FB Financial Corp Q4 FY2020 Earnings Call

Good morning and welcome to FB Financial Corporation's Fourth Quarter 2020 Earnings Conference Call. Hosting the call today from FB Financial is Chris Holmes, President and Chief Executive Officer. He is joined by Michael Mettee, Chief Financial Officer; Greg Bowers, Chief Credit Officer; and Wib Evans, President of FB Ventures; who will be available during the question-and-answer session. Please note, FB Financial's earnings release, supplemental financial information and this morning's presentation are available on the Investor Relations page of the company's website at www.firstbankonline.com and on the Securities and Exchange Commission's website at www.sec.gov. Today's call is being recorded and will be available for replay on FB Financial's website approximately one hour after the conclusion of the call. At this time, all participants have been placed in a listen-only mode. The call will be open for questions after the presentation. With that, I would like to turn the call over to Robert Hoehn, Director of Corporate Finance. Please go ahead.

Thank you. During this presentation, FB Financial may make comments which constitute forward-looking statements under the Federal Securities Laws. All forward-looking statements are subject to risks and uncertainties and other facts that may cause actual results and performance or achievements of FB Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond FB Financial's ability to control or predict and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in FB Financial's periodic and current reports filed with the SEC, including FB Financial's most recent Form 10-K. Except as required by law, FB Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events, or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to comparable GAAP measures is available in FB Financial's earnings release, supplemental financial information in this morning's presentation, which are available on the Investor Relations page of the company's website and on the SEC's website.

Thank you, Robert, and good morning. Thank you all for joining this morning. We appreciate your interest in our company. As we prepared our comments for this quarter, I realized how significant 2020 was for our associates and our shareholders. Our team had a remarkable year, and I want to share a few highlights. Our adjusted net income for the year was $142 million, resulting in adjusted earnings per share of $3.73, up from $2.83 per share last year, which is a 31.8% increase. We achieved an adjusted return on average assets of 1.68% and an adjusted return on tangible common equity of 19.1%. These earnings boosted our tangible book value to $21.64 a share, reflecting nearly a 17% growth from the previous year, even after we set aside $108 million for loan losses and increased our allowance to 2.48% of loans, one of the highest in our industry. Our balance sheet stands strong as we conclude 2020. In addition to increasing our allowance, we grew our assets from $6 billion to $11 billion during the year. Instead of straining our capital ratios, we maintained a tangible common equity to tangible asset ratio of 9.3% and increased our total risk-based capital ratio from 12.2% to 15.2%, all achieved without raising equity. Alongside our financial results, we achieved other significant milestones. Four years ago, our presence in the market was limited to Jackson, Tennessee, where we held the third market position. Over the past four years, we've built top 10 market shares in Nashville, currently sixth with $4.8 billion in deposits, Chattanooga, fifth, Knoxville, ninth, and Bowling Green, seventh. These markets are projected to see household income growth exceeding 8% over the next five years and population growth of 4% and above. Additionally, we are proud to be recognized as a great workplace for our associates. I’m particularly proud that American Banker named us one of the top banks to work for this year. We've been recognized as a top workplace by the largest newspaper in Tennessee for the past five years, and it's gratifying to gain national recognition as well. Throughout the pandemic, we have maintained our workforce without any job eliminations, and associates unable to perform their duties due to branch closures did not see a pay reduction. I believe our associates felt secure in our commitment to them. Overall, 2020 has been an exceptional year, and I want our team to take a moment to be proud of what they have achieved. After that moment, it’s time to roll up our sleeves and work towards an even better 2021 and 2022. We enter 2021 with great excitement and optimism, ready to leverage several opportunities to build on last year’s success. While acquisitions often grab headlines, our strength lies in organic growth, and we are committed to outworking our competitors and gaining market share. Despite the challenges posed by two acquisitions and COVID last year, we are now well positioned for organic growth in Nashville, Knoxville, Chattanooga, Jackson, and Bowling Green, all of which are vibrant growth markets. We have strong leadership, an effective branch network, a solid market presence, and plenty of potential to increase our market shares. In Memphis, we've established a new market presence along with a team of relationship managers. In Florence and Huntsville, we have minimal market share, allowing us to aggressively pursue new business. We anticipate steady, albeit slower growth, but with a higher margin contribution from our smaller community markets. We will actively recruit and hire more relationship managers across our regions; with our positive workplace culture, we offer an excellent environment for ambitious talent. Across all markets, we have set internal targets, and we expect to achieve mid to high single-digit loan growth in 2021. We predict the first half of the year to be slower compared to the second half, but we are confident our markets will excel as economic activity ramps up. The mortgage segment remains robust with elevated volumes and margins, and our team is poised to take advantage of this favorable environment. Last quarter, we generated $23 million of adjusted pre-tax contribution during what is typically the slowest mortgage activity period. Our team has continued to perform well in January, so we expect another strong first quarter. After that, we will be ready for the purchase season, projected to be solid due to low rates and current housing trends. While forecasting mortgage volumes is challenging and we haven’t been successful in previous attempts, we do expect the first quarter results to mirror the fourth quarter with 70% to 100% of the previous quarter's contributions and anticipate ongoing strength in the second and third quarters unless significant external changes occur. Regarding net interest margin, we are currently carrying high levels of liquidity which impacts margins, but it should allow us some leverage in the coming quarters to improve our funding costs. Last quarter, we successfully refined our balance sheet by reducing non-core funding by $462 million through FHLB advances and wholesale deposits. We have about $80 million remaining to address in the first half of the year. On the asset side, it remains challenging to plan for higher-yielding assets. It is well known that we will likely see some erosion in yield on our contractual loan rates, excluding PPP loans, as long as the rate environment stays the same. However, we believe we can make good progress on our deposit costs to balance this out. On the expense front, we realized our cost savings from the Franklin merger ahead of schedule. We anticipate an additional $1 million to $2 million in annual cost savings in the latter half of 2021, although we don't foresee further significant improvements in the first half. With our larger balance sheet and the merger activities concluded, we are in a strong position to focus on operational enhancements that will help reduce expenses, improve productivity, and prevent unnecessary costs. I expect our core bank expenses to grow at a low to mid-single-digit rate compared to the fourth quarter run rate of 2021. On credit, we feel more confident than ever about our portfolio. While deferrals and PPP loans helped our customers regain stability, we took the opportunity to enhance the overall quality of our loan book. We did have one credit issue, which we've been updating you on, that we decided to charge down in the fourth quarter, accounting for 55 of our 58 basis points in net charge-offs. We believe this matter has been resolved. I would like Greg to provide further insights, but I'm quite optimistic about our position, and I think our performance metrics in 2021 will reflect that. To summarize, we've established density and relevance in exceptional markets, supported by local leadership teams ready to capitalize on the resources available to them. Our capital and liquidity positions are stronger than ever to seize promising business opportunities. We have an effective non-interest income engine that is likely to continue delivering great results. We've achieved our targeted cost savings from the FSB transaction and see further opportunities to control expenses. Although the margin is tight, we are well-positioned to continue lowering funding costs while channeling lower-yielding liquidity into core loan growth. Credit is not expected to be a hindrance for us in 2021. We enjoyed a wonderful 2020, and I want to reiterate that we grew our tangible book value by almost 17% despite a $108 million provision that year. We are set up for a tremendous future. Now, I will turn it over to our Chief Credit Officer, Mr. Bowers, for more details on credit.

