FB Financial Corp Q2 FY2021 Earnings Call

Good morning, and welcome to FB Financial Corporation's Second Quarter 2021 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 an 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, Chad. 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 at www.firstbankonline.com and on the SEC's website at www.sec.gov. I would now like to turn the presentation over to Chris Holmes, FB Financial's President and CEO.

Thank you, Robert. Good morning, everybody. And thank you for joining us. We always appreciate your interest in FB Financial. We had a great quarter as we delivered annualized loan growth of 13.9% when you exclude PPP. Adjusted EPS of $0.88, adjusted return on average assets of 1.43%, adjusted return on tangible common equity of 15.8% and grew our tangible book value per share to $20.43 or a 16.4% annualized pace. Back in April, when we had our last call, economic activity in our markets had started picking back up and folks across our footprint were returning or had already returned to their normal schedules. We felt that this return to normal was reflected in our numbers last quarter as we had loan growth of 1.8% annualized, most of which came in March. We also had a 19 basis point release in our adjusted allowance, deferrals declining to $152 million and net charge-offs of 5 basis points. In this quarter, our markets have really been buzzing. People have almost universally returned to work and our customers are transacting business again. This quarter's results reflect our footprint rebound, as loan growth ex-PPP was a stellar $240 million. We saw a 26 basis point release in our adjusted allowance. Our deferrals are down to $74 million, and net charge-offs were only 2 basis points. Our loan growth this quarter is a sign of the strength of our markets, as well as the quality and capacity of our relationship managers. Our growth came from a broad range of areas. Middle Tennessee continues to show very strong economic activity. Our teams in Knoxville and North Alabama had some notable wins this quarter. We're also seeing strong performance out of Birmingham, which delivered $40 million of loan growth. We just recently received FDIC approval for a full branch location in Birmingham. So we look forward to continued momentum from that team. Our Memphis team has contributed approximately $90 million of loan growth since we added several new relationship managers in that market last year and has a strong pipeline of relationships that they're converting to FirstBank customers. Our relationship managers in the field are excited about the opportunities they have in front of them, and the pipeline remains strong. We feel good about our loan growth for 2021. We're adjusting our guidance to high single-digit growth for 2021, and we could potentially reach double-digit growth, though we have some expected payoffs that might make that 10% hard to achieve. On the liability side of the balance sheet, we've reduced our cost of interest-bearing deposits by 12 basis points this quarter. I believe we still have some room for improvement on our cost of deposits. We'll continue to press our team to find pockets where it's appropriate to lower our rates. We also continue to tackle operational technology and customer experience initiatives that create scalability and position us for the future. We're committed to executing our customer-focused organic growth strategy in a way that creates the highest performing bank in the Southeast. Following our Franklin combination and our growth over the last few quarters from $7 billion in assets to $12 billion, we have focused on integrating teams, associate retention and satisfaction, and building out scalable credit and risk management platforms. These initiatives ensure that we have the necessary people and infrastructure in place to execute on organic growth and acquisition opportunities without sacrificing our customer-focused community banking model that we believe will be a key differentiator for us over the coming years. We believe that if you're not currently executing at a high level, then you're wasting shareholder resources by adding scale to a less than optimal organization. We see this frequently in bank M&A, but we're determined that it will not happen to us. On M&A, the universe of traditional banks continues to shrink. Scarcity value is real, given the relatively few quality banks that provide scale and geographies that are attractive to us. We keep a list of those banks and will be interested if they choose to seek a merger partner. At the right time, we will also pursue opportunistic M&A, which I define as banks that aren't necessarily on our radar at the moment but would add value to our footprint or funding profile. Until then, we operate with great teams and great markets capable of producing organic growth, as this quarter shows. On mortgage, our results aligned with guidance provided last quarter, but at $500,000 they were less than we would like. Given the market movement yesterday, we're re-forecasting. Our best estimate right now is $2 million to $4 million of contribution for the third quarter, and I will allow Michael to provide additional context on the current mortgage backdrop in his section. To summarize, we had a very strong quarter of loan growth that we believe reflects the strength of our markets, the quality of our team, and our focus on execution. We expect that growth to continue over the remainder of 2021. The mortgage market is challenging, but should contribute better in future quarters. We continue to improve our funding costs and think we have more room for improvement. Most importantly, we have the people, systems, and processes to capitalize on strong growth prospects ahead. I'll now turn the call over to Greg to discuss credit.

