Simmons First National Corp Q3 FY2022 Earnings Call

Good morning, and welcome to the Simmons First National Corporation Third Quarter Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Ed Bilek, Executive Vice President and Director of Investor Relations. Please go ahead.

Good morning, and welcome to Simmons First National Corporation's Third Quarter 2022 Earnings Call. Joining me today are several members of our executive management team, led by our Chairman and CEO, George Makris. Before we begin the Q&A, I would like to remind you that our third quarter earnings materials, including the release and presentation deck, are available on our website at simmonsbank.com under the Investor Relations tab. During today's call, we will make forward-looking statements about our future plans, goals, expectations, estimates, projections and outlook including, among others, our outlook regarding future economic conditions, interest rates, lending and deposit activity and net interest margin. These statements involve risks and uncertainties, and you should, therefore, not place undue reliance on any forward-looking statements as actual results might differ materially from those expressed in or implied by the forward-looking statements due to a variety of factors. Additional information concerning some of these factors is contained in our earnings release and investor presentation furnished with our Form 8-K today, our most recent Form 10-Qs and our Form 10-K for the year ended December 31, 2021, including the risk factors contained in that form 10-K. These forward-looking statements speak only as of October 25, 2022, and Simmons assumes no obligation to update or revise any forward-looking statements or other information. Finally, in this presentation, we will discuss certain non-GAAP financial metrics we believe provide useful information to investors. Additional disclosures regarding non-GAAP metrics, including the reconciliations of these non-GAAP metrics to GAAP are contained in our earnings release and investor presentation, which are included as exhibits to the Form 8-K we filed this morning with the SEC and are also available on the Investor Relations page of our website, simmonsbank.com. Operator, we are ready to begin the Q&A session.

The first question is from Brady Gailey of KBW.

So loan growth was pretty impressive in the third quarter in the low double-digit range. I know you guys have talked about that moderating from here. But how do you think about loan growth as we head into 2023 with some potential economic uncertainty?

Brady, this is Matt. I'll point you back to our second quarter comments and really what we said, we started to see the fallout from the rising interest rates kind of at the end of the second quarter where we delivered some really impressive loan growth. Throughout the third quarter, two Fed hikes, 150 basis points, and it's really illustrating our pipeline on Page 12, where that pipeline is now $1.6 billion. That's really a result of staying disciplined to our relationship strategy, underwriting hurdles, and stress tests. It's still a strong pipeline, but it's definitely reflective of current economic conditions. We've had a lot of success in the construction space. I think we'll continue to see some loan growth in the fourth quarter and beyond, but just depending on what the Fed does. I just look back at what happened between the second and third quarter and what the increase in interest rates did to our pipeline. If you have another 150 basis points, I think that's something we look at as we move forward. But loan growth is going to continue through some construction but moderate as interest rates continue to rise.

Okay. All right. And then on the expense side, if you look at core expenses when you back out the one-timers, it was pretty flat. It's actually down a little bit linked quarter at $137 million. How are you thinking about expense creep into 2023?

Well, I think this is Jay. I'll provide some initial remarks. We will continue to address the challenges posed by inflation. We have benefitted from our acquisitions over the past few quarters and will keep finding ways to enhance efficiencies from those transactions. However, the impact of inflation is significant, and we need to remain vigilant. I'm happy to report that our efficiency ratio is improving, and I expect this trend to continue throughout 2023. However, we will face similar challenges as others, particularly with wage inflation. So far, I'm satisfied with our response to that, but we still have room for improvement. We are managing our expenses carefully and will stay focused on this issue.

All right. Finally, the share buyback did not slow at all in the third quarter. It remained at a robust level, repurchasing about 1.5% of the company. How do you view the buyback going forward now that your TCE has a 6th handle on it?

Well, Brady, this is Bob. I would tell you, we continue to have the buyback as part of our capital management plan. As always, we'll evaluate each quarter as we go in. So I think it will be part of our plan in the future, but we'll evaluate where we are going forward. We look at TCE, as well as all our regulatory capitals, which are well above well capitalized and in good shape there. So it's just overall management. What we will say is our plan is we won't buy back any more than our current earnings in the quarter while paying back both cash dividends and stock buyback. Again, I'm not saying that's what we'd do this quarter, but it is part of our management strategy.

The next question is from David Feaster of Raymond James.

