FB Financial Corp Q3 FY2023 Earnings Call

Good morning and welcome to the FB Financial Corporation’s Third Quarter 2023 Earnings Conference Call. Hosting the call today from FB Financial are Chris Holmes, President and Chief Executive Officer; and Michael Mettee, Chief Financial Officer. Also joining the call for the question-and-answer section is Travis Edmondson, Chief Banking Officer. 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.

All right. Thank you, Jason. Good morning. Thank you all for joining us on the call this morning. We always appreciate your interest in FB Financial. For the quarter, we reported EPS of $0.41 per share and an adjusted EPS of $0.71. We’ve grown our tangible book value per share excluding the impact of AOCI at a compound annual growth rate of 14% since our IPO. In recent quarterly calls, I’ve discussed priorities of maintaining the strength of the balance sheet and improving internal processes and procedures with the goals of efficiency and scalability. We’ve made significant progress on both of those priorities. First, let me talk about the balance sheet. Our capital positions are strong across the board, including a CET1 ratio of 11.8%, and a tangible common equity to tangible assets ratio of 9.2%. And in doing that, we haven’t reclassified any of our available for sale securities as held-to-maturity. Our capital and reserve levels are prepared for difficult times, but we don’t expect economic conditions to become as severe as our preparation allows for. Our liquidity position, which is detailed on page 11 of the financial supplement that we provide each quarter, continues to be strong. We keep our securities portfolio plus our loans as a percent of deposits near or under 100% to keep from overleveraging our deposit base. If you use that metric to compare banks, you’ll find that we have one of the lowest levels of leverage - often the lowest on our deposit base among our peers. When you consider that our deposit base is quite granular and we make very little use of brokered and internet deposits, this keeps us in a strong liquidity position. Our credit portfolio continues to perform well, although we did move one C&I loan to non-accrual in the quarter. Outside of that credit, we haven’t seen significant changes quarter to quarter. Again, we’re positioned very well with an ACL of 1.57% of our HFI loan portfolio. We also reduced our CRE and construction exposure over the last five quarters. CREs within our long-term tolerance level and construction will be there by the end of the year. And so, as we enter the fourth quarter, the balance sheet feels well positioned. We built some momentum there and we’re excited about the growth opportunities that lie ahead of us. From an operational perspective, we feel as strong as we ever have and we’re focused on improving profitability and returns. In the late third and early fourth quarters, we executed on pieces of two broader initiatives to both increase revenue and reduce expenses. While actions were taken in the third quarter, the majority of the benefit will be felt in the fourth quarter and beyond. On the revenue side, as you’ve seen in the earnings release, we executed a securities trade that will lead to improvement in net interest income in Q4 and in 2024. Trade also resulted in a pre-tax loss of $14.2 million in the third quarter. I’m going to let Michael discuss our strategy there in more detail, but we continue to look for ways to continue to enhance our profitability. The margin, net interest margin has been difficult to forecast over the last several quarters, not only for ourselves, but for others as well based on the discussions we’ve had with our peers. The margin is becoming somewhat less volatile because the velocity of change in the variables has slowed. Models have been tweaked and in some cases overhauled and confidence in the forecast is increasing. Funding costs will continue to increase as long as we remain in this rate environment, but the rate of increase on our deposits has slowed materially, and we expect the NIM to remain in the same relative band that we experienced in the last two quarters for the next couple of quarters. Again, Michael is going to provide some deeper analysis in his commentary. On expenses, and significantly we reduced our run rate on core banking non-interest expenses by $15 million. The realization of most of those expense savings begins in late October, so we expect a couple of months of benefit in Q4. By mid-January, we anticipate achieving an additional $5 million in annualized expense reduction, so $20 million annualized in total. We currently expect core banking non-interest expenses of $255 million to $260 million in 2024, which compares to third quarter core banking expenses of $66.2 million or $265 million annualized. M&A conversations seem to be picking up across the industry, and we’re increasingly receiving inbound calls, asking to engage in those discussions. As we’ve said before, we don’t believe in acquiring for the sake of growing our asset size, but there are some banks across our geography that we respect and believe would be great cultural and strategic fits. Following our internal efficiency and scalability initiatives of the last couple of years, we’re very confident in our ability to effectively execute on M&A, should the right opportunities arise. So, to summarize before handing the call over to Michael, we spent time and resources focused on internal improvements and enhancing our balance sheet. We made ourselves a better place to bank for our customers, a better place to work for our associates and in that process we’ve improved our operational efficiency. At the same time, we built our capital, maintained strong reserves and put ourselves in a great liquidity position. Increasing profitability and returns are in focus for us, and we’re ready to execute on attractive opportunities that may come our way. Now, I’m going to let Michael go into our financial results in a little more detail.