Thanks, Chris. And good morning, everyone. As you can see, we've scaled back our credit disclosures this quarter as our local economies continue to improve. We are keeping an eye on COVID case counts with the Delta variant picking up some steam across the country. However, in the absence of further widespread outbreaks and related shutdowns, we feel positive overall about the portfolio's performance over the past 15 months. While we have not issued an all-clear memo yet, we are cautiously optimistic about how things have unfolded. As noted, our overall deferrals are down to less than 30 loans, with roughly $74 million outstanding. The bulk of those, as highlighted previously, are actually on an interest-only payment schedule, while the remainder is on a full principal and interest deferral. Hotels continue to be the largest component, but most of our operators are reporting improving trends, especially those seasoned managers who benefit from newer properties and better flags. We actually had one of our smaller hotel loans that we had identified as a concern pay off this quarter, which helps our outlook as well. As noted in Chris's comments, I’m pleased to see the pickup in our loan book as our teams continue to compete aggressively across the markets. Our associates are identifying good opportunities, and our people continue to balance growth and asset quality to achieve long-term profitability, which is the core of our company's historic success. I'll now turn the call over to Mike.

Thank you, Greg. And good morning, everyone. Speaking first to mortgage, this quarter, we achieved a contribution of approximately $550,000. We're seeing margin compression and reduced volumes due to excess capacity in the industry, refinance fatigue, and a shortage of housing in our markets. We expect the housing shortage to be a continued headwind, and margin compression will be a concern until we see capacity exit the mortgage industry. However, margins have stabilized over the last couple of weeks. The $2 million to $4 million guidance from Chris reflects our estimate without considering the recent rate drop. It is challenging given the recent changes in the rate environment and the FHFA's removal of the adverse market fee on refinancing, both of which could lead to more refinance activity, but it's too early to tell. Moving on to net interest margins, we saw our headline number remain flat at 3.18% in the second quarter compared to 3.19% in the first quarter. We were able to decrease our cost of total deposits by 10 basis points this quarter. We continue to focus on lowering our funding costs and see room for continued improvement. Our contractual yield on loans, excluding PPP, dropped by 11 basis points to 4.37% in Q2 from 4.48% in Q1 due to fierce pricing competition. Yield on new originations during the quarter came in at the 3.8% to 3.9% range, a trend we expect to see continue. In the absence of rate increases, we expect margins to stay in the same relative band we've been in. Our cost of funds should also continue to decline slightly. In terms of CECL and our allowance, we saw a release of $13.8 million this quarter as economic forecasts continued to improve. We will continue to weigh the improving forecast against Q factors necessary to capture risk levels not reasonably picked up by our model. We would currently expect further releases over the upcoming quarters, assuming the outlook continues to improve. Our exposure to our non-core commercial held-for-sale portfolio declined by an additional $50 million this quarter. With these paydowns and improving economic conditions, we saw a gain of $1.4 million on our portfolio, compared to a loss and gains in previous quarters. In terms of banking expenses, they were higher than we anticipated as we implemented systems and took advantage of hiring opportunities to support growth. We don't expect our banking expenses to exceed current levels over the next two quarters, and we expect next year's expense growth to be in the low to mid-single-digit range. With that, I'll turn the call back over to Chris.

Thanks, Greg and Michael, for the insights. Certainly, we believe that we delivered strong financial performance this quarter, and we're pleased with the team's results, particularly our loan growth. That concludes our prepared remarks. Thank you, everybody, for your interest in FB Financial. Operator, at this point, we'd like to open the line for questions.

Thank you, sir. The first question will be from Stephen Scouten with Piper Sandler. Please go ahead.

Hey. Good morning, everyone.

Good morning, Stephen.

So just maybe start with loan growth here a little bit. Obviously, I think the 14% level was a very impressive number. We'll see how other peers shake out, but I don't think they'll be anywhere near that level. So wondering, other than just the strength of the markets you spoke to, were there any other nuances that led to that growth? It seemed like maybe there was more residential real estate growth. So can you talk to that? Was that maybe just holding more on balance sheet or what are the dynamics there?

Yes, we can address that. Certainly, Stephen, it came across the board, with a couple of components to the net growth number. Our fundings were surprisingly balanced across C&I, CRE, both owner-occupied and non-owner-occupied, and multifamily, which was probably the biggest area of growth for us. We had good originations but just frankly had fewer paydowns. It was impressive. While I appreciate you calling it an impressive growth number, our level of paydowns as well was remarkable. We had great originations and didn't see many paydowns in multifamily, which led to higher growth in that segment. Residential also saw some growth, so it was really balanced across the board. Anything to add?

I'd also add that balance point is key, and I saw it in the loan dollars side as well. There were a lot of $2 million, $3 million, $4 million deals that were representative across the footprint.

We thought that once things really opened back up, we'd see lots of activity, and if you walked down Broadway in Nashville even at 8 o'clock in the morning on a Tuesday, you'd be surprised at the amount of activity.