All right, thank you, Chris. I'll share your sense of optimism for 2021 and confidence in our overall asset quality. The integration of our portfolios has moved along well and I appreciate all of the hard work that our teams in the markets have done in this regard. It's no easy feat. We asked them to coordinate the move of their customers onto the new systems while ensuring great customer service at the same time. It's been remarkable. We say that asset quality remains positive overall, with one exception. We believe you will see that in our credit metrics today. That exception is a problem credit that, as Chris noted, we have called out with you for the past three quarters. Like most deals that get into trouble, information comes in over time, and you assess that accordingly. Circumstances change, information gets updated, and things either improve or worsen. In this case, it just continued to decline. And just like any other deal in our portfolio, when problems surface, we address them swiftly and decisively and then take the appropriate steps. In this case, it was determined that appropriate steps included a charge down related to that loan. As a result, our net charge-offs for the fourth quarter were 58 basis points or $10.4 million, of which $9.9 million or 55 of the 58 basis points in charge-offs were tied to that one credit. The balance was placed on non-accrual, accounting for 17 basis points of our 88 basis points in non-performing loans to loans held for investment this quarter. With that, we believe this loan is appropriately marked and rated and our focus will continue to be on its resolution. With that one exception, the asset quality of the portfolio remains good and as Michael will detail for us, significantly reserved. When I speak about the portfolio's quality one measure, this is in our deferred portfolio. Deferrals were down to about $200 million or 2.9% of the portfolio. That's a long way from the roughly $1.6 billion we had at one point. Now when we say deferred, we are including all of the loans that remain on some form of modified payment schedule. We take comfort in noting that, of that approximately $200 million, roughly 65% is making interest payments, with about 35% of that portfolio on a full deferral; that is we have allowed them to forgo interest and principal. Hotels remain the hardest hit area within deferrals, no surprise, they are making up 44% of the full deferrals and 41% of the interest-only deferrals. We remain cautiously optimistic about the ultimate resolution for the remainder of that portfolio and are very pleased to see that it has come down so far. The next area that we believe continues to reflect positively regarding our overall portfolio is in what we have called our industries of concern. And as you know, we've broken these out each quarter since the beginning of the pandemic. I think you will share our sense of overall improvement here too as you review these slides. Specifically, we will move to the hotels on Slide 15 and try to provide a little more color on that segment. Again, overall, we still feel confident in the underwriting of that book as a whole, but occupancy rates continue to be impacted by the pandemic. We continue to work with those customers that we believe are strong operators, and our customers are continuing to work with us in instances where we have asked for additional capital. We continue to be confident in the quality of our properties, management teams, and investors and we sleep well at night knowing that we have awarded projects in Nashville's core downtown tourist area, larger luxury properties, and conference center properties. I look at these figures, specifically that the bulk of the deferrals are paying interest as a positive. Another segment that continues to struggle is restaurants, which we have on Slide 16. That's due to the reduced capacity restrictions, especially in our metropolitan markets and overall trends across the geographies. On the whole though, our grid generally continues to be okay, but I'm not recommending that we give them an all-clear flag. These shutdowns and reduced capacity limits are a challenge and long-term prospects for the industry remain cloudy. We will share with you this as a main, we haven't had various specific issues. For example, we have one customer with a full-service operation that recently closed. However, the guarantors that were part of our underwriting are stepping up and performing on the debt. As we've also noted, on the positive side, the quick service segment of the business has fared well. While overall we're cautious about restaurants, we would entertain opportunities for seasoned and well-capitalized operators in this segment if it made sense. Lastly, roughly 25% of our other leisure portfolio, slide 17, remains on deferrals. So we have included that disclosure again this quarter. Rather than a systemic issue in that portfolio, it's a handful of loans that comprise roughly 90% of the deferred balances. Those are customers in the industries that remain impacted by the pandemic, but we feel good about our guarantors and collateral in each situation and think that the businesses should bounce back well once the vaccine is widely distributed. Our other industries of concern, for example, retail, healthcare, and transportation continue to perform and have minimal remaining deferrals. You can see that we have reduced our disclosure on these industries this quarter and that's because simply in general, they have returned to normal and there is nothing significant to highlight. As always, if that changes we will re-incorporate that into the deck for you. From an overall economic viewpoint, with the exception of hospitality and entertainment, our footprint has continued to perform economically better than any of us would have guessed back in April. Moving on now to the institutional portfolio, our held-for-sale portfolio, it has been reduced down to roughly $215 million, down from $241 million at Q3. You will recall that announcement roughly a year ago now, that portfolio stood at approximately $430 million. We maintain our position of exiting this portfolio as soon as we can. We're willing to sell on a one-off or a bulk basis. But as we've said before, we're not willing to give away a performing portfolio. We will continue to work on this from the sales side and in the meantime, we'll just continue to do what we do with any loan and manage them on a one-on-one basis. So for the institutional portfolio, that held-for-sale portfolio, we see positive trends with it continuing to reduce, standing now at half of where it was at announcement. It is appropriately marked and our expectation is that it will reduce further from pay-downs, one-off loan sales, or selling it in bulk. Regarding our outlook for 2021, we continue to be cautiously optimistic about trends throughout our markets. The additional government stimulus should continue to be a welcome assist until the vaccine is successfully distributed and our markets move back to normal. The residential housing market in Nashville and really across our entire footprint is still performing very well and is aided by continued influx of corporate relocations as our new neighbors arrive from California, New York, Chicago, and come to enjoy our lifestyle and business environment here in Tennessee. And as loan growth continues to pick back up, we will remain vigilant in our underwriting. Our mantra has been and will continue to be long-term profitable growth. So in summary, a few points to highlight. We're still in a pandemic and remain cautiously optimistic. We had a jump in charge-offs due to one specific deal. Deferrals were down, industries of concern have levels of improvement. The held-for-sale portfolio continues to decline, our overall credit metrics are stable, and our reserves are strong. With that, I'll turn things over to Michael.