Thank you, Chris, and good morning, everyone. It’s a bit of a noisy quarter due to our securities trade and the charges related to our efficiency initiatives. So I will take a minute to walk through this quarter’s core earnings. We reported net interest income of $100.9 million, and reported non-interest income was $8 million. Adjusting for the $4.2 million loss on sale of securities, $115,000 gain on a sale of OREO, we had core non-interest income of $22.1 million. Of that $22.1 million, $10.1 million came from banking. We reported non-interest expense of $83 million and adjusting for $4.8 million in charges related to the efficiency initiatives, we had core non-interest expense of $78.2 million. Of that $78.2 million, $66.2 million came from banking. So we delivered consolidated core pre-tax, pre-provision earnings of $45 million and banking core pre-tax, pre-provision earnings of $44.8 million. Going into more detail on net interest income and our margin, I’ll touch first on our securities trade. We sold $77 million of securities at a $14.2 million pretax loss at the end of September. Given the timing, we do not see any real benefits in net interest income in the third quarter from that transaction. The trade should deliver approximately $4 million in additional net interest income annually. At this point, we are continually examining how we can increase our yield on our liquidity. We would be comfortable with another loss in the $10 million to $20 million range if the trade met our parameters on earn-back, expected duration, earnings accretion and capital dilution. We wouldn’t do a trade that would not meet our parameters, as there will be many options to deploy capital over the next couple of quarters. Next, our contractual yield on loans increased by 16 basis points during the quarter to 6.32%. For the month of September, our contractual yield on loans held was 6.35%. Yield on new commitments for the month of September were coming in a little over 8%. Remember, 48% of our loan portfolio remains floating rate, which leaves $4.9 billion in fixed rate loans. Of that $4.9 billion of fixed rate loans, we have about $200 million maturing in the fourth quarter at a yield of about 6.7%, $300 million maturing in the first half of 2024 with a yield of 6.05%, and about $175 million maturing in the second half of ‘24 with a yield of 5.65%, so about $680 million maturing through year-end 2024, at a weighted average yield of about 6.13%. Cost of deposits continued to rise. But as Chris mentioned, we have seen that rate of increase moderate recently. For the quarter, our cost of interest-bearing deposits increased by 27 basis points to 3.33%. For the months of July, August, and September, our cost of interest-bearing deposits was 3.2%, 3.43% and 3.35%, respectively. Incremental interest-bearing deposits for the month of September were coming out of the balance sheet at around 3.6%. As a reminder, we’ll have public funds accounts begin to build in the fourth quarter. We would expect $400 million to $500 million to come back out of the balance sheet in the fourth quarter with a cost of a little over 5%. Those gives and takes left our margin for the quarter at 3.42%, effectively flat with the second quarter. With all the moving pieces that I laid out above, we anticipate margin being in the 3.30% to 3.40% range for the next couple of quarters. Moving to non-interest income, non-mortgage, non-interest income continues to perform in the $10 million to $11 million range and we expect that to remain in the band plus or minus the next few quarters. Our non-interest expense also needs more explanation than is typical for this quarter. At this point, we’ve taken $15 million in annual expenses out of our run rate, most of which occurred in September and early October. We’ve also acted on an additional $5 million in annual expense reduction that will be realized by the end of January. These reductions have come through a combination of a voluntary early retirement program and some position eliminations, reduction of redundant processes, limiting utilization of professional services and contract renegotiations and cancellations. Most of the expense reductions still to be realized will come from a closure of seven branches, which we have communicated internally and to customers. For the fourth quarter, we expect banking non-interest expense to be in the $64 million to $66 million range and for 2024, we anticipate annual banking non-interest expenses of $255 million to $260 million. To achieve this reduction, we took a $4.8 million in charges in the third quarter in connection with the early retirement program and related severance costs. We also took $1.4 million in charges related to this project in the second quarter. So we’re at about $6.2 million so far. We anticipate an additional $5 million to $7 million in charges through the fourth and first quarters as we continue our focus on efficiency and profitability. On the ACL and credit quality, our ACL on loans held for investment increased by 6 basis points for the quarter, or a $5.5 million increase in the allowance. Much of that $5.5 million was related to a specific reserve on the credit that Chris mentioned earlier. That credit was also almost entirely responsible for our $10.4 million increase in non-performing loans held for investment this quarter. Excluding this credit, our ACL to loans held for investment would have remained roughly flat as economic indicators remained in line with the prior quarter. I’ll close by speaking to the progress that we’ve made in the past year on our recent priorities of balance sheet strength through liquidity and capital management. In the past 12 months, we’ve increased our TCE to tangible assets by 60 basis points and total risk-based capital by 110 basis points. Our loan to deposits have declined from 91% to 87%. Our construction and development bank level Tier 1 capital plus allowance has declined from 124% to 104%, and we’ll continue to move lower and closer to our long-term operating target for that ratio of 85% to 90%. On balance sheet liquidity to tangible assets has increased from 7.4% 12 months ago to 11% today, and we have grown our available sources of liquidity from $6.2 billion in the third quarter of 2022 to $6.8 billion today. As Chris said, we feel very well prepared for any economic downturn. And our current view is that any downturn we experience will be milder than what we have prepared for. I’ll now turn the call back over to Chris.