Stephen, it's Mike. I'd add that your point about putting more residential on balance sheet is one of the benefits of the mortgage division. If we choose to do that, we have the ability to portfolio mortgage loans, and sometimes we do this.

Okay. And I guess, is that a strategy shift in general or just something you took advantage of this quarter? And what kind of production are you keeping on balance sheet? Is it arms or shorter term?

It's not really a strategy shift. Very little production. We're still selling about 97% of our mortgages in the secondary market moving forward. We do see some jumbo customer loans that we'll put on the balance sheet, but good customers within our footprint, but it's not significant at this point.

Net of payoffs, it contributed, but I'd say it wasn’t a huge contributor.

Got it. Yeah, makes sense. Okay. And then maybe thinking about capital deployment, you seemed a little more aggressive in your commentary about the ability to deploy capital and you mentioned a handful of M&A targets you guys would be active with if they came to market. Can you give us a feel for how many of those targets might be out there? And what kind of asset sizes would you be looking at? And if M&A doesn't come about, how aggressive could you be on share repurchase, especially with the stock having pulled back somewhat?

Yes. On the M&A front, we've always considered potential opportunities. However, we've not been aggressively pursuing M&A for a couple of reasons including internal initiatives that we feel enhance the quality of everything we do and our associate and customer experiences. We've grown significantly over the last 18 months and focused on that as well. We do keep a small list of names in and around our footprint. It wouldn't hit double digits in terms of our targets because the scarcity of quality franchises is high. Some banks may reach out soon; others may not for several years which is fine for us.

Okay. Yeah, that's really helpful. And then just following up on thoughts about share repurchase, down to 1.5 in tangible book, obviously, makes the math look more attractive. You mentioned you have a lot more excess capital now. How do you think about that today?

You're exactly right, Stephen. We're accumulating a lot of capital and expect that to continue. A buyback of shares is a possibility as we move forward over the next couple of quarters. At 1.5 times tangible, we’re considering that seriously as it has become more attractive.

Okay, great. Well, thanks for the color. And congrats on a great quarter.

Thank you, Stephen.

And our next question will come from Brett Rabatin with Hovde Group. Please go ahead.

Hi. Good morning, everyone.

Good morning, Brett.

I wanted to first ask on the mortgage, the guidance for the $2 million to $4 million in contribution for 3Q, can we talk about the assumptions for that? Does that assume the current rate down drop we've got here sticks or is that your assumption? And then just maybe talk about how you're assuming gain on sale margins trend from here?

So really, as we look through the quarter, it doesn't include some of the recent rate rally, I'd say, from the last couple of days. The $2 million to $4 million estimate was framed before that. The interest rates have been volatile, so we think there may be some tailwinds because of the recent lower rates. It's too early to tell how long they will stick and if mortgages will follow. Margin perspective, on slide six, our pipeline metrics show a range of 2.40 in terms of where our margins have been coming in.

Okay. I appreciate the color there. And then the other thing was just you highlighted the hires and expansion and talked about Birmingham, but you also mentioned that you wouldn't expect the core bank expenses to grow from here. Are you sort of accomplished what you wanted to in terms of adding talent for the near term? And what other opportunities might you look at? In what markets might those be, if any?

Recruiting is a 7-day-a-week, 365 days opportunity for us. We could always opportunistically add teams or individual revenue producers as opportunities arise. There's always things falling out of the expense side and things getting added to it, so it's a constant roll forward. We know of a few expenses that will decrease in the quarter, but we are also allowing for some adds to personnel. We continue to look for talent not only on the revenue-producing side but have made key hires in financial and risk areas. We'll keep pursuing talent upgrades.

Okay, great.

Thank you, Brett. We expect we can do that within our existing expense structure for the next couple of quarters.

And our next question will come from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.

Hey. Good morning, everyone.

Good morning, Kevin.

Just another follow-on question on mortgage, so looking at components of mortgage banking income on page 12 of the supplement. Would it be reasonable to assume that the fair value hit of about $17.6 million this quarter will come lower and there will also be some additional pressure on the gain and fees from originations line? Is that a fair assumption?

That's fair. The pipeline has decreased about 30% quarter-over-quarter. The new rate lock volume reflects that fair value mark.

Great, thank you. I appreciate it.

Sure thing, Kevin.

And just a housekeeping question on loan growth guidance, taking it up to high single digit. It was previously mid to high single digit, is that correct?

That's correct. It was previously mid to high. We're now saying it should be high at this point.

Okay. Can you remind us what the day one CECL level is, on a combined basis? What you consider that level and when you might approach it?

