Good day, and welcome to the Simmons First National Corporation First Quarter 2023 Earnings Call. All participants will be in listen only mode. Please note, this event is being recorded. I would now like to turn the conference over to Ed Bilek. Please go ahead.

Good morning, and welcome to Simmons First National Corporation's First Quarter 2023 Earnings Call. Joining me today are several members of our executive management team, including our Executive Chairman, George Makris; CEO, Bob Fehlman; and President and CFO, Jay Brogdon. Before we begin the Q&A, I would like to remind you that our first 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, credit quality, liquidity, and net interest margin. These statements involve risks and uncertainties, and you should, therefore, not place undue reliance on any forward-looking statement 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 as well as our Form 10-K for the year ended December 31, 2022, including the risk factors contained in that Form 10-K. These forward-looking statements speak only as of the date they are made, 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.

We will now begin the question-and-answer session. Our first question comes from Brady Gailey with KBW. Please go ahead.

Hey, thanks. Good morning, guys. So, I wanted to start with the piece of the provision expense that was related to the corporate bonds. Could you just give us a little more color as far as what happened there and any remaining exposure within these corporate bonds?

Yes. Brady, this is Jay. The corporate bond portfolio, as a remainder, represents a little less than 7% of our total bond portfolio. The overwhelming majority of that is from Fortune 500 type companies. We've done a review of the portfolio. We think this has isolated bonds in there. It relates to some events that took place with the issuers of those bonds in the first quarter that were unique to those companies. We were very aggressive in how we provisioned for those in terms of really trying to carve that out. I think, probably blended all in, there is a little bit of exposure left on those bonds, but it's nothing that we don't think we've already provided for.

Can you explain the components of the $15 million cost savings plan? Do you expect that this is part of your ongoing efforts to improve profitability, considering that you have consistently reviewed your expense base and worked on becoming more efficient?

It is. I mean I really tie this back, Brady, to the Better Bank initiative overall. We've been telegraphing this for a few quarters. There are certainly some specific initiatives we have within the bank that have been months-long initiatives. As we've sort of been able to execute through those, we've been able to identify some specific cost savings. We've also had, in late the first quarter and into early the second quarter here, a very successful early retirement program. We do that periodically every couple of years. So we had good uptake there. These are the types of initiatives. One we've spoken about before as an example, just sort of anecdotally is our credit optimization process. As we've worked through that, we've been able to identify a number of redundancies in our processes. We standardized and centralized a number of those activities. So these are things that both allow for efficiencies to be identified but also lead to a much better end-to-end process for us, better standardization of those processes across the entire footprint. And so those things should be revenue-enhancing as well. That's not a part of the $15 million cost-saving initiatives. But when you think about improved timelines, better customer experience, and better associate experience related to those types of activities, those are sort of the things that, again, are examples of the types of initiatives that we have leading to that figure.

And Brady, this is Bob. Just to kind of add on to Jay's comments. As we've said, we've been talking about the Better Bank initiative, the people, processes, and systems for the last six months or so. We've been working on some of this, as Jay said, on the credit optimization for a year now. So this is just kind of, as we indicated in prior quarters, when we felt comfortable we could firm up the numbers, we would share it with the market, and that's what we're doing today is sharing that. And as Jay said, our early retirement program, we've done multiple times over the years. It was well received by some of our associates, and it exceeded our expectations, and we'll be able to absorb that within the system pretty well.

All right. And then the margin has been expanding quite nicely over the last year or so, but it did take a step back in the first quarter, which the industry has seen as a whole. What are your thoughts on where the net interest margin trends for the rest of the year?