Thanks, Michael, for that color. And to summarize before going into questions, our balance sheet’s situated in a position of strength, we’re focused on improving profitability and returns. We’re excited about the future and from a financial perspective, we feel very prepared to execute on any opportunities that may come our way, so both financially and operationally. So that concludes our prepared remarks. Again, thank you for your interest. And operator, we’ll open up the line for questions.

We’ll now begin the question-and-answer session. Our first question comes from Stephen Scouten from Piper Sandler.

I wanted to get some more information on the security sale. I think last quarter you mentioned the time frames you were considering for the earn-back were between 9 to 27 months. It seems like this one is a bit longer. I'm curious about a couple of things: what types of securities did you reinvest in for that 6.43% yield? Also, what did you sell that led to this longer earn-back? Was it a longer duration portion of your securities portfolio? That would be helpful.

Yes, it was a little bit longer. It’s a little over a three-year earn-back. As we went through the process, we thought about even if rates move down 300 basis points, these securities we sold which are mostly mortgages and some CMOs would be with us in any rate environment. So that has extended out so far that it just made sense to kind of get rid of the dogs, as I’m calling them internally. Reinvestment of some government agency stuff, FHLB type paper and so that’s where the yield came from, although we are seeing current market securities all in that range. It’s all well within our guidelines and duration, not any extra credit risk there.

Okay. That’s helpful. And then maybe thinking about just that one C&I credit that you noted that kind of encapsulates a lot of the move into credit metrics. Any additional information you can give us there, kind of what sector that is and if there’s any lingering issues along the same lines and then the other similar sectors?

Sure, Stephen. It’s Chris. Travis Edmondson, our Chief Banking Officer, is here with us as well. Let me make a comment. There was a bankruptcy related to Mountain Express, which you’re familiar with. We are not involved in that credit at all. We do have a client who had a vendor involved in that bankruptcy, and that represents one C&I credit for us, roughly a $10 million credit. It is well secured and has guarantors, as most of our credits of this type do. However, once it enters bankruptcy, we take a conservative approach. There is a major vendor in bankruptcy, so we have put the credit on non-accrual and set aside additional reserves, despite our optimism about it.

I understand. Michael mentioned that there are no significant changes in your approach to the allowance for credit losses and the underlying economic conditions, but you have increased the reserve despite only experiencing 2 basis points in charge-offs. It seems that this increase reflects a cautious stance on your part. You never know what unforeseen challenges may arise. Is that the correct interpretation, or should we anticipate further reserve increases in the future?

Yes.

Go ahead, Mike.

Well, I think we’re well positioned, Stephen. And I think this range didn’t move up because of the credit we’re talking about individually evaluated loan. But I think you’ll sort of stay in this range. We feel comfortable with where we are. And like I said, we haven’t seen deterioration in the portfolio. And so, right now, that $155 million range where we’ve been is likely where we’ll stay.

Stephen, I would just add, and Michael and I both alluded to this in comments, both our capital levels and reserve, we’re prepared for difficulties moving forward. We don’t really actually expect things to get that difficult. But our preparation allows for things to get more difficult than we anticipate they will.

The next question comes from Catherine Mealor from KBW. Please go ahead.

