SmartFinancial Inc (SMBK) 2018 Q3 法說會逐字稿

Good day, and welcome to the SmartFinancial Third Quarter 2018 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, Executive Vice President, Investment and Institutional Investor Relations. Please go ahead.

Thank you, Austin. Good morning, and thank you for joining us today on our third quarter 2018 earnings call. With me this morning are Miller Welborn Chairman of SmartFinancial, Inc.; Billy Carroll, President, CEO; Ron Gorczynski, Chief Administrative Officer; and Bryan Johnson, our Chief Financial Officer.

After our prepared remarks, we will then take questions.

Yesterday evening, we issued an earnings release discussing our third quarter results. We have 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 today's call, we will make forward-looking statements, which are subject to risks and uncertainties and are intended to be covered by the safe harbor provision of the federal securities laws. Actual results and trends could differ materially from those set forth in such 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 Risk Factors and Forward-looking Statement 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 may be required by applicable law.

Additionally, today's presentation contains non-GAAP financial measures. The reconciliations of such measures to the most comparable GAAP figures are included in our earnings press release at the end of the earnings call presentation.

Please also note, this event is being recorded.

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

Thanks, Frank. Good morning, everyone. I appreciate you joining the call this morning. As each of you know, we released our Q3 '18 earnings at the close of the market yesterday. Our team is excited about where we are to date this year. Q3 continued our pace of improvement in almost every area of the bank, and our board is excited about this team and their ability to drive growth, earnings, operations, risk and credit.

A couple of highlights from Q3. We did complete our sub debt raise of $40 million. Our earnings of $4.3 million more than doubled our $1.7 million earnings in Q3 '17. Our yield on earning assets was up about 33 bps to 503. Our ROE, ROA and efficiency ratios continue to improve as projected and promised, and our credit remains pristine.

Overall, we are very positive about the balance of '18 and excited about the bank today.

Now I'm going to turn it over to Billy and let him dig in just a little bit for you.

Thanks, Miller. I'll begin today with some highlights for the quarter and in the year, and then I'm going to turn it over to Bryan and let him dive into the financial results in a little bit greater detail. Then he'll turn it back over to me, and I'll give you a little color on what I expect as we wrap up the remainder of 2018.

As Miller said, overall, I think a very solid quarter for our company, and we feel extremely good on where the bank's positioned today. Just to note, in the deck, we've also made a few changes to it, with the first several pages being an overview for our company for those of you on the call that may be new to our story.

But let's go ahead and jump into the highlights of the quarter, and we'll start off from here. Our story, not to bury the lead, our story and corresponding financial metrics are moving along as expected and we really feel good about where we are today. If we look on Slide 10, if you'll start Page 10 of the deck, net income of $4.3 million for the quarter, up significantly, as Miller stated, from a year earlier, with our net operating earnings non-GAAP right at $5 million for the quarter. This is a record earnings quarter for our company and something that we're very proud of from that front. ROAA, 0.85% for the quarter, with a net operating return on average assets non-GAAP of 0.98% right at our 1% target. Net interest margin of 4.11% was a -- our core NIM tightened a little as we had some accretion impact differences quarter-to-quarter. We're going to dive into that a little bit deeper in a moment, but overall, continue to hold a relatively strong margin. Nonperforming assets of 0.27% for the quarter demonstrates credit quality continuing to hold firm. And as Miller said, completed a subordinated debt offering of $40 million with some of the best terms that the market has seen recently on top of receiving an investment-grade rating from the Kroll Bond Rating Agency. That coupled with obtaining all of approvals for our Foothills Bancorp acquisition highlight the quarter. Again, another very busy and very productive quarter for SmartFinancial.

If we'll flip over to Slide 11, I really like this slide. I think it tells a really good story on where the bank is -- has been moving over the last several quarters. Looking at these 4 charts, I draw your attention to the trendlines on ROA, ROE and the efficiency ratios, all trending in a very positive direction just as we had projected. On net interest margin, we continue to hold relatively well. The chart shows the accretion impact with Q3 realizing a little less accretion than the previous quarters. But excluding all accretion, we continue to hold in high 3s, reporting a 3.85% for the quarter. Bryan's going to delve into the components of that margin a little bit, so I'll stay right there with that -- with him jump into those.