Thank you, Greg, and good morning, everyone. My prepared remarks today will focus on margins, mortgage, CECL, and an update on the financial impact of the Franklin merger. Starting first with margins, we are seeing the decline in contractual yield on loans beginning to slow. Excluding PPP loans, our December contractual yield was 4.48% compared to 4.53% for the fourth quarter and 4.54% in the third quarter. New originations in the fourth quarter had a weighted average rate of around 4.15% and we would expect to continue to lose a few basis points per quarter on the contractual yield going forward. Meanwhile, our cost of interest-bearing deposits was around 59 basis points in December compared to 53 basis points for the quarter. We have $314 million in CDs coming due in the first quarter with a weighted average cost of around 151 basis points and the sheet rates on those deposits are currently 41 basis points. In the second quarter, we have an additional $308 million with a current rate of 124 basis points and a sheet rate of about 40 basis points. So for the past few quarters we've managed to keep around 60% of our maturing deposits at rates around 5 to 10 basis points above what the rate sheet would indicate, and we expect those trends to continue. We also believe that we have continued room to lower our cost of money market accounts and think that next quarter we should be able to match reductions in our contractual loan rate with declines in our deposit costs. We also continue to make strong progress in paying down non-core deposits and borrowings. Last quarter, we discussed $571 million in non-core funding from the Franklin merger that we felt would leave the balance sheet in the fourth quarter. We were successful in exiting $362 million of that $571 million and the remaining $200 million in wholesale funding is a money market relationship that we ended up keeping, and we actually marked that at a cost of approximately 35 basis points. We expect to keep those on our balance sheet until the contractual obligation ends in 2024. In addition to the $362 million in legacy Franklin funding, we paid down $100 million in legacy FirstBank federal home loan bank advances. As noted, the prepayments early on that federal home loan bank advances amount to around $4.5 million and we had no federal home loan bank funding remaining on our balance sheet as of year-end. Looking forward, we have an additional $50 million in non-core money market accounts that are scheduled to leave the balance sheet in the first quarter and another $20 million expected to leave in April. We also intend to redeem Franklin's legacy subordinated debt, $40 million of which becomes callable after March 31 and $20 million of which is callable after June 30. Both of those tranches are on the balance sheet with a marked cost of around 5%. Despite our progress in exiting non-core funding and some stabilizing trends in our core margin, excess liquidity does and will continue to weigh on our stated margin. Strong deposit growth led by seasonal increases in public funds of around $400 million drove our cash balances to increase 24% from the third to the fourth quarter and cash now represents 12% of tangible assets. Our total on-balance sheet liquidity increased to 15.2% of tangible assets during the quarter. Based on historical seasonality with public funds, we anticipate that these deposits will begin to leave the balance sheet by early second quarter and continue to decline in the third quarter. On our loan growth, the field is very confident about what we'll be able to produce this year. However, we are not expecting growth to come back into our numbers yet. So we remain fairly conservative on how much growth we'll see in the first and second quarters. We think that mid to high single-digit growth for the year is achievable and we will keep you updated as the outlook changes. For the remaining liquidity, we intend to continue increasing our investment portfolio while we wait for organic loan growth to restart. Moving to mortgage, the team produced another strong quarter, leading to a record year for the division. Mortgage continues to provide the company with a counterbalance to NIM pressure that the bank has been facing. During the third quarter earnings call, we discussed elevated gain on sale and a peak margin for new production, which is demonstrated on slide 7. As expected in the fourth quarter, there was a seasonal dip in volume and margins. But overall, the group continues to benefit from elevated originations. We do expect some compression in 2021 as refinance volume declines and capacity returns to the marketplace, but this was somewhat offset by the strength in the housing market and a very strong purchase market. We would like to congratulate the team for a record year and continued robust earnings. Additionally on fee income, we received relief on the interchange reduction associated with crossing $10 billion in assets for the year, so that planned $3 million in reduced revenue that we had expected in the second half of 2021 will now be delayed until 2022. On CECL, we went to a 100% baseline scenario. The change in the forecast compared with the slightly changing mix in our loan portfolio was responsible for approximately $17 million in reserve release. In order to adjust for what our ACL committee determined was too little of the model allowance on our C&I portfolio, we adjusted our qualitative factors on the C&I piece, which resulted in approximately $8 million in additional allowance on that portfolio, offsetting some of the model decline in reserves. Those, along with a few other moving parts, including charge-off results in the net $3 million release that you saw in our provision expense this quarter. If the vaccine is more broadly distributed and the economic forecast continues to improve, we believe that it's likely that we'll see further reserve releases over the coming quarters. The extent of those releases will depend heavily on how our outlook for our local economy changes. Finally, I'll finish with an update on the purchase accounting related to our Franklin Financial merger. We experienced an additional $9.5 million in merger charges in the quarter. While we could have an additional $2 million to $3 million of charges in the first quarter, all significant merger expenses are now behind us and you should see a relatively clean non-interest expenses line going forward. We also saw an increase of goodwill of $10.7 million, with the majority of the increase related to the new mark on $200 million in non-core money market funding that I referenced earlier. With these merger charges and additional goodwill, we have to make the transaction while that being roughly neutral to tangible book value per share. Spending a second on cost savings, I would point you to the other non-interest expense line item in our banking segment income statement disclosure. This quarter, there is the $4.5 million FHLB prepaid affiliate embedded in that line item. Excluding that, the banking segment other non-interest expense was $52.9 million with our first full quarter of Franklin included. This is about $12.5 million more than we were running prior to the Franklin second quarter. This indicates we've already hit our 30% cost savings target on the Franklin synergy merger. So those are some details on all the various moving pieces. But the end result was, as it have been for the past few quarters for us, exceptionally strong profitability with an adjusted pre-tax, pre-provision return on average assets of 3.43% and adjusted return on average assets of 1.95%. We expect to remain the lead financial performer and we look forward to updating you over the coming quarters.

