FB Financial Corp Q4 FY2022 Earnings Call

Good morning and welcome to FB Financial Corporation’s Fourth Quarter 2022 Earnings Conference Call. Hosting the call today from FB Financial is Chris Holmes, President and Chief Executive Officer; and Michael Mettee, Chief Financial Officer. Both will be available for questions and answers. 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. During this presentation, FB Financial may make comments, which constitute forward-looking statements under the federal securities laws. Forward-looking statements are based on management’s current expectations and assumptions and are subject to risk and uncertainties and other factors 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 may cause actual results to materially differ from expectations. This 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, and 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.

Alright. Thank you, everyone. Good morning. Thank you everybody for joining us this morning. We appreciate your interest in FB Financial as always. So, as we wrap up 2022, we're pleased with some of the results from the year and we're disappointed with some others. We grew loans by 22.3%, while holding deposits flat was a poor result. We made strategic investments in our people, systems and processes that will propel us into the future. We exit the year with strong capital and liquidity positions. With an adjusted ROAA of 1.11% and an adjusted PTPP ROAA of 1.58%, our profitability was not where we expect it to be, which was disappointing. The restructuring of our mortgage segment, our capital liquidity management actions in the second half of the year, and our operational enhancements scheduled for 2023, should position us well for a range of potential economic scenarios entering 2023. For the quarter, we reported EPS of $0.81 and adjusted EPS of $0.85. We've grown our tangible book value per share, excluding the impact of AOCI, at a compound annual growth rate of 14.8% since our IPO in 2016. On last quarter's call, I highlighted that we were prepared for a potentially challenging operating environment in 2023, particularly in C&D and CRE loans while focusing on liquidity and customer deposits. This quarter's performance reflects those near-term priorities. Our deposit portfolio increased by $850 million this quarter or 33.7% annualized, which we're proud of. When you exclude the change in mortgage escrow-related deposits, the real growth is actually $915 million or 37% annualized, which is even more impressive. Deposit growth includes some seasonal increases in public funds, but the vast majority is customer funding spread across our customer base in both TAM and non-TAM products. The negatives to that stellar deposit growth this quarter were our decline in non-interest bearing accounts, which were down $225 million during the quarter when you exclude the effect of the mortgage escrow deposits and the cost of our interest-bearing deposits, which were up by 93 basis points, compared to the prior quarter. While our deposit growth came at the expense of our profitability this quarter, we have urgency to increase deposit balances now as we expect deposit competition to intensify in the coming months. We know some of the decline in non-interest bearing accounts was a permanent movement out of that category. With Fed funds being over 4% for the first time in 15 years, we're seeing less idle funds sitting in noninterest bearing accounts. While we expect tough conditions for noninterest bearing growth in 2023, we believe the fourth quarter decline is an anomaly, and this will always be a focus for the company. Our goal with interest-bearing deposits and rates is to continue attracting customer relationships, maintaining a loan and deposit ratio near its current level. We limited our loan portfolio to 8.4% annualized growth after producing over 20% annualized growth in each of the prior three quarters. We could have grown more than the 8% by holding onto more of the balances that we originated as we sold $126 million in participations during the quarter. If we retained that $126 million in participation on the balance sheet, we would have had 14% annualized loan growth during the quarter. The current economic environment calls for caution around credit and liquidity, so we will continue to intentionally limit our loan growth to maintain our loan to deposit ratio in the 85% to 90% range and be conservative on credit until we gain some clarity on which asset classes will be impacted by this economic environment. As we indicated last quarter, our combined C&D and non-owner occupied CRE balances decreased by $12 million during the quarter; however, we are not seeing any negative credit trends in these portfolios at this point. We've been managing our new commitments down since the early part of the second quarter of 2022, but due to funding existing commitments, the balance has increased over much of the year. The balance decline we saw in the fourth quarter is a result of our management of commitments throughout 2022 and indicates a trend we expect to continue throughout 2023. In the mortgage segment, combined market headwinds and seasonality led to a pretax loss of $4.2 million for the quarter. While we felt this unit was right-sized following earlier actions taken in the year, we've continued to reduce the size and scope of the segment as the mortgage industry continues to face challenges. The environment has made mortgaging difficult to forecast. So, we're budgeting a positive contribution for 2023, although we are not comfortable getting more precise at this time. Another area worth noting for the quarter is our commercial loans held for sale portfolio. We had a negative mark-to-market adjustment of $2.6 million in the quarter, primarily driven by one credit. The portfolio has reduced to three relationships with $30.5 million in remaining exposure. We believe we will see full payoffs on two of those three remaining relationships in January and should exit the quarter with one remaining relationship and less than $10 million of remaining exposure. As a reminder, we conservatively marked this portfolio when we combined with Franklin and have experienced net gains of $7.4 million since closing. As a result of actions taken during the quarter, we entered 2023 with loans HFI to deposits comfortably below 90% at 85.7%. We also paid down over $300 million in short-term borrowings at a cost of nearly 4% and now have approximately $7 billion in contingent liquidity readily available should we need it. We maintained strong capital ratios with a CET1 ratio of 11% and a total risk-based capital ratio of 13.1%, while repurchasing $7 million worth of shares following a decline in our stock price in December. We expect to continue balancing our management throughout the first half of 2023. Our actions have positioned the bank for improved profitability when we gain clarity on the economic environment. I want to touch on a couple of our longer-term priorities that we will continue to implement during 2023. First, improving the efficiency and effectiveness of our core community banking model through a project we've been operating on, known as the FirstBank way. We operate through a local authority, regional presence model that has served us well and will continue to do so. As we grow the company, we see an opportunity to better quantify the “why” and “how” of our community banking model. This will enable us to better share our culture as we expand, ensuring consistency in processes that allows us to deliver efficient and effective customer service while improving the experience of our associates. In 2022, we committed significant time and resources to define what we wanted our community banking model to look like as we move from our current base of $13 billion in assets. Much of the implementation will take place in 2023, and we are excited to see the fruits of that labor. Second, our local authority model positions the bank for strong organic growth through recruitment and team lift-outs in new markets. We had outstanding results in Memphis and Central Alabama recently due to lift-outs, and we are engaged in discussions with bankers across the Southeast, both in existing markets and new geographies. Lastly, we will maintain discussions with a limited number of banks we find attractive as potential partners. We have structured our balance sheet and internal processes to act with these partners should the opportunities arise. The current uncertainty around the operating environment clouds the timeline for some management teams; however, with the scarcity of potential partners that align with our values, we want to be positioned to act when the opportunity presents itself. To summarize, we have defensively positioned ourselves over the last half of 2022 to improve profitability and aggressively pursue opportunities when we’re confident in the economic outlook. We have undertaken various strategic initiatives that will better serve our customers and associates, improving our operational efficiency. We believe these improvements will create superior returns for shareholders through organic growth and strengthen our capacity to seize opportunities. I'll now turn it over to Michael to provide more detail on our financial performance for the fourth quarter.