Just some additional comments before I flip it over to him. Loan growth overall was sound but a little bit slower with net -- from a net balance standpoint due primarily to payoff from some acquired CRE loans. Loan balances grew about $10 million late in Q3, while most of those payoffs that I discussed were anticipated, we did not expect them to have quite as lumpy or be quite as lumpy as we did as we saw in the quarter. We had a little -- just a little bit more anticipated paydowns and payoffs in Q3. That's a trend that I do not see continuing, and I think most of those payoffs are behind us now as we look forward.

Loan production was very healthy and on target for the bank and still -- we still feel very good about our high single-digit organic growth targets moving forward. Including the Southern Community Bank transaction, we are up around 20% in the loan balances for the year.

Deposits for the quarter were adjusted with our Southern Community Bank transaction. Bryan's going to walk through the mix in a little bit and talk about some of that reshuffle. From an efficiency standpoint, we posted a solid 67% core efficiency ratio and continue to gain momentum from our recent deals. Our noninterest expense to average assets was down at 2.90%, which was a new low for that financial metric.

Core ROA and EPS were in our target ranges, as we move toward our consistent 1% ROA goal, and then with a 39% -- $0.39 core earnings per share number, we felt earnings were solid for the quarter. And as I said earlier, credit quality, which is the crux of what we look at here at the bank, credit quality remains very sound, with nonperforming assets to assets at a 0.27%.

Again, overall, I feel a very solid quarter as we digest and shift some areas around with our recent transaction. But I think the real story is just continued progression in our core operating metrics and movement in a positive direction there.

I'm going to stop there, turn it over to Bryan and let him jump into the financials in some greater detail.

Thank you, Billy, and good morning, everyone. As Billy said, we're very pleased with everything we're able to accomplish in third quarter. I'm going to start on Slide 12, which is our earnings profile for the quarter.

As we already mentioned, EPS was up 70%, $0.34 per share. Pretax net income was up over 120% compared to a year ago and $5.6 million compared to $2.6 million. Key driver of net improvement was a growth in net interest income by 73%, with noninterest income being up 49% was also a factor.

Noninterest expense was up 54% year-to-year and that's primarily due to salary and occupancy expenses from both the Capstone and the Tennessee Bancshares mergers as well as higher merger expenses in this quarter compared to the prior year.

Finally, our submission that our effective tax rate for the quarter was 23.2%, which is slightly below our year-to-date run rate.

Turning over to Slide 13, our net interest income. Net interest income was $18.9 million in the third quarter compared to $19.5 million last quarter and $10.9 million a year ago. Net interest margin, taxable equivalent, was 4.11% compared to 4.54% last quarter. The majority of that decrease was due to lower accretion of acquired loans. As you probably remember, last quarter, accretion positively impacted margin by about 60 basis points. At the time, we said we felt that, that amount was on the high side due to both initial spent up accretion from the Tennessee Bancshares acquisition, which is in -- which was during that quarter, as well as some payoffs for some larger balance marked loans from previous acquisitions.

This quarter, accretion impact was 26 basis points, which is back within our historical range for the last 5 quarters, a 30 basis points plus or minus 3 or 4 basis points on a core accretion run rate. We do believe accretion might tick up a little bit with Foothills, but given the fact that their loan portfolio is about 10% the size of ours and their current profile is very clean, we don't expect it to be a disproportionate impact. That 30 basis points is probably a good go-forward number for us on the core accretion rate.

Outside accretion, the other item impacting margin during the quarter was a higher cost to deposits and other interest-bearing liabilities. Cost of the interest-bearing deposits increased 15 basis points quarter-to-quarter to 1.11%, while our cost to funds was 95 basis points or up 12 basis points quarter-to-quarter.

Turning to Slide 14, we see noninterest income. We made great improvement over -- in this over the last year every single quarter. Noninterest income to average assets ticked up 3 basis points to 36 basis points, so we're driving that number higher. Service charges on deposits were up nicely in large part due to 2 acquisitions we've completed over the last couple of years. We also had very nice gains sales or loans in other assets due to the best quarter we've ever had from our mortgage business. We do expect those service charges to increase over the coming quarters.

