1.35 EPS number that we anticipate next year along with trending up, getting really close to that 1% ROA by the end of next year. I think as we project out, look at those metrics, we're still right on that time line. It just speeds the -- the Capstone deal just speeds up the EPS.

We think it's extremely crucial to be accurate and hit the targets that we project to you all, and we anticipate just really drilling down to be able to hit those targets.

(Operator Instructions) The next question comes from Daniel Cardenas with Raymond James.

Just a quick follow-up on the M&A strategy. Any change to the size parameter, the size of institution you'd be focusing on once the Capstone deal is closed and you're a little bit bigger?

Yes, no, Dan, I still think we are -- we're still looking at probably that, primarily, if we're looking at an integration deal, that we're probably still at $200 million to $500 million. I think the Capstone deal was kind of on the outer edge of within, again, a great market that we're very comfortable in. So we kind of pushed the higher end of the target on this transaction. I still think we're right there. We could go -- it might be -- it could go a little above the $0.5 billion. I don't see us looking at anything much on the smaller side, really much under. There might be a strategic deal that we would want to do under $200 million, but probably $200 million to $500 million is still the primary target.

And I would agree with that. I don't think we've gotten big enough to have to start moving the sliding scale up any. At some point, I think they might get too small. But gosh, we might find a good fold-in that's $150 million, $200 million and roll it right in. I would also wouldn't rule out -- we're probably one of the few folks who aren't afraid to look at -- we've proven an MOE doesn't scare us. So we're continuing to look at the same size we have been over the last year.

Okay. And what are seller expectations like right now? Are they beginning to -- is a disconnect beginning to build a little bit here?

I don't think so, Dan. I think obviously with over the last year, we've seen valuations trend up. So I think folks are still relatively reasonable, the conversations that Miller and I have had. I mean, obviously, folks want nice premiums for good banks. But I think overall, still reasonable and expectations trending up, I think, is a fair statement, but still reasonable.

I would agree with that. I don't think we have many conversations with people who are unreasonable. So I would say, if we continue the conversations, we seem to be on the same page.

Okay. All right. And then looking at loan growth, maybe some color on the pipeline, how it compares coming in to 3Q say versus a quarter ago. And then geographically, where do you see more opportunity?

Pipeline for the second half, which are like, as we said, organic closings for Q2 were extremely strong. And I've alluded to that in our Q1 call where we were a little flatter Q1, but strong Q2 growth. I think we'll continue to have nice growth in Q3 and Q4. So -- and I think that's going to probably come with a similar mix of what we've seen. I think as we have pivoted a little bit, started chasing and going after more quality C&I, more operating companies, especially now that we're building out the teams in Chattanooga and in Knoxville and in Pensacola where we've got good C&I markets to go after, we're -- I think we're going to continue to see that. The mix probably is similar to what we've added in the second quarter related to that growth. So we feel pretty good about that. And Dan, what was the second part of your question?

Geographically, if there was any one region that was stronger.

Geographic spread has been very, very even there in the first half of the year. Really, all of our markets are -- have been able to really add to those loan growth numbers. So it's really not one market in particular that's growing. I think we're seeing -- in Chattanooga and Knoxville, we're seeing some great opportunities, but we're still continuing to bring in nice opportunities in our Sevier County, our Sevierville and Pigeon Forge market. Cleveland is kind of getting up on play now post branch acquisition down there. And then Florida is continuing to have just nice solid quarter-on-quarter loan growth as well. So it's really been evenly spread throughout our entire footprint, Dan.

Okay. And the growth -- the organic growth we saw this quarter, was that pretty granular? Or was it kind of concentrated to just a handful of larger credits?

Very granular, Bryan. I'm looking at Bryan, Dan. I think really when you look at the mix, a very granular mix throughout all the markets. Isn't that correct?

That's correct. And I mean, you can see it's a little [tough]. I mean, we basically [told people this isn't] the way it happened. But you look at it, $14 million out of C&D and $14 million in C&I, so a really nice mix. And the other thing we kind of alluded to earlier is, I mean, we really touched on, we've had a revenue producer in Knoxville, one in Chattanooga and one in Florida. They've all hit the ground running. While they had a nice second quarter, their loan pipeline for the second half of the year looks a lot better than what they've already booked. So organically, we look to be in great shape.

Good. Good. And then jumping over to the margin. I mean, how sustainable do you think that number is coming into the third and fourth quarter?

Bryan, I'll let you speak to that. I know we talk about it on a very frequent basis because they held -- our margins held really well. And -- but Bryan, do you want to just add a little color to that for Dan?

Sure. I mean, I would say that 4.15% might be on the higher end of what we'd expect. But I mean, we've been able to keep it above 4%. I mean, we might tick down a bit, but I mean, we're going to fight like the dickens, and I think we've done a pretty good job of keeping it 4% or above. And what we've been booking has good rates. As I've said, we've been able to lag on the deposit side. We haven't seen any change on that, and we have a pretty good slug of floating rate, and we are still asset sensitive as our margin has shown. So if the Fed does move, we expect to benefit from it.

And the yield accretion contribution this quarter, you said that's been averaging around 22 bps. Was it right around there again for Q2?

Q2 might have been a little bit higher, might have been 25 in Q2, 20 the quarter before. But on average, it comes on at about 22.

I think we were slightly -- a couple of basis points higher in accretion this quarter, Dan. We had a couple of legacy deals that paid out that gave us a little bit of pop, not material, but a couple of basis points this year -- or this quarter.

Okay. And are there [net] positive influences in the quarter, prepayments or anything like that, that would've helped the margin?

No, we didn't get a real kick from prepayment penalties, if that's what you're referring to. (inaudible)

(Operator Instructions) Seeing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to the Chairman of the Board, Miller Welborn, for any closing remarks.

Thanks, Phil. I'll just close by saying thank you. We're happy with where we are and for our -- with our performance year-to-date. We're right on target where we thought we would be, and we really just want to thank each of you for participating in the call today and for your continued interest in and investment in SmartFinancial. Thanks so much.

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