I just wanted to ask about your outlook for balance sheet growth. You’ve been really conservative on your outlook for loan growth over the past couple of quarters. And you saw loans pull back again this quarter. Just curious how many more quarters your gut would be that we’ll see a decline in loan balances before we kind of hit that inflection and start to see growth again?

Yes, Catherine, I have a couple of points to make. You are correct that we have taken a conservative approach to loan growth. We've maintained this stance to avoid overleveraging our deposit base, which serves as a key constraint for us. While we recognize there are still opportunities for growth, we are also reducing balances, especially in our construction portfolio, and we are not expanding our overall commercial real estate portfolio. Given these factors, we anticipate growth to be subdued for another quarter or possibly two, but we do expect some improvement in 2024. Additionally, our commercial and industrial segment should position us differently moving forward. The economic environment will also play a crucial role, and we hope to avoid significant economic downturns or recession. Travis, do you have anything to add?

First off, good morning, Catherine. Nice to talk to you. Nothing much to add to that. I think you’re spot on. We still have a lot of opportunities in our markets. We’re in a lot of growth markets, Birmingham, Huntsville, Memphis, Knoxville, and the list goes on and on. It’s more of a self-imposed governor at this point. And when we decide that the economies look better for us, where we can see more clearly into the future, we will turn on some more growth initiatives internally.

Are you noticing opportunities in commercial and industrial lending? It seems like you mentioned that you’re not currently lending in construction and commercial real estate. Could you provide an overview of the current landscape in commercial and industrial lending?

Yes. We’re seeing a lot of opportunity. Of course, there’s a lot of competition in that space today. A lot of other institutions are derisking their balance sheets, similar to what we’re doing. But we’re seeing a lot of opportunities. And we’ve actually grown committed balances in the C&I space by a little over $100 million last quarter. So, we continue to really engage in that space, and we’re seeing some positive momentum.

Okay, great. And then on the deposit side, your NIM guide was really helpful and seems like we’re stabilizing, which is great. Can you just talk about just the incremental cost of deposits and just kind of what you’re seeing within the behavior of your clients, maybe one, where you’re seeing the most stress in terms of higher deposit costs versus where things are really starting to ease, maybe in product or kind of deposit type.

Hey Catherine, it’s Michael. I’ll start and then Travis can jump in. I mentioned public funds, most of our deposit outflows in the third quarter were down $230 million, but $300 million outflows in public funds, so that all of it centered around that. As those come back on, I mentioned 5% range, those are mostly expected to be Fed funds minus a little bit. So highly competitive, expecting full market rates, their large customers, commercial, corporate are expecting 5-plus-percent on deposits, you’re getting large balances. The challenge we face, and I know we’ve talked about this before, as you look across our footprint, tackets of banks, whether they’re community banks or smaller or some of the larger institutions, the community banks have CDs priced at 5.75% for six months, right? And so that’s impacting our retail. And then you get the money market and stuff that’s still over 5%. What we’ve seen is because the velocity of rate increases has slowed that the constant request for repricing has moderated. And so that’s been a benefit. And as long as there’s stability, I think you continue to see that. But new deposits, new customers, they expect market rates.

Correct. Just one quick thing to add. A lot of the people this time last year were chasing yields where they could get much higher yield, right? We’re talking from 1% to 4%. It’s been somewhat stabilized over the last few quarters, where you might go from 5.25% to 5.75%, and there’s not as many people chasing that incremental yield in the footprint. So that’s helped us a little bit.

That’s great. Go ahead, Chris.

Yes, I would like to mention that moving forward, as Michael indicated, the pace of change has significantly decreased. One of the main factors for us in the upcoming two quarters will be public funds and the fluctuations in and out of these funds. We consistently observe outflows in the second quarter, which result from how these funds are typically managed by our public entities, as well as some investors making market share moves for reporting reasons. They tend to return in the third and fourth quarters, often at higher prices, which represent some of our most expensive offerings. We plan to navigate this situation in the third and fourth quarters.

So it’s really a function of your public funds that are driving some modest but more margin pressure in the back half of the year more so than your retail and kind of core customer base? Would that be a fair comment?

That’s right. Exactly.

The next question comes from Brett Rabatin from Hovde Group. Please go ahead.