Turning to next slide, with noninterest expense. You'll see a dip down quarter-to-quarter. Noninterest expense is down to 2.90%, which is part of what we said with our -- the top of our target range was last quarter. At the same time, we managed to get our efficiency ratio down to 71.4%. Very pleased with the gains we've made in efficiency, and we believe we can continue that trend. We will see increases from the fourth quarter of the Tennessee Bancshares operations in our numbers, most notably 3 months of salaries and 3 months of occupancy this quarter versus to the prior quarter.

Finally, merger expense decreased to $838,000, as we transitioned from the Tennessee Bancshares conversion integration in the third quarter gearing up to the Foothills acquisition in the fourth quarter. As was the case in the last 2 acquisitions, we expect merger accretions -- excuse me, merger expenses to be the highest in the quarter of acquisition and then decrease slightly in the quarter of conversion and integration then tape off in the following quarter.

Our balance sheet is on Slide 16. You probably remember that in the second quarter, we ended up a little cash-heavy and securities-light as we liquidated the Tennessee Bancshares securities portfolio, and we're in the process of reinvesting. We did reinvest those funds toward the end of the third quarter, which is driving the increase in securities portfolio of approximately $16 million. I should note that those investments that we made are both floating rates and are also federally tax exempt. So the impact of securities yield will be positive next quarter and it should continue after that as rates continue to rise.

As Billy mentioned, loan balances growth increased approximately $10 million and strong production quarter was temporarily offset by higher payoffs.

Looking on the liability side, there's a couple things to note. First, we made a concerted effort to reduce our reliance on fundings from money market accounts, which tend to reprice quickly and that have a higher immediate impact on the cost of deposits.

On the retail side, we continue to grow our balances in interest-bearing demand accounts. Over on the wholesale side, we transitioned $20 million out of the wholesale money market and the wholesale time deposits, so we could lock in those rates early in the quarter according to February's rates. Second, as you note that the subordinated debt offering is listed there. We used those proceeds in part to pay down the holding company line of $15 million to 0. So sub debt is at $5 million to $5.8 million. Holding company line was probably minus 20 basis points. Working the math on that means a new delta of interest expense of $375,000 per quarter going forward.

Turning on to Slide 17, we see our deposit mix where we continue to hold 1/3 demand accounts, 1/3 money market savings, 1/3 time deposits. Deposits, I would note, did just tick down just a little bit quarter-to-quarter as we let some higher beta accounts go to some competitors as we had sufficient liquidity to fund what we needed and we didn't want to pay those out of cost.

Flipping to Slide 18, we see our loan portfolio. One thing I'd note there is we managed to grow the portfolio across all loan types. Especially in 2018, we had very nice growth in residential real estate, C&I and owner-occupied CRE. We can start to further tell that trend, if you flip to this next slide, which shows the SmartBank CRE ratios, which are well within regulatory guidance that trended down nicely.

Finally, I'll flip over to Slide 20, asset quality. Foreclosed assets were down quarter-to-quarter, offset by some increases in nonperforming loans. I should note that those loans were all smaller credits unrelated, and we don't see anything systemic in the portfolio that gives us any concern. The graph on the right shows our allowance and the allowance to loans as well as the discounts on acquired loans, which are approximately 1/3 of our portfolio over it.

And with that, I'll turn it back to Billy to wrap it up.

Thanks, Bryan. Again, as you see from Bryan's comments, a really solid financial quarter with improvement in a number of our core operating metrics. And what I'll do now, I'll provide a little bit additional color on kind of where we see the bank now and as we look forward through the end of the year, and then we'll open it up for some questions.

But first, let me start with an update on our Panama City, Florida market. As you know, Hurricane Michael caused some major damage in the Panama City area in the Florida Panhandle. We had a branch and a loan production office there, both of which are still currently closed as the city works to restore power and services. Fortunately, we've been able to relocate -- temporarily relocate our staff over to our Destin office to keep business moving forward in that area.

From what we see today, we see no major financial impact on our clients. Most of their business in that zone is commercial related and they've had appropriate insurance coverages.