All right. Thanks, Greg and Michael for that information. I'd like to quickly discuss a few other changes that we announced during the quarter, and then I'll open the lineup for questions. First, we removed the interim tag from Michael's title. We had many applicants interested in the position, including several good friends of the company. For that reason, we hired an outside advisor to take us through an objective process and Michael overwhelmingly proved to be the right person to be our CFO. Michael is a rising star in the industry. He has spent nine years with the bank and he has been extremely impressive in each role that he's held with us. The only regret is that because of COVID, many of you haven't been able to spend any time with him. As soon as we can safely travel, we will rectify that, and you'll see why we are excited about our team and our direction. We look forward to his leadership elevating the finance function to a new level for us. Next, Jim Ayers has stepped away from the Chairman role in the company. Jim has reached a point in life where he is enjoying the fruits of his labor, and he is well earned. Jim will continue to be a member of our Board. He will continue to be a very significant presence at FirstBank. We look forward to his continued valuable counsel, his continued support as our largest shareholder, and to him continuing to be the bank's most passionate advocate for the bank in our communities. Replacing Jim as Chairman is Stuart McWhorter. Stuart is one of our Independent Board members and he was a member of the Board for 12 years prior to stepping away to become Tennessee's Commissioner of Finance and Administration in 2018, and he rejoined the Board late last year. He's been a very successful investor in his own right. He has experience on other public company boards and we look forward to his experience and guidance as he assumes the role of Chairman of our Board. So to close, our team delivered phenomenal results in 2020. More importantly, though, we prepared a runway for the next two years. Our team has a mandate to go forward and dominate, and we're eager to share how well they execute on that plan in the coming quarters. With that, I'd like to open it up for questions.