I wanted to start off, it’s college football season. And I know you guys followed that quite a bit. And I know there’s been some desire to get FBK back in the college playoffs, so to speak. And so I wanted to ask, you’ve obviously taken some actions here in 3Q on offense and defense with the securities portfolio and the expenses. I wanted to see what else you might be considering doing to get, quote, back in the playoffs in ‘24, or if you feel like what you’ve done is kind of what you’re able to do, and if maybe up in the playoffs in ‘25 instead.

Yes, this is Chris. You’re correct, it is college football season, and we are fans who experience the usual Monday morning banter after a loss. Losing isn't enjoyable, especially in banking regarding our performance. Historically, if you look at our track record, we have been a strong performer since going public, and we strive to maintain that position. Over the last several quarters, we recognized the need to ensure our company's scalability and foundational stability, which required some investment that temporarily affected our performance. We have intentionally eased our pace to implement necessary changes, but we want you to feel our confidence moving forward. We believe we will be back in contention and competing for the championship soon. You witnessed a significant improvement last quarter, with noticeable progress this quarter as well. We are taking steps to enhance our performance in 2024. Our goal is to strengthen our balance sheet, providing us with levers to boost profitability and meet our higher return expectations as shareholders. We appreciate the metaphor, and we consider ourselves playoff-ready and ready to compete for the championship.

That’s good to hear. It sounds like you’re expecting 2024 to be significantly better, which is reassuring. I wanted to revisit the topic of credit. You have a slide in the presentation regarding the office portfolio, but I’m actually interested in hotels. Given that it’s slightly smaller, I’d like to know if you foresee any consumer-driven weaknesses in the next year or 18 months that might put hotels at risk. Have you conducted any analyses on RevPAR or occupancy levels for the hotel portfolio, and how do you view that segment?

Yes, we do have a hotel portfolio, but it is not significant for us when compared to others. I don’t have specific statistics available, and our Chief Credit Officer isn't here today. However, we have been monitoring the hotel sector and haven’t made many new investments in the last couple of years due to various factors. We do have a few properties, but we are focusing on well-established brands in desirable locations. We have some suburban properties, and we have a little bit in central business districts, including a Hampton Inn. That's the kind of brand we are working with.

One other thing I would add is, it wasn’t too long ago, it was the pandemic where hotels were on everybody’s mind. And we did a thorough analysis during that time frame to make sure that our borrowers were able to withstand that pandemic. And what we found was we have very strong borrowers in this asset class that did everything that they said they were going to do. We continue to monitor that portfolio. We’re not seeing any struggles to date on RevPAR. We are mindful as the consumer spending goes down in ‘24, that’s something we need to definitely keep our eye on. But no alarms at this time.

In the past year or 18 months, we have worked on a Hilton project with impressive parameters. We had very high expectations for it, and it has exceeded those expectations significantly. This is the only project we've completed recently.

Okay. If I could just add one more question about mergers and acquisitions. Chris, it seems you are more focused on expansion when it aligns strategically. Everyone understands that the challenging aspect is the impact on the balance sheet. Could you discuss how you perceive the dilution of tangible book value or what kind of criteria would be acceptable to you regarding a potential opportunity?

Yes, Brett, there are definitely increasing conversations happening. I believe that 2024 will bring significant challenges that require strategic thinking. The landscape is evolving, and it demands more deliberate strategy. Our approach has always been strategic, and we don't consider asset size unless it aligns with our strategic goals. Usually, our considerations won't involve tangible book value type agreements, as we focus on valuable properties. We typically look for a three-year earn back as our guideline. One of the frustrating things I encounter is that investment bankers often assume that because we mention this on the call, they can calculate a three-year tangible book value and use that figure to determine value. Just because they can afford a certain amount doesn't mean that's the true worth. While we keep that as a guideline, we focus on what the acquisition means for us. In some cases, it might push us beyond that guideline, although it hasn’t happened yet. We strategically consider EPS accretion, aiming for a reasonable-sized institution to achieve double-digit EPS growth. Smaller institutions may not reach that level. Our main concern also involves the impact on our tangible capital levels. Additionally, calculating those figures has become more complex due to AOCI, which can lead to tangible book value dilution, but this tends to recover quickly in terms of earnings and GAAP accounting.

The next question comes from Alex Lau from JP Morgan.

What are the key areas of the bank where you’re seeing the expense reduction coming from? Can you give some color as to how much of this retirement or cuts are coming from front office, back office? And also, what are the types of projects or investments that you’re putting on the back burner for now?