Yes, around 140 to 150 on the original level. I wouldn't say that we think about it like that because the business has changed so much. It’s tough to form that view since we've moved from $7 billion to $12 billion. The combination changed the environment further. So it’s hard to think about from day one. We'll address the issues as things continue down that path and will likely push to 2022 as we observe our economies and situations with the Delta variant.

Exactly. I think that's a good summary. It’s been frustrating with CECL as we’ve put a lot in and now we’re slowly seeing it come back out. This makes it hard to pinpoint core earnings from quarter to quarter.

And that's why I asked because I didn’t want to place too much weight on that number when you were a different bank at that point.

Absolutely. But we try to be as transparent as possible. Future releases are expected if things continue as projected. However, we lack a specific timeframe on that.

One last one for me, on the M&A front you highlighted the targets in and around your markets. Are there any markets where you would be more open to looking at such as maybe the Carolinas or Northern Georgia? I would assume Birmingham is one of your targets.

Yes, the list is all within our geography. Northern Georgia is included in that geography as well. We wouldn’t do anything too far outside of our area because we’d prefer consistent growth. For instance, there’s no physical presence in the western part of the Carolinas but wouldn’t reach that far and we’re interested in anything close due to proximity.

Thank you very much.

You're welcome.

The next question will be from Catherine Mealor with KBW. Please go ahead.

Thanks. Good morning.

Good morning, Catherine.

I wanted to follow up on bank level expenses. I want to ensure that we hear your guidance correctly. You're saying you think core expenses will grow from here. What kind of annualization are you seeing? I recall last quarter, the annualized figure was about $212 million, guided for low to mid-single digit growth rate this year. It appears guidance is increasing. Can you provide clarity?

So for the rest of the year, we don't expect the third and fourth quarters to be as high as the second quarter was. We expect some stability in expenses, with a slight downward trend for the remainder of this year. The low single digit growth rate, particularly for 2022, remains applicable. So, yes, we expect core expenses to come down from quarter two’s numbers.

Great. To clarify, core expenses will come down from this quarter, with low single digit growth for next year from that base?

Yes, that's correct.

Perfect. What's the difference between gain on sale margins and the consumer direct business versus the in-footprint core mortgage business?

Catherine, in the consumer direct space, margins are around 175 to 190 basis points. In the retail front, you're looking probably at 320 to 340 basis points.

Okay, great. Thanks.

Thank you.

Thanks, Catherine. Appreciate you joining us today.

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

Hi. Great. Thanks. Good morning, guys.

Morning.

Looking back on the loan growth, I think you're clear that the paydowns eased significantly in Q2, but could potentially return in the second half. What about utilization rates? How do the levels in Q2 compare to those before the pandemic?

So a couple of things, Matt. We had significant paydowns in the second quarter but were still able to produce 14% loan growth. Our originations were really strong this quarter. We didn’t see much help in fundings on our lines, just about $20 million in C&I lines in terms of existing lines funded. So while we had assists in utilization, it wasn’t too significant for us.

Yeah. We're still below pre-pandemic levels for sure, probably around 5% lower than pre-pandemic levels. If you look back to Q4 2019, we're still 7% or 8% below utilization rates.

Okay. That’s helpful. On mortgage, you mentioned supply shortages in your core markets. Is this a short-term issue or a longer-term problem we’ll be discussing for years?

It’s a great question. I don't think it's a short-term issue. It’s something we won’t talk about for just a few months. We'll likely discuss it for several quarters, if not longer. I don’t see how Nashville gets back in balance with supply given the strength of the economy. This conversation won’t be resolved quickly.

It’s a good point, Chris. Middle Tennessee has a positive influx of population and job growth, which creates a good problem with increased demand in the market.

Correct. The other markets are not as robust, but they are performing well. The overall economy in Tennessee is strong and we’re one of the best states where we operate. As we assess, places like Huntsville and Birmingham are showing good signs of growth and demand.

We’ll keep an eye on that. Lastly, a housekeeping question. There was a notable increase in ATM interchange fees this quarter. Any specific drivers behind this? And when should we expect the Durbin impact, and what do you think the amount will be?

The increase stemmed from economic activity as people made more transactions, resulting in a $1 million increase quarter-over-quarter. However, it’s too early to determine if this is a repeatable trend.

Durbin will hit on July 1st of next year. We're effectively losing 40% of the current number that we have booked. We expect that number to grow which reflects a good retail presence in many of our markets.

Okay. Thank you.

Thank you, Matt.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Chris Holmes for any closing remarks.

Thank you very much, and thank you for joining us this morning. I always appreciate the interaction and the questions. If there is anything that we didn't cover, we're glad to follow up. Everyone, have a great rest of your day, and I hope your earnings season is successful. Thank you.

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