Going forward, we plan to be involved in opportunities to help in the rebuilding in that area, which will be extensive. We did have a number of associates that were impacted personally and had several that are still unable to utilize their homes. We are working to assist those team members during this very tough time. This is a great city and a great market for us, and it will be strong again, but I think the main takeaway from a business standpoint for us is no major financial impact to our company as a result of the storm.

Moving on, during the quarter, we converted and rebranded Southern Community Bank over in middle Tennessee, Northern Alabama markets. So we had a chance to move our SmartBank brand into those zones. The integration went very well. We're now looking for opportunities to add sales resources into our newest markets in various areas.

We spent quite a bit of time now in Murfreesboro and Huntsville, Alabama as well as Tullahoma, and I'm very bullish on the upside of those areas for our company.

Next up, on the acquisition front, is the planned closing of the Maryville, Tennessee-based Foothills Bancorp and Foothills bank acquisition. We plan to close that deal on November 1. While a little smaller than our last couple of deals, this is going to be a great acquisition. As I said earlier, there's a great energy already in the market with their team, and I believe this will be a very smooth integration as we're very familiar with the area and the team.

Organically, I think it's important to note, we continue -- as Bryan alluded, we had very nice production for the quarter. While balance growth was a touch slower, our originations were very strong and quite frankly right on pace for our targets. We still feel very good about projected originations during the fourth quarter as we meet with our sales teams. We think the kind of the lump of paydowns that we saw in Q3 will not be moving forward, and we think that the balance growth moving forward on the loan side will be very healthy.

As I stated earlier, we still feel very good about our projected high single digits annualized growth targets and very excited to see that trendline continue to move up.

On the deposit side, we're now putting resources solely devoted to the deposit growth, and we put those in place with the addition of Bill Yoder as a new Chief Banking and Deposit Officer for our company. And I'm looking forward to watching that area continue to grow and gain traction.

Also, we've mentioned a couple of times that also we want to kind of close out with the accomplishment of our Kroll BBB unsecured debt and BBB- subordinated debt writing. This is something that was quite an accompaniment for our team, for a Bank of our size. We leveraged that rating into a very successful $40 million sub debt raise. It's a very favorable terms that now positions us very well from a capital standpoint as we look at our future growth plans.

So all in all, to summarize, really a great quarter for our company. And with our upcoming acquisition here next month, and we're positioned extremely well to continue to improve and grow those financial metrics as we close out 2018 and start to plan for 2019.

So I'll stop right now and really just open it up for some questions.

(Operator Instructions) And our first question comes from Daniel Cardenas with Raymond James.

So appreciate all the color on what was going on this quarter. So as we look at loan growth, maybe more for 2019, I mean, it sounds like you're still feeling pretty good about organically staying in kind of in that mid- to high single-digit range. Is that correct?

Yes, it is, Dan. Yes, really, the sales teams that we've got with Greg Davis, our Chief Lender, have -- really the momentum has been outstanding quite frankly. Growth pipelines are -- have been strong. We converted a lot of that pipeline into closings and still feel really good, with kind of that high single-digits target. I think just a little bit of an anomaly this quarter with some payoffs. And quite frankly, we also tempered some of our CRE growth in the early part of the year as we knew we had some upcoming acquisitions with Southern, with Foothills that we were going to be doing some applications to get those deals approved. We wanted to keep our CRE ratios kind of well below our threshold. So we tempered -- even tempered some CRE growth early in the year. Now with a capital base and with lower ratios through some of those paydowns, I really feel strong that we can get the growth back. Sales teams and our markets are performing very well.

Good. And then as -- so a little bit of noise in the margin this quarter. Maybe some color as to how we should be thinking about that ratio on a go-forward basis. I mean, we saw contraction on the core margin. Imagine there's going to continue to be some pressure, but kind of that 4%-plus margin, is that kind of a good way to be thinking about it on a reported basis?