Yes. I mean, it’s broad-based across the Company, front end, back office. Early retirement was probably more management-driven activity. But again, it’s front end, back office, some leadership type stuff and change. Positions, as you look across, obviously, we’ve had slower loan growth, so we’ve seen some reduction in relationship managers, but not very much. And some of that is just a product of the environment. I’ve mentioned the branches. That’s a piece of it. And then just some other back-office stuff. But I think if you think about projects, Chris mentioned the investments we’ve made. I mean we’re still positioning ourselves for becoming a larger, more scalable institution. So, we’ve invested a lot in risk management, a lot in data, a lot in audit functions. And so those continue. We’re just in a really sustainable, scalable place at this point operationally. And so, we’re looking to capitalize on that. But yes, it’s just making sure that we’re well positioned for next year and the years after.

Hey Alex, I would like to add a few comments. Some of the expense reductions are a result of our growth since our IPO in late 2016, during which we have quadrupled in size and made four acquisitions, the latest being 40% of our size. This was followed by a pandemic. All these factors combined have influenced our operations. We have been deliberate in making these expense reductions over several months, without creating much anticipation around them. This has been a gradual process and has impacted various areas both geographically and operationally. I also want to highlight a few investments that remain priorities for us. We have made significant investments in data to ensure we have actionable information for managing the business. As I mentioned earlier, we’ve adjusted some of our models and even overhauled others to ensure we are equipped with the right data. Our risk management side has seen substantial investments over the past two years, and as the company grows, we have invested heavily in our third line of defense. Regarding professional services, we have seen a significant reduction in that area, which reflects intentional spending with top international consultants to ensure our strategies are well-executed. As for items we might put on the back burner, I can’t think of any. We haven’t pursued much branch expansion, which is about the only thing I can identify.

And I had a question on security sale. Can you update us on the parameters that you look for in terms of an acceptable earn-back period? And then separately, as bond yields were rising in the quarter, when in the quarter did you sell these securities? And what is the appetite for more sales at the current yield curve? Thank you.

Yes, the parameters really haven't changed much. We aim for a couple of years for the earn-back period. We slightly adjusted that due to the low-yielding securities we sold, which made the rate environment less significant. We saw some opportunity there. As we look ahead, we still expect the earn-back to be in that couple of year range. We sold some securities in mid-September, just before the 10-year yields surged, and we paused reinvesting for a few weeks afterward. We invested about $90 million in mid-September but held back recently. The 10-year yields have since decreased by 25 to 30 basis points, and we feel comfortable within this range. It's about finding the right investments. Our portfolio size has reduced, now representing about 10.8% of total assets, which is acceptable. We're not aiming to grow to 20% or shrink to 5%; we plan to maintain this range.

And then just a follow-up on the public funds. If you look at last year’s fourth quarter, that grew in the $400 million range. Is that a fair amount to assume for this year, or is there something different going on in the fourth quarter?

Yes, that's reasonable. We anticipate around $400 million to $500 million or so. We are handling that with considerations for profitability, liquidity, and the competitive landscape. It's a daily challenge, I would say. But as we project forward, that's our expectation, and we're navigating all the various factors involved.

Yes. I’d just say, yes, I’d say you’re right on our assumption. Yes, Alex, I mean it’s going to be right in that range. Well, that’s what we anticipate it will be.

The next question comes from Kevin Fitzsimmons from D.A. Davidson. Please go ahead.

I know we have a few questions on this, and I want to make sure I'm thinking about it correctly. We're expecting a positive impact on the margin from the securities transaction, but this will be offset in the fourth quarter by the public funds, which are causing an increase in costs. We are still seeing a shift in the deposit mix, but it seems like the pace of deposit rate increases is slowing down. I appreciate the margin range provided, but aside from the public funds, are we nearing a point where the margin will bottom out in the next quarter or two, and then potentially start to expand in the first half of 2024? I know that's a lot to consider, but I want to ensure I'm covering all the variables. Thank you.

I appreciate the introduction. I think you understand it well. However, I would like to point out that you mentioned the public funds should dominate over the securities trade, and those two factors will indeed counterbalance each other significantly.

Yes, because it’s kind of a rate volume challenge, right, is the volume of the public funds we expect to come on 4x, 5x with securities trade.

Yes, that's correct. The rest of what you're mentioning, Kevin, relates to what's actually happening. You referred to it as a preamble, but those factors and others contribute to our model and assist us in predicting future trends. That’s why we operate within a range, which we've indicated will likely remain relatively stable over the next few quarters. However, as you noted, we anticipate an upward movement after that, particularly as we approach 2024.