Thank you, Chris, and good morning, everyone. I'll first discuss our core bank's results for this quarter. Our baseline run-rate pretax pre-provision income was $55.5 million in the fourth quarter. According to the core efficiency ratio reconciliations on Page 19 of the slide deck and Page 19 of the financial supplement, we had $111.3 million in core bank tax equivalent net interest income this quarter. Along with that $111.3 million in net interest income, we reported $11.1 million in core bank non-interest income. Finally, we had $66.9 million in non-interest expense at the bank. Together, this results in a pretax pre-provision income of $55.5 million, growing by 27.7% over our comparable figure of $43.4 million from the fourth quarter of 2021. Moving on to our net interest margin, detailed on Page 5 of the slide deck, our net interest margin of 3.78% contracted by 15 basis points from the third quarter. Of that decline, 9 basis points resulted from lower loan fees attributed to reduced loan origination activity. The remainder can primarily be attributed to the balance sheet restructuring and the cost of interest-bearing liabilities rising at a faster rate than the yield on our earning assets. Looking ahead for our margin, we hit a run-rate margin for December in the 3.75% range, inclusive of 23 basis points of fees on loans. Our cost of interest-bearing deposits was 1.97% in December versus 1.67% for the quarter. From the period of our deposit cost trial in February of 2022 through December, we estimate experiencing approximately 40% beta for our interest-bearing deposit costs. The contractual yield on loans continues to increase due to Fed rate hikes, now at 5.61% for December compared to 5.45% for the quarter. While we re-priced our existing deposit portfolio in the fourth quarter, which ultimately led to a decline in overall margin, the spread on the contractual yield on new loans originated versus the cost of new deposits raised remains above 4%. With the acceleration of deposit costs in the fourth quarter, we are cautious in our future guidance. Currently, our best estimate for the first quarter is that we maintain margin relatively close to December's margin. We anticipate a mid-to-high single-digit loan growth for the year, and we will actively manage the cost of incremental deposit growth through our funding sources. We project banking non-interest income for 2023 to fall in the $10 million per quarter range. As previously mentioned, our core banking non-interest expense was $66.9 million in the fourth quarter. We expect continued growth in banking non-interest expenses due to higher regulatory costs and inflationary pressures. For 2023, we estimate mid-single-digit growth over the fourth quarter's annualized run rate of $267.6 million. In terms of our mortgage segment, we reported losses this quarter as rising interest rates coupled with seasonality drove down demand for rate locks by 31% quarter-over-quarter, reducing revenue. While we previously anticipated being done with restructuring efforts, ongoing volume reductions have prompted us to reevaluate staffing and organizational structure to return to operational profitability despite seasonal headwinds. While we do not expect Q1 to be profitable, we anticipate minimal losses if conditions remain unchanged. Regarding our allowance for credit losses, we saw our ACL to loans decrease by 4 basis points this quarter and we recorded a release of $456,000. Economic forecasts have deteriorated slightly from quarter to quarter, but this was offset by improving overall portfolio metrics and a lower required reserve on unfunded commitments. We are cautiously optimistic about the long-term health and growth of our local economies while closely monitoring the inflationary pressures we are experiencing and increasing expectations from economists that a recession could be imminent. If conditions do not change, we anticipate maintaining a similar level of ACL to loans held for investment in the near term. With that, I'll turn the call back over to Chris.