Maybe just starting on deposits. I'm just curious how you think about deposit flows near term, what you're seeing there? And your strategy as you think about managing deposits, obviously, we're much better positioned in this cycle with a lower loan-to-deposit ratio. But I'm curious how you and your Chief Deposit Officer are thinking about defending deposit costs, continuing to lock in some funding. And maybe just from a geographic perspective, if you could touch on some of the competitive dynamics and where you're seeing the most competition and funding pressure.

Well, David, I'll jump in on that, Jay. First, I want to say you are absolutely correct. The competitive environment has changed significantly over the year, and I believe it will continue to shift. In our business, we strive to perform well, and I think we manage our deposits effectively based on geographic differences within our operation. We maintain a customized approach to this aspect of our business. Overall, based on our experiences in Q3 and throughout this tightening cycle, we observe that deposits are leaving the bank primarily due to customers with excess cash. This includes commercial customers with operating accounts who, until recently, had limited options for utilizing their funds, as well as high net worth individuals. These customers now have choices. We are trying to retain some of that revenue by involving our wealth team in these cases and moving those deposits off balance sheet. However, the outflows we are seeing are not due to customer loss; it's mainly excess funds leaving. We will be as competitive as possible within reasonable limits. We are committed to protecting our margins. Fortunately, asset prices have adjusted considerably this year, giving us some leeway from a margin standpoint to retain some of those funds on our balance sheet.

Okay. And then maybe just touching on asset quality. You've done a great job managing credit. We've seen continued improvement in credit metrics. Maybe just as you look into your portfolio and the economy more broadly, is there anything that you're seeing that's causing you any concern or that you're watching more closely? And I guess, how do you think that plays into reserves and provision? I mean, do you think that the reserve ratio has probably dropped here just given the likelihood for worsening inputs in CECL models?

David, this is George. I'll touch on that and the other guys can jump in if they want to. As you recall, we said last quarter that we had five specific categories where we had qualitative adjustment factors that we had carried since COVID began. Those were hotels, retail, restaurants, student housing, and office space. During this quarter, we took a look at individual loans and eliminated three of those categories for additional category-specific adjustments. What we kept in place were retail and office space because those two are going to have a tail on them that we just don't understand quite yet with the renewals of leases and whatnot. You probably noticed that we significantly increased our reserve for unfunded commitments, partially because that number went up, but also because that's where construction resides. We believe between retail, office space, and construction, while we have a good feeling about that, those are the three areas that we just have some additional uncertainty in the future. Our Moody's scenario was skewed toward the downside S2 scenario, but our quantitative model indicated a number of less than 1%. So we feel very good about where our allowance is today. We believe, as some of that construction funds go forward, you may see a migration from our reserve for unfunded commitments to our actual allowance for credit losses. Collectively, we've got $240 million of allowance set aside for our funded and unfunded loan balances. Our credit team does a fantastic job of stress testing and evaluating our credit. You can see that over time, those numbers continue to go down. Even those numbers are heavily dependent on credit we acquired from other banks and not necessarily credit that was initially approved under Simmons underwriting standards. Uncertainty is certainly something that is prevalent in the market today, but based on our analysis, we're very comfortable with where we are today.

That makes sense. And then maybe switching gears to touch on fee income. This has been an emphasis for you all in the past. It's great to see the hard work showing up. Maybe if you could just touch on some of the fee income businesses where you're having the most success. And obviously, we do have some headwinds in the market for a few of these. Just curious how you think about fee revenues and any other trends in other puts and takes within the fee income lines would be helpful.

Yes. I'll give a couple of remarks there as well, David. No doubt it was a good quarter of fee income for us, and I certainly don't want to discount that at all. In the wealth management area, we're having some really good success there, both on the hiring front as well as in customer acquisition. There were, however, a couple of fee events in the quarter in the wealth area that were a little bit timing-related. This is going to happen from time to time, but a quarter that was perhaps a little bit ahead of our typical run rate, that's an area that is certainly a headwind area. I think we're cutting through some of that headwind again on the customer acquisition and sales side. So we feel good about that in the quarter. It was good to see a moderate, albeit, but an uptick on a linked-quarter basis in mortgages. It's a tough business right now, but it's one we are committed to. It's very much customer-centric focus to us. Virtually all of that business in this environment is overwhelmingly purchase volume. We'll also have typical seasonality that will impact service charges and deposit-related fees from time to time. We had a good quarter there. I think one of the tailwinds for us late in Q3, hopefully, will stick a little bit in Q4 as well, just some of the waivers and whatnot that we did around the Spirit acquisition that are phasing off here late in Q3 and in Q4. That certainly aided us on the fee front late in the quarter as well.