We will now begin the question-and-answer session. Our first question is from Catherine Mealor of KBW. Please go ahead.

Thanks, good morning. I just wanted to follow one comment that you made on Durban. I think I overheard you say, Michael, that you have been granted a waiver on Durban for this year. Just want to see if you could talk a little bit about how that happened because it looks like you're still over $10 billion in assets. Thanks.

Yes, thanks, Catherine. There was some regulatory guidance that came out late last year that gave some relief because of asset inflation due to COVID, and we had a path to being under $10 billion going into the end of the year. And so we worked with our regulators very closely and walked through that. They did end up providing us relief even though we're still over the $10 billion mark.

Yes, Catherine, I want to provide a bit of insight into that. We conducted a thorough study and engaged with multiple parties, including discussions with regulatory agencies. When we announced the deal in January 2020, we anticipated that we might face some balance sheet reduction due to wholesale funding and other factors. We believed we could end 2020 with our assets under $10 billion, but then COVID happened, along with the PPP and increased funding, leading to elevated balance sheets across the banking sector. Regulatory agencies then announced relief on the asset thresholds due to these unusual circumstances. After our discussions, it seems we qualify for this relief and will not be excluded from it.

Okay, great, great explanation. And then can you just remind us of your thoughts on your outlook for the accretable yield. I know that there are a lot of moving parts with that, just given the change in the loan mark from the Franklin deal and it looks like this quarter accretively it was very low. Is that still your expectation for 2021? Thanks.

Yes, that is our expectation; it's going to continue to be quite low in terms of the accretion impact on our yields. So it's the way that I look at it when I talk about it internally, it's a fairly purified number at this point. Accretion can really give you some artificial confidence in your margin, but again, it's the way we look at it. So when you boil it down, yes, most of that is out and in fact as we look forward for the next few quarters, it's going to continue that way is what we expect.

And given some of the movement on the interest rate marks, is there a period where it could be actually negative, be more than amortization?

I don't think... it's certainly not impossible, but it's not likely.

Got it, okay. All right, thanks for the color. Great quarter.

Thanks, Catherine.

The next question is from Stephen Scouten of Piper Sandler. Please go ahead.

Hey, good morning, everyone.

Good morning, Stephen, hope you're well.

I'm doing very well, thank you. So I'm curious maybe first and foremost where if you guys have given any guidance around where you think the loan loss reserve could eventually normalize in a CECL world. I mean obviously, there is more noise in yours than maybe some of your other peers given the FSB acquisition and the absolute level is still extremely high. I'm just wondering how you're thinking about that assuming of course that kind of the economic improvements and vaccine trends we've seen continue.

I won't comment first, Stephen, as it's going to be much more global, and Michael will contribute as well because I agree with your observation. It certainly appears high compared to peers, and we have a defined process in place with both consultants and outside auditors, which involves a lot of dialogue. While it does look high, we want to be clear that I don't expect we'll encounter that level of losses by any means. I believe every CEO would likely echo the same sentiment based on our experience with CECL thus far. We are adhering to the process, and as seen in this quarter, it indicated the need for some release. We won't rush that going forward, and I've heard respected CEOs mention wanting to maintain certain percentages, but we're avoiding that approach. We're just following the process and observing its development. As we gain confidence quarter after quarter, we may apply more qualitative input than we have so far, but that's our current position. Mike?