So again, Brady, I'll take a first shot at this. I want to remind you, I think the most important thing to remember is the baseline here. Last quarter, we sort of back-end loaded some moves on the funding side. So I talked about that in the last call. We expected sort of the full quarter impact of that this quarter. I think that, coupled with the continued migration within the portfolio itself, is really the main contributing factors to where we see the margin compressing in the quarter. I don't expect that level of compression to sort of continue because, again, we had that back-end loaded. If you look at Q4 to Q1, a lot of that Q4 was back-end loaded, so you shouldn't see that kind of dynamic from Q1 to Q2. But I do expect there'll continue to be some migration within the portfolio, like what we're seeing. So that will be the ongoing headwind on the expense side. But, on the asset side, we'll continue to have a lot of good repricing dynamics there as well. I think near term, the next quarter or two, margins should be much more stable than what you saw in Q4 to Q1. And then just a reminder that in the fourth quarter of this year, when we look toward the back half of the year, look at the cash flows we expect overall across all of our portfolios and the repricing of those cash flows and then the interest rate swap that kicks in in late September, and we'll have all of that in the fourth quarter. I think all those fundamentals kind of continue to be in place for us as we look out toward the horizon here.

All right. And then just the last one for me. I know a lot has changed from when you all gave guidance 90 days ago, but you guided to mid-single-digit loan growth, and you did a little better than that in Q1. How are you thinking about loan growth from here on now?

Brady, it's Matt. I would say that's still in line. I think we said in our last quarter that it's going to be a front-end loaded loan growth for 2023 based on those unfunded commercial construction fundings. And when you look at our investor deck and look at Page 21, that really illustrates that. But then at the same time, I'd point you to our pipeline. As of this deck, it was right at $1 billion, and even since that point has come down even more so. So I think it's trending that direction right now on the loan growth side.

All right. Great. Thanks for the color, guys.

Thanks, Brady.

Our next question comes from David Feaster with Raymond James. Please go ahead.

Hi. Good morning, everybody.

Hi, Dave.

Good morning, David.

Could you provide some details on how demand is trending? Specifically, from a geographic and segment perspective, where are you seeing good risk-adjusted returns? It's encouraging to see the pipeline yields improve, so I'm also interested in the current new loan yields. Any additional information regarding loan growth and the pipelines would be appreciated.

Dave, it's Matt. Great question. I'll provide a summary on the current loan rate situation. The $800 million pipeline we have is currently showing signs of improvement. We're navigating the yield curve and are starting to reach a point where we can access higher yields while maintaining our asset quality, which is where it should be. Regarding demand, it's certainly moderating in all markets due to the interest rates, but there is still demand present. In each of our metro markets, we see opportunities, though we are being selective in this environment. We're ensuring that we secure comprehensive relationships and are meeting the yield targets we set, while also increasing credit spreads where necessary.

That's helpful. Switching to the deposit side, there’s a lot of uncertainty in the market and banking turmoil in March. Looking at the noninterest-bearing average and period-end balances, it appears much of this occurred fairly early in the quarter. I'm interested in how much of the core deposit flows you believe were more typical business activity and how much was due to clients moving to higher-yielding accounts versus the actual effects of the banking turmoil. Since the quarter ended, have you noticed core deposits stabilizing, or do you anticipate more migration or outflows in the future?

So David, I'd tell you that we've spent a lot of time this quarter dissecting everything you just asked about. And we're having trouble convincing ourselves that what we're seeing is anything other than just sort of normal course activities. We're still opening a tremendous volume of accounts all across our footprint. So everything feels very normal course. Even when we look at larger commercial moves, overwhelmingly, those are also normal course payments, and we're seeing the typical activity that we've seen with those accounts historically. But absolutely, we continue to see migration to a degree within those accounts, out of noninterest-bearing accounts as an example and into the higher-rate accounts. And so you're right, we saw a lot of that really all throughout the quarter, but including early in the quarter. I'll go back in time not very far. We grew noninterest-bearing accounts in the third quarter of last year and really had a pretty stable amount of noninterest-bearing accounts even throughout October and early November. That trend really has picked up, that migration has picked up very late in the fourth quarter, continued in the first quarter. I'd like to think that, that's going to stabilize here sooner rather than later. But it's hard to have a perfect crystal ball on those migration trends. We're certainly getting to a point on a lot of accounts where you're looking at just sort of the normal operating accounts or normal customer checking account type balances, which I think is more flourish than anything when you see that level within the customer base. But that's some color around what we're seeing in the portfolio for the quarter.