I will say, the mix shift, if you think about from noninterest-bearing to interest-bearing has moderated as well. We’ve been in this 22% range for a couple of quarters now. So, the velocity of deposit or the velocity of rate increases has slowed. We’ve seen that moderate as well. I always point back to kind of pre-pandemic as we talked about the combination with Franklin, we expected that number to be around 20%. So I would say this range feels about right for migration from NIB to interest-bearing. We do see some move between products, interest checking to money market more so, a little bit in CDs, but we’re trying to keep those fairly short. But competition there, as I mentioned earlier, some community banks and then treasury, but not too as much outflow anymore to treasuries.

I have a follow-up question regarding M&A. Chris, you've mentioned before that you have specific targets in mind over a long-term period, and it's really about timing when these targets might be willing to sell. However, you seem to express greater confidence that opportunities will arise soon. Is that because you’re sensing that some of these appealing prospects are getting prepared for discussions, or is it that, given the current environment and your position, you are broadening the range of potential opportunities?

It's the former; we still have the same criteria we look for. This means there will be a limited number of institutions that meet our requirements, and that list hasn't changed. However, as we look ahead to 2024 and engage with others in the industry, we believe some might consider exploring their options. So, it's really about that. We're not expanding our parameters, either geographically or in terms of what we're seeking.

And one last thing, you mentioned a couple of times that you made these deliberate moves to strengthen the balance sheet for difficult times, but you feel now that things won’t likely get that difficult. Has that been more of an ongoing thought, or is that something based on recent observations that you’re feeling like, all right, we’re glad we prepared, but it’s probably not going to be as bad as what we might have thought a couple of quarters ago?

Yes. I want to slightly rephrase that to say we are ready for challenges. We don’t believe they will be as severe as what we’re prepared for. If we find ourselves in a situation similar to 2008 and 2009, we believe we are equipped to handle it. Reflecting on what happened in March of this year, we feel confident in our preparedness for whatever may come our way. However, we do anticipate that things may slow down from this point forward. We’re saying that if the situation becomes very slow or difficult, we are ready for that. But we do not expect it to be as severe as we are prepared for. So, to clarify, we believe there will be a slowdown, but we do not think it will be as bad as we are ready for.

The next question comes from Matt Olney from Stephens. Please go ahead.

I just want to follow up on the capital discussion. We’ve talked about potential for additional securities transactions and M&A conversations heating up. So can we assume that as far as any kind of share repurchase program that in the near term, that’s going to be less likely, or how would you characterize the appetite of the buybacks?

That’s less likely, mainly due to the unpredictability of the future. We don’t want to risk making a poor decision if we begin buying back shares now and then face a tough credit environment globally; it would reflect badly on us if we needed to raise capital afterwards. Therefore, we will be conservative with our capital until we believe that the outlook for the industry improves from a credit standpoint. Additionally, we believe that interest rates have reached their peak.

Okay. That’s helpful, Chris. And then, I guess, also circling back on the deposit discussion. I think, you gave us lots of good details around the public funds, and that’s kind of where the focus is now. What about on the customer time deposits? I think there’s a $1.4 billion balance. That average cost in the third quarter still feels quite a bit below most of your peers. Can you just kind of walk through the repricing dynamics there, what’s maturing more near term? And then what are the current rates that you’re seeing for your customers?

Last year, we conducted a significant deposit campaign and offered some CDs, including special rates for 13, 18, and 24-month terms in September and October. Currently, the weighted average term is about 18 months, and we haven't shifted our rates much since then. We're still experiencing renewals at historical renewal rates. As I mentioned earlier, we've increased some CD rates, but these are primarily for shorter terms. When customers opt for a shorter-term CD at a slightly higher rate, it appears that the yield curve is somewhat inverted. If customers remain in the same terms as last year, they're receiving very similar rates. Our approach is customer-centric, allowing us to assist our customers in competitive scenarios while ensuring we prioritize both the customer’s and the company’s interests. Therefore, there is some flexibility in our offerings.

And then, Michael, just to follow up on that. As you look at some of the renewal timelines, is it spread evenly in the next few quarters, or are there one or two quarters where you anticipate seeing higher volumes at set rates?

It’s spread pretty evenly fourth and first. There’s a little bit of a lump in the second quarter of next year. Yes. But it’s already higher-priced stuff than what’s renewing in the fourth and first quarter.