Next question is from Gary Tenner of D.A. Davidson.

I wanted to follow up on the commentary, George, around the construction portfolio, $5.1 billion of unfunded commitments this quarter. You mentioned a large amount of that is in the construction book. Can you talk about how much is commercial versus residential? And I'm really curious about any commentary around projects that are being maybe delayed or terminated as the economic uncertainty increases and rates rise.

This is Matt. I can start on that; and others can jump in. A couple of comments. When you think about the $5 billion unfunded commitments, that includes all of our unfunded. That's our lines of credit and our C&I businesses. When you look into the construction book itself, it's about $3 billion unfunded. Of that, $500 million is your 1 to 4. In terms of the question about where it's coming from, a lot of our originations in the last six months have been in industrial and multifamily. Both of those segments are holding up very well in this environment with affordability pushing into multifamily and supply chain issues in industrial. We're pleased with where we've put our capital in the construction sector. Regarding your question around delays, we're not currently seeing that, and we have a robust monitoring system outside of our daily bankers; it's a centralized function. We look at that very carefully. So far, outside of what I now want to call normal supply chain issues, we see no significant delays that are causing concern. Projects are on scheduled release so far, so good. I also want to point out our comments from Q2: we are very disciplined in this space. We are not betting on interest rates; we're underwriting well above where rates are today and stressing those further with inflationary costs. As a result, we're producing low-leverage construction loans on our books.

I appreciate the comment. And then the second question, in terms of the rate sensitivity, Slide 16. I'm curious, as you think of the next 100 basis points of tightening since you provide 100 basis points to 200 basis point sensitivity, what deposit betas are embedded in that kind of next 100 basis points of your sensitivity?

Yes, and I'll answer that consistent with how I have historically. The way we model this is based on historical betas. So it's not really a forward-looking beta; it's not a management override. When we look at that historical beta for us and for the industry, you're seeing betas in the kind of mid-40s that are modeled into this sensitivity, but much higher than what our beta has been year-to-date.

The next question is from Matt Olney of Stephens.

I want to go back to the loan growth discussion. And Matt, you gave us some good commentary about construction balances likely to fund up in the near term. Is it fair to assume that loan growth could remain in this low double-digit range annualized for the fourth quarter and then likely slow into 2023 due to the overall uncertainty in the economy?

Matt, I think that's a reasonable assumption. I can't say that for certain though. Just knowing, I'll repeat my comment again: we saw 150 basis points of upward rate increases in the third quarter, and we see that possibly happening again. With our unfunded construction, yes, that's out there. But we're also seeing borrowers pay down in this environment, which adds some unpredictability. So it's a reasonable expectation. Depending on where the Fed moves afterward, I would point you back to our pipeline graph to show you where we're taking our yields and where the pipeline is moving in this environment.

Yes, and I'll just add to that. We're, of course, like every other management team out there, spending a lot of time forecasting and doing a lot of sensitivity analysis here. The first thing we have to acknowledge is these are pretty uncertain macro times in terms of creating conviction around those forecasts. As Matt Reddin mentioned, one of the biggest levels of unpredictability is money flows and cash flows here surrounding the timing of some of these fund-ups. We aren't modeling many prepayments right now, but we do see some from time to time. We know what our scheduled maturities and cash flows look like, but when deposit flows and deposit repricing occur, these factors can create interesting dynamics right now.

Yes, understood. And then I guess on the betas on the loan balances, they looked pretty good in the third quarter. Anything unusual with that from your perspective? Or do you think you can maintain similar loan betas going forward from here?

I'll say I'll take first and let Jay comment. We are being very disciplined with our pricing models still in the relationship business, and we have the means to always ensure we take care of core customers, but we're very aligned with the market. We're adjusting our rates sometimes every two weeks and remain disciplined in the field with communication to our bankers and ultimately our clients. I think we're going to fight that fight, and we're hopeful that we'll continue to do that on the yield side.