Yes, and Chris, I think you hit on it really well. There is not a whole lot to add other than as the economy improves, with some more stimulus, I think you can see opportunities for release. But yes, as Chris mentioned, and like we called out, as we look at certain buckets, C&I, for instance, that's where we felt like it was prudent to maybe increase from our model results, where construction and CRE we came down because of the outlook improving in the economy and in the commercial real estate space. We're taking it month by month, quarter by quarter and just going through the process, and I think that there will be opportunity in an improved economy to see some releases, assuming that we continue to see COVID abate.

Yes, that all makes a lot of sense. And I guess maybe a follow-up to that is, maybe at the end of the day, and my view it's all capital; you're just putting it in a different bucket. But let's say it moves back into maybe core capital, if you will. How do you think about share repurchases because even apart from loan loss releasing, as I see it, you should build capital internally at a very rapid pace.

Yes, I completely agree with what you said. We see things in a similar light. It's like capital for us. I appreciate your perspective. We consider share repurchases as one of the options for managing our capital. This is something we keep at the forefront of our thinking, especially now because you are absolutely right. The good news is that we are accumulating capital very quickly, which is certainly positive. Just to note, our tangible book value rose by nearly 17% last year. So, we are really building up capital at a fast rate. This topic is very much a focus for us, and it's still early to determine our actions regarding it. Nonetheless, it's a favorable challenge to have.

No, definitely not. And maybe just one last from me. I know, Chris, you guys were talking at the start of the call mostly about organic growth opportunities, which I think is great, but I'm just wondering, given the success of this FSB deal and getting the cost saves out sooner than expected, I mean it really shines a light on your capabilities there. So do you think more about M&A sooner than we maybe would have thought previously given the success here and what it seems like it will be a pretty active environment?

Yes, it's a fair question and one that we face often. We are watching the environment, but it's not something that we feel compelled to jump into. The things that we've done have been, again in my comments I said the acquisitions get all the headlines and ours have got some headlines. But they've actually been very strategic, they've all been in footprint, and we have all had an eye on operating leverage on every time, everyone we've done. We've had a keen eye on operating leverage. It's an option, but it's one that we will be pretty restrained on and we are really excited about some of the things internally that are going to improve our operation, improve our organic growth capability, and improve our customer experience. Those are not the things that grab the headlines, but we're really focused on those things. So we will be available but cautious, I guess is the way I'd put it.

Great, makes sense. Well, congrats on a really good quarter and a great year.

All right. Thanks so much, Stephen. Really appreciate it.

The next question is from Matt Olney of Stephens. Please go ahead.

Hey, great. Good morning, guys. I wanted to circle back on the operating expenses and want to make sure I appreciate what's going on here. It sounds like you already received the cost saves from the Franklin deal, but there is a chance you could get additional savings perhaps in the back half of 2021. I'd love to hear more about what drove the accelerated recognition of some of those cost savings? And then secondly, the guidance of the low to mid-single-digits, I assume that's based off the core number in the fourth quarter of $52.9 million. Did I get that right?

You are correct. Regarding the second part of your question, I apologize, but you mentioned that we might have recognized the expenses a bit quicker. Remember that in 2020, we aimed to recognize and fast-track our expenses. During the pandemic year, we believed that if we could complete the systems conversion, it would be a good opportunity since the world was relatively inactive. Our goal was to accomplish this while things were at a standstill, which we thought would position us well entering 2021. The team worked diligently to achieve this. In response to Stephen's earlier question about our readiness for further acquisitions, I can highlight how hard the team labored in 2020. While it might seem straightforward for the executive team to consider doing it again, the reality is more complicated. You both are correct in noting our efforts; we managed to get some expenses recognized earlier than originally anticipated, which benefits all shareholders. We feel confident about the next few quarters and may find opportunities for additional efficiencies as we aim to exceed our targets. We are currently at a standstill with those targets but hope to improve upon them in 2021. Therefore, while we remain open to acquisitions, we are not actively seeking new opportunities at this time, and we stand by our previous comments regarding expenses.

Yes. This is Michael, and I would like to elaborate a bit. One of the challenges we've faced during COVID is related to office space. We have some leases that we expect to exit later in the year, which will help with the second half of the year. The growth in expenses has been modest, really low single-digit growth, assuming that the world will open back up. Chris briefly mentioned travel, and we look forward to reconnecting with our customers and clients to build our business. As we've surpassed $10 billion, Chris mentioned several aspects that may not grab headlines. Some of that includes internal investments that could lead to some expense growth. However, we believe we can manage this growth with minimal impact, which is what my previous comment was referring to.