And David, this is Bob. I want to add that as Jay mentioned, we started observing this in December of last year during the fourth quarter. We discussed it on our fourth quarter call, noting that the trend shifted like many other banks early in the quarter. When the bank turmoil occurred in early March, we were monitoring and analyzing the situation daily. We really did not notice much change after that time. Most of our changes were associated with the deposit mix we have seen in the industry, primarily on the commercial side. The consumer side has remained relatively stable throughout the quarter.

Yes, that makes sense. I appreciate the insights provided in the slide deck regarding the loan portfolio and credit. Credit has remained solid, but we did notice a slight increase in non-performing assets. I'm interested in your broader perspective on credit and what factors contributed to the change. Additionally, there is a strong focus on the office sector. I'm curious about your observations there and how discussions with those clients are proceeding, as well as your overall thoughts on the office segment within the portfolio.

Hi, Dave, it's Matt. Regarding your first question about the increase in non-performing assets, it was primarily due to one specific loan from an acquisition partnership. This situation is quite isolated and is what pushed the number higher. Overall, our asset quality remains very strong, and we are closely monitoring it. We are particularly focused every day on any emerging challenges, which are primarily similar to those we faced during COVID. These issues existed before interest rates began to rise, and we are actively addressing those relationships. However, we are not observing any systemic issues in our portfolio or any specific industry contributing to this. I recommend you look at Page 20, which details our office and all major categories in commercial real estate. The office category comprises $1 billion, accounting for 6% of our portfolio, with an average loan size of $2 million and a weighted average loan rate of 4.9%. This reflects who Simmons is. Our office portfolio is very granular and community-based, consisting of local businesses like CPAs and insurance companies. We do not have large office towers or office parks, and we are experiencing stability in our office sector, unlike trends observed on the East and West coasts.

Got it. That’s helpful color. Thanks, everybody.

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

Hi. Good morning, everyone. Thanks. I guess maybe if I could start just around the construction growth you guys saw this quarter. Could you give me a feel for what type of projects you're seeing there, and how you feel about your construction exposure currently?

Steve, it's Matt. Yes, I'll give you what the growth we're seeing in our portfolio is in two specific categories, in multifamily and industrial. Those are the segments where we have some proven developers, proven operators, and that we have had reoccurring business with, and that's where those fund-ups are happening on time. We have a pretty robust monitoring system over that today, and we look at that very carefully. So far, those two segments are doing very well. Underneath that, you're going to move into the one to four construction category and then owner-occupied construction, which we love. But overall, that portfolio is funding up just like we expected it to.

Okay. Very helpful. And then you guys noted in the presentation that the $330 million subordinated debt will go adjustable here this quarter. Can you give the margin impact of that? And then also within margin, do you have any color around kind of where the marginal cost of deposits is coming on or the margin for the month of March potentially or anything that would give us a feel for late in the quarter trends?

I can tell you on the subordinated debt there, Steve, that I think the rate on that for the second quarter is at 7.32%. So you could calculate the margin impact from there easily.

5% to 7%.

Yes, it's going from $5 million to $732 million.

Okay. That's perfect. And anything on kind of where the margin was in March, maybe or where the cost of deposits ended the quarter at or just kind of an idea of where those marginal deposits are coming on today?

I don’t have the exact spot margin available right now, Stephen. However, it will likely be slightly lower than the full quarter's margin. It's important to note that the margin trend from Q4 to Q1 isn't something you can simply extrapolate due to the back-end loaded nature of our actions in Q4, which also involved some extensions of our liabilities. We've absorbed a considerable amount of that. Regarding our interest rate sensitivity included in the presentation, we are currently more neutral to rate changes, whether it’s a 25-basis-point increase or decrease. This should give you an idea of our perspective on marginal rates at this stage.

Okay, very helpful. Just one last thing from me. You have set a quite ambitious long-term ROA target, which is impressive. I'm curious about how you plan to reach that target. It seems like a significant jump from your current returns. Additionally, is your long-term executive compensation linked to achieving that 150-plus ROA in any way?