Thanks, Michael. Once again, we are pleased with how we're positioned and prepared for what lies ahead. Thank you for the prepared remarks and we look forward to your questions.

Thank you. Today's first question comes from Matt Olney at Stephens Inc. Please go ahead.

Hey, thanks. Good morning everyone.

Hey, good morning, Matt.

You mentioned the deposit growth would continue and be relatively in-line with the loan growth, any more color on what the market rates are you're seeing for the incremental deposit growth in recent weeks?

Yes. Hi, Matt. Good morning. Yes, we saw kind of time deposits depending on term coming in around 350 basis points and that's kind of an 18-month weighted average term there. And then – and money market rates were coming in below Fed funds, but roughly 60% to 80% of Fed funds is where we're seeing money market rates coming in. So, it's very much in line with the market.

Okay. Thanks, Michael. On the non-interest bearing deposits, just reflecting on your comments, Chris, it sounds like you expect continued pressure on those balances, but perhaps not to the same degree that we saw in the fourth quarter. Did I get that right and can you provide more color on why that might be?

Yes, you understood it correctly, but let me clarify further. I believe they won't decline as much as they did in the fourth quarter. I think they'll stabilize to a large extent. However, I expect this to be a continual point of pressure. Over the last couple of years, we had seen growth in this area without much effort, so to some extent, it was bound to revert. If you go back to our discussions in the latter part of 2020 and through 2021, we often questioned how sticky these balances were. And honestly, we still don’t fully know, but some of that decline was anticipated as consumer accounts are returning to pre-COVID balances, making for a tougher environment for non-interest bearing accounts in 2023.

Understood. Finally, on the outlook for net interest margin, Michael, you mentioned that you expect the incremental spreads in 2023 to be similar to the December level, is that correct? And remind me what the December margin was again?

Yes. The net interest margin for December was around 3.75%. Therefore, our outlook indicates that we should maintain a similar level. The spread between new loans versus new deposits is strong, exceeding 400 basis points.

Got it. Thank you.

Hey, Matt. I would just add this on the deposit side. We felt the need to proactively manage our deposits. We had a significant growth in deposit this quarter, which was costly but expected considering our dynamic situation. Given our trajectory regarding the loan-to-deposit ratio, along with our previous loan growth of over 20% in three consecutive quarters, we viewed it as a necessity.

Understood. Thank you.

Our next question comes from Catherine Mealor with KBW. Please go ahead.