Okay. And then, circling back on the discussion around the core margin, it sounds like there is some additional room to take down the interest-bearing deposit costs from the fourth-quarter levels. And I think I heard at least for the comment for the first quarter you think there is some room to offset the pressure on the core loan yields. Did I hear that correctly? And I know it's early, but do you feel like you can kind of continue that trend beyond the first quarter at this point?

Some of that core loan yield is uncertain, but we believe we might be able to offset nearly all of it, as we managed during this quarter. It's a somewhat uncertain situation, but our goal is to try to offset it. We cannot promise that we can fully achieve that, but that is what we aim for.

Okay. Additionally, another point regarding the margin discussion you mentioned, along with what other banks are addressing, is the excess liquidity position. It seems you're inclined to allocate a portion of this to the securities portfolio. I would like to know your thoughts on how much you might consider building this up and what types of securities you have been acquiring recently.

Yes, Matt, we're currently at about 10.5%, but historically we've been closer to 12%. Therefore, you might expect some growth in the range of 11% to 13%. This won't all happen in the next quarter or this quarter. We've also reduced our exposure to municipals as they continue to have longer durations and narrower spreads. Instead, we’re focusing on shorter-dated CMOs, specifically those in the 3 to 5-year range. We're monitoring durations closely. Mortgages still feel quite expensive, so there hasn't been significant growth in the investment portfolio. However, we're committed to being cautious and considering the overall strategy of the balance sheet; we prefer to allocate it towards quality loans, but we will seize opportunities as they arise.

Okay, that's great. Thanks for the commentary. Nice quarter.

The next question is from Alex Lau of J.P. Morgan. Please go ahead.

Hi, good morning.

Good morning, Alex. Hope you're well.

Thank you. My first question is on the mortgage business. So you operated very efficiently for the past three quarters within the efficiency ratio in the 50% to 60%. Can you talk about some of the factors contributing to this efficiency during the pandemic? And looking into 2021, can you continue at these levels as the gain on sale margin moderates? Thank you.

Yes, Alex, we got Wib Evans is with us, who runs our ventures including mortgage, and now let Wib and Michael talk about that. Mike?

Yes, hi, Alex. Obviously, margins have thickened up tremendously, from an efficiency ratio standpoint, which helped us a lot. We don't expect that to continue. We see some compression already coming down in the latter part of the year. We see, again here in early January, so we see that coming down. You would see, obviously, we've had some capacity issues in the industry, which allowed that margin to creep up as we have hired additional folks to maintain this volume. That will also put pressure on that efficiency ratio. So being in that 58% to 60% range, is not sustainable generally through the year, and we expect that to be elevated some.

Thanks for that. And then my second question, I want to touch on technology. Have you seen an acceleration of your digital platforms in terms of adoption during the pandemic? And in 2021 you mentioned some investments. Are any of those related to technology initiatives? Thanks.

Yes. Alex, on the technology front, we're definitely noticing an increase in adoption rates. Last year, we made changes to both our online and mobile systems, which have been well received by customers. We've observed a significant rise in adoption rates. In hindsight, it would have been ideal to implement these upgrades in the first quarter rather than the second quarter of last year. This isn't the end for us. Many customers who didn't utilize the technology during COVID are now coming back to it as branch lobbies reopen, and that trend is continuing. We've been ramping up our technology investments for about three years, focusing on continuous improvement. These investments are growing as we enter 2021. I mentioned earlier about the steps we're taking to optimize expenses and gain efficiencies, both on the customer side and in the back office. This is our largest area of capital investment.

Great. Thank you.

Sure.

The next question is from Brock Vandervliet of UBS. Please go ahead.

Hey, good morning, guys. Wanted to follow up on the mortgage question. These gain on sale margins, as you well know, have just been giant. Where do you see that normalizing to from say where it was in the fourth quarter? Just trying to get a sense of where we should think about the business kind of retracing to?

Hey Brock, it's Michael. If you look at Slide 7, you'll notice the 30-40 range that you mentioned. This reflects the new originations in the fourth quarter, and we've obviously seen a decline from the second and third quarters due to capacity constraints. We're still seeing some better compression in that area. It's difficult to compare to '19 or '18, as we were in different channels then. Our focus is on retail consumer direct business, and we are likely normalizing to slightly below that figure. Regarding your earlier comments from June, I believe there’s still some potential for a decline, but we shouldn't expect to return to the 227 figure from the fourth quarter of '19.

That was.

Okay, got it. And you mentioned office space coming up in the second half of 2021. Just as we emerge from COVID, any other strategic, not that office space is necessarily strategic, but any other changes you see making in the business, or is it really a return to normal?