Our long-term compensation is linked to ROA, while our short-term metrics focus on efficiency ratio and pretax preprovision. We're committed to these numbers. As we've discussed, our Better Bank initiative emphasizes improving our people, processes, and systems. Over the last decade, we've developed our company and expanded geographically into six states in Middle America, targeting both strong metropolitan and rural areas. Our footprint and franchise are solid. Most of our efforts in the past were dedicated to mergers and acquisitions and growth to diversify our geography and size for necessary investments. Currently, we are focusing on becoming a better bank amid the challenges posed by the current interest rate environment and rising deposit costs. Daily, we concentrate on our initiatives to enhance our operations and aim for a 150 ROA on a year-over-year basis, with an efficiency ratio in the low 50%. Our initial report this year indicated $15 million in annual cost savings as part of this effort. We have several additional months of work planned on this project to establish a strong foundation for our goals.

I would like to emphasize the significance of optimizing our balance sheet, which will happen naturally over time. As I consider the reduction of assets and their repricing, I anticipate a substantial increase in profitability. Our loan-to-deposit ratio has risen from 70% to 72% to 74% over the last three quarters as we work on this expansion. Regardless of the rate environment, we are currently in a phase of stabilization, and as everything aligns, I believe these fundamentals will lead to enhanced profitability.

That’s perfect. Great answer guys and impressed to hear, like you said, you are putting your money where your mouth is on that. So appreciate that color.

Thanks, Dave.

Our next question comes from Matt Olney with Stephens. Please go ahead.

Hi. Thanks. Good morning, everybody.

Good morning, Matt.

I want to go back to the funding discussion, and like most of your peers, the overall level of borrowings were higher at March 31 compared to the average levels, not surprising given the turmoil we had late in the quarter. I'm curious if you still hold this high level of borrowing? And if so, what are the current thoughts on how long you want to keep this? Thanks.

I mean, Matt, there's just a small pickup in borrowings there in my mind. We have increased the amount of cash at the Fed. But it's nothing that's sort of a material driver in my mind to margin. We thought it was a prudent thing to do as we saw things transpire in March. But I don't think there's sort of any major strategy around that. When I look at our borrowings overall, I think they're something like 6% of total liabilities, and that's really right where they were last quarter as well. I just don't see a major shift there unless it becomes more advantageous from a rate perspective to do that relative to other opportunities, whether it's brokered CDs or other types of deposits. I think we'll be pretty capitalistic in how we think about that, but nothing beyond that mindset.

Well, let me ask it this way. As far as just the need for incremental funding from here, because I mean, it sounds like loan growth is going to slow a little bit from where it's been. You've got some pretty good cash flows coming off the securities portfolio. Incremental funding costs are still pretty high. I'm just curious how much incremental deposit growth you need from current levels?

Yes. I mean, I don't think it's a lot. We've talked about timing of cash flows, I think, every quarter for the last couple of quarters, and that's still where we are. We saw loan growth we were experiencing it late last year. We continue to expect good activity with our fund-ups over the coming quarters. So is there a moment in time here in the next quarter or two where we have fund-ups that exceed sort of self-generated cash flows? That could be a more modern degree than what we've experienced in recent quarters. But again, as you look out, as we look at the pipeline, Matt commented on it a while ago, we were at $1 billion at quarter end, we're closer to $800 million at today's pipeline. The yield continues to do exactly what we wanted it to there. And so I think about prepayment speeds, our existing book, I think about fund-ups of unfunded commitments, those are all kind of what they are. We can measure those pretty accurately. And then we see what's happening in the pipeline. I think all that leads to a much lower need for incremental growth and more of an optimization of the balance sheet like we mentioned a question or two ago.

Okay. And then going back to the discussion around expenses and kind of targeting the $50 million of incremental savings over the next few quarters. If I assume some normal annual merit increases, expense increase of, call it, 5% per year and then kind of layer this on. Is the goal just to keep the expense levels relatively flat from where they're at now over the next few quarters from a forecasted standpoint? Is that the right way to think about this?