Thanks. Good morning.

Hi, Catherine.

Chris, you talked a lot about efficiency initiatives that you believe will help profitability this year. Can you give any guidance on the core bank expense growth outlook excluding some of the mortgage challenges? Also, have you considered specific initiatives within the mortgage sector?

Sure, Catherine. When I discuss efficiency initiatives, remember where we're coming from; we grew from $6 billion at the start of 2020 to $13 billion now, following two acquisitions completed during the pandemic. In 2022, we focused on ensuring our core banking model is scalable as a community bank. Implementing various elements of this model in phases should lead to efficiency gains. We anticipate a 6% to 7% expense growth over the previous quarter. Regarding mortgage, we've conducted two phases of expense reduction and are now proactively managing expenses in that segment. While we are forecasting a positive contribution next year, we are apprehensive about being overly specific with figures.

So, your 6% to 7% expense growth guidance applies to the fourth quarter 2022 expenses, excluding mortgage. Should I use about $67 million as a basis?

That's correct, Catherine. You can use the $67 million, annualize that, and apply the 6% to 7% growth assumption to estimate your 2023 expenses.

Given the projected growth dynamics for the balance sheet next year, would it still be reasonable to anticipate net interest income growth despite the 6% to 7% expense growth rate?

Yes, that’s correct.

Is there flexibility in your expense plan if net interest income growth comes in lower than expected? What options do you have to manage your operating leverage if margin compresses more than anticipated throughout the year?

We do have some flexibility, Catherine, which we sought to create in the fourth quarter. We are trying to provide some levers to pull on both the net margin and expense sides.

Thanks for the clarity.

Thank you.

Our next question today comes from Brett Rabatin with Hovde Group. Please go ahead.

Hey, guys. Good morning.

Good morning, Brett. Hope you're doing well.

I wanted to use a football analogy, Chris; you guys are usually in the playoffs regarding profitability, but mortgage banking has been a hindrance to that in the past year. Do you need mortgage banking to achieve a solid level of profitability?

I appreciate the analogy, Brett. I often share a similar sentiment internally. I tell our new hires that joining First Bank is like signing a scholarship with an elite football program; we expect to contend for titles every year. While we missed the playoffs this year, it is important to confront the brutal facts of our performance. Since becoming a public company, we've never had a return on assets below 1.5% until now. Mortgage banking has contributed significantly in the past, with a $105 million contribution in 2020, but we do not depend on it for our success. Our bank segment has been performing well, and if we look strictly at the bank side, we remain comfortably in the top half of our peer group. Despite a $0.20 to $0.30 EPS impact from mortgage this year, we've made changes there and will continue to improve. Thus, we do not need mortgage banking to return to that 1.5% ROA, but we do strive for higher. That’s our position.

That's valuable insight. I wanted to clarify further about the liquidity situation. You improved liquidity with added cash to the balance sheet by the end of the quarter. How do you see seasonal funds impacting your balance sheet in upcoming quarters?

Michael, please step in. I'll mention that we had Federal Home Loan Bank borrowings of $540 million at the end of the third quarter, which we significantly reduced by year-end. We paid it off completely, maintaining our strategy of funding our balance sheet through customer deposits, particularly as seasonal funds usually hold steady through the first quarter and begin to pay down by late second quarter. Our balance sheet management is built around that cycle and we look to remain stable.

Certainly, Chris. That's right. We always prioritize using customer deposits to fund our balance sheet.

Thank you for that color.

Our next question comes from Stephen Scouten with Piper Sandler. Please go ahead.

Hey, good morning everyone.

Good morning, Stephen.

Could you clarify how much of your public funds deposits are directly indexed versus longer-term metrics?

The public funds represent a mix. Most are not long-term, and the larger portion would be in non-time or non-indexed. Some are indexed, but overall, we do not have a lot tied directly to Fed funds.

Understood. If I'm grasping your comments correctly, it seems you believe you may have put yourself ahead of the curve on deposits relative to your peers going into 2023. Is that accurate?

Yes, that's correct.

I noticed an uptick in other expenses in your report, should we consider any notable factors contributing to that, like the regulatory costs you mentioned?

There were no noteworthy changes to highlight apart from a rise in franchise excise taxes, which affected the comparison to the third quarter.