Yes, and I'll make couple of comments, and I'll let Bryan jump in to give some color as well. But yes, I think, overall, we saw a little bit of contraction this quarter. We'll probably have a little more contraction. You've got the sub debt component that will factor in a little bit. So I think as we look forward, we think that there's probably a little more contraction in the margin. The accretion number that Bryan said, we still feel pretty good about kind of the quarter plus about 30 on top of recurring basis. We don't see that number changing dramatically over the next couple of quarters. So I think probably around the -- probably the 3.90 to 4-ish number all-in is something that we're comfortable with. Byran, I'll let you speak to that as well.

Thanks, Billy. Yes, Dan, couple of other things I would add. As you know, working to try to maintain net margin. I mean we are taking steps. As I mentioned, we transitioned out of some stuff that repriced immediately to locking in some funding cost on the wholesale side and we deployed some cash and securities that there'd be some floating rates. I mean, if you go back and you kind of calculate the deposit betas, it went first quarter kind of 40%, second touch over 70%, back down to 60%, higher than we would like in the third quarter, but we think we're taking steps to try to keep that in check.

All right. And then as you kind of look on a go-forward basis, I mean, do you think you can keep that deposit beta closer to 60%? Or can you work that down a little bit?

I'd like to say we can work it down, but I mean part of that is going to come back to a function of liquidity needs based on loan growth in terms of if those guys go off [to the] raises again like they did in the first quarter, then we might have to temporarily fund, and that could tick it up slightly. Of course, it would be a net add to the bottom line, but that's about the only thing I would say that could really go against us.

Okay. Great. And then last question. I'll step back here. On -- in terms of that -- the margin guidance that you provided, what kind of rate hikes are you baking into your assumptions?

I think, basically, what we've got in our assumptions is really kind of what the consensus is, which is, what 2 more...

Yes. December and then again, after that.

Yes, from that standpoint. So really, just kind of what the consensus rate projections are, Dan. We're not really looking to -- I think, you're going to continue to see a couple of more -- it's so tough to project out much past what you think over the next couple of months, but probably a couple more here in the near term.

(Operator Instructions) And at this time, I'm showing no further question. I would like to turn the floor back to Miller -- I apologize, we do have a last-minute question from Stuart Lotz with KBW.

I Just had one question on just any future M&A. I know you're focused on closing Foothills in the fourth quarter. But after that and with the new sub debt you raised, you think you'll be back in the M&A market as early as 2019? Or do you think it's probably a [check point]?

Stuart, it's Miller, I'll address that. I don't know that I would use the term back in the market. I think we stay in the market and really feel that's a line of business that we have. It's no secret the equity markets have been -- [tightened] financials lately, so currency is certainly a challenge, and we're just -- we're pretty dead-gun disciplined on how we price these things. We are having -- we always keep several conversations going. I think you see 2 divergent paths right now. I think you see about half the group that just says, "Boy, based on the price of the currency" -- not our groups wouldn't have, it's people that we're talking to, half of them are still on the sidelines until the currency returns, and then the other half say, "Wow, man, maybe I do need to start to optimize and looking around." So I think we will remain active, and we just have to wait and see for a portion enough to be able to put something together, but we like where we're stand and we like the opportunities ahead.

And then just one follow-up that in terms of geography, are you active in the market or are you looking, let's say, farther out? I know you've gone as far as South as the Florida footprint as well as South Alabama. I'm just curious what specific markets you're looking at right now.

Well, certainly, I'm not going to give you specific. But as we've stated before, we feel like we pretty dead gun much defined our current market, kind of the 4/4 of it. Might at least stretch out if something really attractive that was in the adjacent market. But no, we like the opportunities that can provide us to get a little bit more dense where we are, and so is that vague enough?

Yes, and I'll just add to it. Yes, I think, for us, as Miller said, I think our -- Stuart, really our plan now as we've kind of staked out Middle Tennessee, East Tennessee, down 65 through Alabama and the Panhandle. You look at the opportunities that we think are in those zones. They're pretty plentiful. And so I think you're going to see -- you would see us looking at deals in that zone are very close to those zones as we move forward.

And this will conclude our question-and-answer session. I would like to turn the conference back over to Miller Welborn for any closing remarks.

Thanks, Austin. We do appreciate your interest in supporting SmartFinancial and SmartBank, and we do look forward to continuing our journey. And thanks to all of you for joining us today. Have a great day.

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