No, Matt. I would suggest looking at the current run rate of expenses for Q4 and Q1, along with our adjusted noninterest expense level. We believe that the $15 million represents the annualized run rate expenses based on that figure. I want to stress that we will not reach 100% of that in the second quarter. We will achieve some of it in the second quarter, for sure, and a bit more in the third. We expect to have it fully implemented by the end of the year.

Matt, just a little more color for your modeling is, in Q1 we had our payroll tax 401(k), the timing difference for payouts in the first quarter. That's about $2.5 million to $3 million. Merit increases went in on April 1. And that's pretty much a push for each quarter thereafter. So I think you have the baseline in the numbers in Q1 for the merit increase.

Yes. Agreed.

Got it. Okay. That’s helpful. Thank you guys.

Thanks, Matt.

Our next question comes from Gary Tenner with D.A. Davidson. Please go ahead.

Thanks. A lot of my questions have been answered or were asked and answered already. But in terms of capital, your stock, unfortunately, is getting ever closer to tangible book. You guys have kind of held off on using buybacks recently. Just thoughts on how you might be thinking about that over the near term with the stock where it is?

Gary, I'd tell you, first off, we're committed to building our shareholder value, and that's a sustainable book value and EPS over time. While we haven't bought back stock in the last six months or so, it's always on the table for us. You'd love to be able to do it in this environment. We look at it every day. I can't tell you today we're going to do it or I can't tell you we're not going to do it. But we're going to look at it. And it's really this environment we're in with the banking environment we had starting in March, maintaining those capital levels. But it really is a good time. So I would tell you, it's on the table for us to be looking at what is the best use of our dollars for investment for our shareholders.

Okay. And then I know, Jay, I don't think you had a spot margin available for a question I was asked earlier, and I apologize if I missed it. But did you mention the kind of spot deposit rates? I didn't catch it in the deck at all, and I don't know if you had mentioned it otherwise?

I mean, honestly, our spot deposit rates by product are pretty widely varied at the moment. So I don't have sort of a blended spot deposit rate. Again, the best way I think to think about the overall equation there is the trend in margin will likely continue in Q2 just at a much slower pace than what you saw from Q4 to quarter.

Okay. All right. And then last question. I just noticed it's a small number, but the held to maturity securities number went up by a few million in the quarter. Did you add anything to held to maturity in the quarter? Or is it just some other sort of accounting item that impacted that?

Yes. It's just the natural amortization of some of the marks in the held to maturity portfolio. There were no additions to that portfolio in the quarter.

Yes. And Gary, we are not purchasing any securities at this time. We are only considering CRA-type investments, which are minimal.

Correct.

Correct. Okay. Yes, I wouldn't think so, that's why I just wanted to clarify. All right, thank you very much.

Thanks, Gary.

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

Thank you very much, and thanks for joining us today. I think you can see in these uncertain times in the banking industry, the diversification of our company has played out really well. When you take a look at our liquidity, our capital, our asset quality, the basis of who we are as a community banking organization. I would hope that you would recognize that all three of those are outstanding, especially compared to some industry peers. So we are very optimistic about the way we have established our company moving forward. And I think you heard Jay and Bob talk about repricing of our loan portfolio, some additional income based on swaps that will kick in later this year, rebalancing of our balance sheet, expense initiatives. I hope that's exactly what you would expect from us based on what we have said over the last six months and the fact that we have spent the last 10 years diversifying our company to get to this point in uncertain times. So while our net income did not quite meet expectations, we believe that primarily that's a result of our conservative nature and our provision for the uncertain times to come. I think we're well positioned regardless of what happens in the marketplace to date where we are at and still take care of our customers. We remain dependent on in the communities we serve, and I think we've done an excellent job over the last six months taking care of particularly the smaller communities where we are a significant portion of the capital available for those communities to thrive and grow. So thanks again for joining us today, and I hope you have a great day.

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