Yes, I would say we did experience normalcy, though we may appear different. We are pleased with our mortgage business for several reasons, particularly because it allows us to learn from various aspects. They have had a greater proportion of employees working from home than other sectors of our business for an extended period. It serves as a strong basis for measuring productivity, and we see robust productivity in specific areas related to home work. We aim to enhance measurement in productivity areas that we haven't focused on before. This will increase efficiency, contribute to a better work-life balance, and boost overall employee morale. The implications of this could affect office and branch spaces. There is considerable discussion about branch consolidations, and while we may experience some of that, it won’t be extensive because we are present in many communities, often with only one branch in those areas. The costs associated with maintaining these branches are generally lower than perceived. While we might see minor branch consolidations, we don’t expect a significant impact because large-scale consolidations would reduce our presence in our service areas. Our footprint in these metropolitan statistical areas is relatively new, and we don’t have the extensive legacy branch network that some of our larger, older competitors possess.

Yes. Okay, great. Thank you very much.

All right. Thanks, Brock.

Your next question is from Ammar Samma of Raymond James. Please go ahead.

Hi, good morning, everyone. So, I appreciate the update on the non-core acquired portfolio from Franklin. Maybe just a couple of follow-up questions there. The $200 million reduction that you've seen year-over-year. Have there been any of those one-off type of sales that you referenced in that or is that just a book kind of paying down and running off? And then the follow-up is what does the secondary market look like for these credits? Would you be content to let it continue to run off or are you committed to exiting in a bulk sale? Thanks.

Yes. Ammar, I will comment and invite Greg to share his thoughts as well. Regarding the first part of your question, we haven't made any sales; we've just been paying off loans, so there haven't been any sales to report at this point. As for our approach, we can sell individual loans or in bulk. If necessary, we would hold on to the loans. We do have the option to sell individual loans, but we don't need to actively buy or sell. Our advantage is that we understand what's in the portfolio, and we have two very capable individuals managing it. However, it's not central to our business. Therefore, if the price is right, we would consider selling. It might seem like I'm negotiating against you, Ammar, but that's not our approach to buying or selling.

Nothing above that. Now with several companies refinancing, there is actually something to highlight that you pointed out. A lot of those companies are doing quite well and growing, and there are opportunities for them to refinance, but we're not interested in being their bank to do that, so that's where some of that's coming from.

Yes, it's a mixed situation because these are private equity type loans, and unfortunately, you often don't get much warning before something goes wrong, and there isn't much safety net in place if it does. This aspect is not central to our operations. However, we have had good experiences with them so far, and we hope that continues.

Okay, thank you for that commentary. And one unrelated question to that portfolio as far as PPP, have you all seen any interest from your clients on this new wave of PPP, do you expect to be active in it moving forward?

Yes. We have seen some interest and we do expect to engage in some PPP. We're already participating in some PPP as we move forward.

Any guidance on where those volumes could ultimately shake out relative to round one?

Yes, it will definitely be less than the first round. We will approach it a bit differently. Additionally, it won’t significantly affect our balance sheet or our fees as we proceed.

Okay, understood. That's it for me. Thanks, guys, and congrats on a strong quarter.

All right. Thank you.

Thanks, good morning. Could you talk about what kind of net charge-offs you're expecting over the next few quarters? Obviously, they were elevated this quarter. Would you expect any other loans to come up in the next couple of quarters or those?

Yes. Jennifer, we discussed the one charge-off that significantly affected our charge-off ratio this past quarter. We haven't seen anything unusual in the last three quarters, and we're keeping an eye on it. There's no news to share at this moment. Our strategy is to act swiftly and decisively if any issues arise, ensuring we handle them directly, which benefits both us and our clients. Currently, we are not aware of any potential issues. As you know, in the credit sector, things can be unpredictable, and I could receive a call soon about a matter we need to address, though I don't expect that to happen. I just want to mention that possibility. Looking ahead to '21, if you review our charge-off ratio from the past two to three years, it has been very low or even nonexistent. I don't anticipate a significant rise, even with some expected charge-offs; we don’t foresee many issues. So, excluding that one credit incident, we don't expect anything that would lead to a spike. Greg, would you like to add anything?

No. I think the main point is that this specific deal should not be seen as an indicator of the overall health of our portfolio. Another aspect we consider is the credit quality of substandard loans; those increased by $5 million from the previous quarter. This is still in line with our figures from year-end 2019. Lastly, we closely monitor non-performing assets, which rose by 9 basis points quarter-over-quarter but are down 4 basis points year-over-year. Our foreclosed and repossessed assets increased by approximately $176,000 for the quarter. However, compared to the previous year, that's a decrease from 11.5% to about 7.5%. As you know, we have also added around $2.7 billion in loans during this time frame. I agree with you. Chris can remove the risk and uncertainty from this, but we can plan and prepare for it, which is something we believe we have managed effectively. As Michael highlighted, our debt reserves are significant and quite strong.

Thank you so much.

Thanks, Jennifer.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Holmes for closing remarks.

All right, very good. Thank you and thanks everybody for joining us. As you can tell, we're proud of the results for the year and the quarter and, but we are excited about moving forward into 2021 and, as always, appreciate your support. Okay, thanks. Good bye. Have a great day.

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