Okay. That’s helpful. And then, I guess, sticking on the deposit pricing pressure theme, your footprint is a good kind of mix of more metro markets and also some rural communities. Just any general commentary for us as we think about deposit repricing pressure in some of your general markets, where the pressure is greater today and where it’s maybe not as great as it once was?

It’s really interesting. Initially, we saw the most pressure from the smaller communities, the kind of the rural markets. We’re now seeing some larger regional banks putting out some specials in the 5s. So, it’s really across the board, either urban or rural that we’re seeing deposit pressures. And they’re all generally in that 5.25% to 5.75% range on the specials.

The next question comes from Steve Moss from Raymond James.

So most of my questions have been asked and answered here. Just one thing on office here. Just curious if you could give any color as to when the rents in that portfolio start to come up for renewal, and any color around that dynamic there?

I'm sorry, our Chief Credit Officer isn't available. Generally speaking about renewals, Michael discussed our fixed rate portfolio, not specifically related to office. Regarding office, I was considering both rent and loan renewals. I will need to gather more detailed information and get back to you. Does that sound reasonable, Travis?

That’s fair.

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

I wanted to start off, I saw borrowings and brokered CDs declined during the quarter, which I’m sure helped on the funding cost side. Did those just mature and you didn’t renew them? And could we see more of that rolling off in future quarters, just given you’ve got loans to deposits, so around 87%.

Yes. That’s right, Feddie. Some of them rolled off and we have some more coming due in November. If you remember last quarter, we increased some of that, just because it was cheaper than retail deposits, quite frankly. And so, Chris mentioned this. And we keep our powder dry on sources of liquidity, so that we can leverage it when we want to, need to. So sometimes when we see brokered market is cheaper or FHLB funding is cheaper, we’ll do that. And so, that lever is out there. But we do have, I believe, it’s $100 million rolling off in November. Whether we renew it or not, that’s TBD, certainly don’t need it, to your point. We freed up a lot of liquidity from a collateral standpoint as well during the quarter, good work by the team there to further create sources of liquidity.

Understood. That’s helpful. Switching gears a bit here. As we consider the expense reductions along with the restructuring of the securities portfolio and other trends we've discussed regarding margins, do you think the efficiency of the core bank, excluding mortgage, can reach the mid-50s range by the end of 2024, given that it is currently around 60%?

Yes is the answer. We do, we think on the core, just core bank? Yes. We think we can get below the mid-50s, even.

Got it. And one last question for me. It sounds like we should expect to see the unfunded loan commitments in the CD space continue to come down. As a consequence, do you think we’ll see the unfunded commitment reserve continue to decline as well?

Yes. That’s right. If you look at the ACL slide, you’ll see we actually increased our reserve on the construction bucket, but we released from the unfunded strictly due to the volume. And so, you’ll see that continue to decrease, and then we’ll probably land in that 80%, 85% range Tier 1 plus ACL and it would normalize from there.

The next question is a follow-up from Stephen Scouten from Piper Sandler. Please go ahead.

I’m not sure if you have this number, but I just wanted to follow up, as you referenced, you had C&I credit, had some exposure to the SNC loan in the industry that went bad. But, do you guys have numbers on your total SNC exposure? And if so, like kind of how much of that you lead of the SNC exposure that you may have?

We have roughly $175 million in SNCs. We lead approximately $80 million of that is for round numbers.

We do not engage in SNCs unless there is a compelling reason to do so; we don’t pursue them merely for growth. Our involvement in an SNC occurs when we have established relationships with specific clients or companies. For instance, we have a significant client within our area where we know the company’s owners and executives, and they expressed a strong desire to include us in their credit. This involvement is crucial because it involves a well-known name within our region. Another example is a company we have supported from its startup phase until it became publicly traded. We retain most of their deposits, including their operating accounts, and their line of credit has now exceeded $1 billion, though we do not lead it; we have a part in the SNC. These are the types of situations that lead us to engage in SNCs. Generally, we are cautious about entering into SNCs, and when we do, it’s due to a significant reason that necessitates our participation.

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

Okay. Thanks, everybody. We really appreciate, again, your interest in the company. We appreciate everybody’s questions and answers today. And if we have things that need clarification, we’re glad to get on the phone with anybody that we need to. So, don’t hesitate to reach out. Everybody, have a great rest of your day, and you analysts have a great rest of your earnings season.

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