One thing I'd like to point out too, looking at our loan beta or net interest margin, we depict this on Slide 6 in the materials. Our revenue growth and net interest income this quarter were impacted by a $5.5 million unfavorable variance compared to Q2 due to purchase accounting accretion or PPP accretion. I believe that some underlying fundamentals are even a little masked in Q3 compared to Q2. Another data point I want to share is found on Slide 16. We have $1.2 billion of fixed-rate loans maturing over the next 12 months. In total, I think we'll have at least $1.8 billion in fixed-rate assets up for repricing or coming due in the next year. Considering our current pricing on assets and where yields will come off the books, this continued migration or optimization of our balance sheet and repricing on the asset side should be beneficial for us.

And Jay, following up on that, just lots of puts and takes around the margin from the third quarter. It seems like there are still some tailwinds here over the next few quarters of the margins yet to see some improvement. Any commentary on any kind of range you can point us towards?

Well, I'm going to go back to my initial caveat, which is timing and cash flows could drive that. Margin predictions on a quarter-to-quarter basis can be tricky. However, I do believe that the industry has improved from a margin perspective as exhibited in Q2 and Q3, and we have experienced that as well. My expectation is that margin will be much more modest or incremental in terms of its expansion going forward. We've had the good fortune of a significant move by the Fed with a lag in deposit betas, and I believe that's moderating for the industry in the coming quarters. Thus, NIM expansion will be more modest.

The next question is from Graham Dick of Piper Sandler.

Most of my questions have been answered, but I wanted to ask about the bond portfolio briefly. There was a significant decrease this quarter, likely due to strong loan growth. I'm curious if you have any updates on the target, or if you expect to see trends in assets over the next year or so?

I think we're certainly not actively purchasing bonds just given where we are from a securities mix point of view or securities to assets point of view, really considering the opportunities we have in the loan portfolio right now. Our first investment priority is always to put funds to work in the loan portfolio when we have good opportunities. We’re still experiencing good growth and pricing, so that's where our priority will be. With that in mind, I anticipate that we'll continue an increase in the loan-to-deposit ratio. Loan-to-asset numbers will expand, and we'll fund much of that growth with cash flows from our securities portfolio.

Okay. Understood. On loan growth, I wanted to ask if I remember correctly, Spirit was growing well after you announced and closed the deal. I'm curious about how much of that pipeline is from Spirit, specifically the commercial loan pipeline.

Great question. I'll give you a couple of data points regarding their growth. As a company, they grew $230 million since joining Simmons in April. That's more than third quarter growth alone. They also produced $1 billion of new originations. We're really proud of how Spirit integrated into our organization and hit the ground running. If you look at their pipeline now, they're around $400 million of our $500 million overall pipeline.

To pile on, we've closely monitored overall deposit retention, which has been incredibly strong. Employee retention has also been very good. We are very pleased with the success across the board.

There are no other questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to George Makris for closing remarks.

Well, thanks to each of you for joining us today. I think the third quarter speaks very well to our organic fundamentals and what we're committed to going forward. I think our runway looks really good. Before we sign off, I'd like to give a special shout-out to one of our directors, Dean Bass, who was involved in a serious car accident a few weeks ago and is recovering in the hospital. Today, I visited with him this morning; he's in great spirits. We just want to send a shout-out to Dean and wish him all the best in his speedy recovery. Thanks again for joining us this morning, and we'll do this again next quarter.

Before we end today's call, I have been advised by our legal counsel that there were some technical difficulties during our forward-looking statement. We would like to reiterate that during the call today, we made forward-looking statements about our future plans, goals, expectations, estimates, projections and outlooks, including our outlook regarding future economic conditions, interest rates, lending, deposit activity, and net interest margin. These statements involve risks and uncertainties, and you should, therefore, not place undue reliance on any forward-looking statements as actual results could differ materially from those expressed in or implied by the forward-looking statements due to a variety of factors. Those factors are contained in our 8-K filed today as well as our other SEC filings, including our Form 10-Q and Form 10-K. These forward-looking statements are as of October 25, 2022, and Simmons assumes no obligation to update or revise any forward-looking statements or other information. We also discussed certain GAAP and non-GAAP metrics, and have provided disclosure in our Form 8-K in our earnings release and in our investor deck, which contains the reconciliation of those metrics from GAAP to non-GAAP. Thank you again for joining us, and have a good day.

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