That clarifies things. One last question - regarding participation in loans, it seems this is primarily targeted at balance sheet management but could involve risk management too. What specific areas are you simplifying through participation?

Yes, it’s really about balance sheet management. We will only participate in loans that we are confident about. The majority of our participations are in CRE and construction is a bit more complicated due to the structure of commitments, but we focus on relationships with trusted peers.

That’s helpful. Lastly, on the share repurchase plan, I see you executed around $7 million last quarter. If the stock price remains lower than where buys are made, do you anticipate increasing the activity on the buyback?

We're cautious about repurchases; however, we have sufficient capital to engage in repurchases if needed. Thus, it’s certainly a tool available for us.

Thank you for all the insights.

Thank you, Stephen.

Thank you. Our next question today comes from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.

Hey, good morning. How are you guys?

We’re good, Kevin. Hope you are.

About last quarter, the deposit growth saw significant acceleration. From here, do you expect growth rates to align more closely with loans, keeping the loan-to-deposit ratio stable?

Yes, Kevin, you have that correct. We finished last quarter with a loan to deposit ratio just above 91%. We aim to maintain a ratio between 85% and 90%, so we are comfortable managing growth within that range.

Can you elaborate on how to consider margin in conjunction with those dynamics? Would it be fair to expect further margin compression if rates happen to increase again?

We typically project 10% to 12% loan growth organically, and while we expect to be slightly lower than that this year, we do anticipate some healthy growth. However, demand may dampen more than it has previously. Our net interest margin will not significantly decline from current levels but could slightly adjust with market fluctuations.

Do you see any effects from managing participation loans, primarily geared toward balance sheet management rather than risks?

Yes, it’s predominantly about balance sheet management. Our participations are primarily focused on CRE, with some construction as they are more complex to manage due to draw against lines.

Thank you for the clarification.

Our next question comes from Feddie Strickland with Janney Montgomery Scott. Please go ahead.

Hey, good morning.

Good morning.

To clarify further, you’re confident about growing deposits and managing loan growth. As such, we shouldn't anticipate a rise in wholesale funding in the coming quarters?

That’s correct, the strategy is to keep growth aligned, not reliant on wholesale funding. Our priority is to stay within our means to improve profitability and not just depend on external sources.

Is potential collateral for places such as the Federal Home Loan Bank a significant factor in choosing what assets go on the balance sheet?

Yes, it is always a consideration, as we aim to keep our balance sheet as flexible as possible. We think about how much collateral we are able to pledge, especially since we prefer to use customer funds.

That's insightful. One last inquiry: in your assessments regarding deposit competition, are the larger national competitors more aggressive, or are smaller local banks competing more for your customers?

Interestingly, it's a bit of both. Larger banks haven't reacted much, while several aggressive, high-performing regional banks closely compete with us. Furthermore, smaller banks have launched incredibly attractive deposit offers, adding to the competition.

Thank you for the insights, guys.

Thanks, Feddie.

Our next question comes from Jennifer Demba at Truist Securities. Please go ahead.

Thanks. Good morning everyone.

Good morning, Jennifer.

Your asset quality remains very strong; can you share any specific loan categories that concern you, especially if the economy weakens?

Certainly. I am most concerned about construction and certain pockets of CRE. With construction, it's a risky asset with potential for surprises, but we know our construction customers and feel confident about them. CRE, particularly office spaces, might face challenges, though we have low exposure. Also, we keep an eye on our specialty portfolio in manufactured housing, noting that past dures have increased but remain manageable compared to 2019 levels.

Can you provide a sense of what your office portfolio looks like?

Yes, about 23% of our CRE exposure includes offices. We avoid high-rise buildings in major downtowns but do have some smaller buildings with quality clients. Overall, we feel positive about our situation.

Lastly, what economic scenario is assumed for your loan loss reserve by year-end?

We used a mix of baseline and S2 scenarios, split about 75% baseline and 25% S2, influenced by the rapid changes in economic outlook between the third and fourth quarters.

Thank you very much.

Thank you.

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

Once again, thank you very much for your attendance. We appreciate your interest in FB Financial. Operator, at this point, we're finished. Thank you.

Thank you, sir. This concludes today's conference call. You may all disconnect your lines, and have a wonderful day.