Smartfinancial Inc. Q2 FY2021 Earnings Call

Good day, and welcome to the SmartFinancial Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Miller Welborn. Please go ahead.

Thanks, Tom, and good morning, and thanks for joining us this morning for our Q2 2021 earnings call. We always love being with this group each quarter to talk about our progress in our company. Joining me on the call today are Billy Carroll, our President and CEO; Ron Gorczynski, our CFO; Rhett Jordan, our CCO; and Nate Strall, our Corporate Strategy Director. Before we get started, I'd like to ask each of you to please refer to page 2 of our deck that we filed this morning for the normal and customary disclaimers and forward-looking statements comments. Please take a minute to review these. Folks, it's another great quarter by our team here at the bank. The passion, the energy, and execution by all our team this year have been phenomenal. We've always counted on the strength and energy of the SmartBank team. And hopefully, folks are beginning to recognize we are serious. Our organic pace of growth has been impressive and we see nothing slowing that down in the months ahead. Between very strong markets and the addition of several new sales team members and a new market lift-out, we feel we're positioned perfectly to continue on our current pace. We talk often about how excited we are about where we are as a company. And I can't stress enough about how we feel this company is positioned today. With that, I'm going to turn it over to Billy.

Thanks, Miller, and good morning, everyone. We have a great group on the call today. As Miller mentioned, we had another extremely solid quarter, and the first half of 2021 has been very exciting for us. This quarter demonstrated how our company is becoming one of the best banks in the Southeast while creating value for our shareholders. I will highlight a couple of key points before turning it over to Ron for financial details and Rhett for credit updates. This quarter, we had impressive earnings and tangible book value, reporting operating earnings of $9.1 million or $0.60 per share, while our tangible book value increased to $18.69, a 10% increase year-over-year. We also experienced strong growth, which I consider one of our highlights. Net organic growth in loans, excluding PPP figures, was over $87 million, or 16% annualized. Our lending teams are doing an exceptional job, and we are seeing balanced growth across all our markets. Deposit growth remained solid as we gained excellent core clients, resulting in over $90 million in deposits during Q2. Referring to the slide deck Miller mentioned, I want to highlight that we received our fifth consecutive regional top workplace award this quarter. While our numbers are significant, it's essential to acknowledge the culture we are fostering within the company. We are a wonderful place to work, and I believe that sets us apart from our competitors. Moving to slide 5, I want to highlight some of our focus areas this year. First, on the left side of the page, we are thrilled to announce our expansion into Auburn, Alabama, with a talented group of commercial bankers joining us from a local regional bank. This is an exciting opportunity in one of Alabama's fastest-growing communities and another vibrant college town in the Southeast. On the right side of the slide, you can see some of our ongoing initiatives. Our acquisition of Sevier County Bank is proceeding well and is on schedule for closing this quarter, along with an October systems conversion and rebrand. The bank is performing ahead of budget numbers in the first half, and we look forward to integrating them soon. We closed our acquisition of Fountain Equipment Finance in early May and completed the integration in Q2. This company is an excellent addition to our franchise, specializing in financing heavy equipment, tractors, and trailers. All key personnel are remaining with us, and we anticipate leveraging our larger balance sheet to grow this already successful business. Ron will discuss Fountain's financial impact shortly. The banking team lift-out in our Gulf Coast region during Q1 has already shown early success, and we expect it to contribute positively sooner than we originally anticipated. I will elaborate on the lift-outs in my closing comments. Before I pass it to Ron, I want to highlight that our revenue diversification efforts are gaining momentum, as shown on slide 6. These business lines and subsidiaries are contributing positively to our revenue and will become even more vital as we scale. Overall, we have plenty of exciting developments within our company at this time. Now, I'll hand it over to Ron for a deeper dive into our financials. Ron?

Thanks, Billy, and good morning, everyone. I'll be starting on slide 8 quarterly highlights. These are some of the high-level metrics for the last few quarters. We have had solid performance with continuing net interest income growth. Our operating pre-tax pre-provision earnings for the quarter totaled $11.6 million. We also reported diluted operating earnings of $0.60 per share, an increase of 25% when compared to the prior year quarter. Moving on to slide 9 performance trends. As both Billy and Miller have indicated, not only did we have a great quarter, but also a great first six months of 2021. As shown in the slide, we have created much momentum over the last eight quarters continuing our strong growth trends with assets reaching almost $3.7 billion at quarter-end. Our loan growth continues to be a bright spot for us, with more than $87 million of net organic loan growth for the quarter and over $53 million of acquired leases from our Fountain acquisition. Additionally, we had almost $160 million of our PPP loans forgiven during the quarter, which Rhett will go over in a few more slides. Looking forward, our loan pipelines continue to remain strong, and we are starting to see the PPP forgiveness process ramp up for the 2021 vintage. In addition, our deposits continue to grow and ended the quarter at over $3.1 billion. Moving on to slide 10. This slide represents five quarters of net activity with escalated rent provisions, high amounts of excess liquidity, and PTPP accretion. Focusing on the ROA metrics on the top graph, we have started to get back to a more normalized run rate. Moving on to the lower portion of the slide, our assets continue to grow. We believe a more consistent gauge of performance in this current environment is our operating return on average tangible common equity, which is up 12.9% for the second quarter, representing some stabilization to what we've been reporting in the prior periods. Turning to slide 11. As Billy indicated, our tangible book value per share was $18.69, an increase of 6.5% on a linked quarter annualized basis. As the graph reflects, we're persistently growing tangible book value. On the lower portion of the graph, our operating efficiency ratio represented by the green line continues to hover at the lower 60s level. The current quarter was slightly elevated due to the additional costs associated with the Gulf Coast team lift-out and from our acquisition of Fountain. Turning now to slide 12 balance sheet and our margin. Starting with loans on the upper left, current loan outstandings compared to the prior year did not change dramatically due largely to our PPP loan activity. But our loan portfolio composition continues to evolve. Rhett will provide more information shortly. For our deposits, we had increases over $90 million compared to the prior linked quarter and increases over $600 million when compared to the same prior year quarter. Currently, our time deposits represent 16% of our deposits, down from 26% from the prior year with the shift going into money market and savings accounts. At quarter-end, we had over $800 million in non-interest-bearing deposits, which represented 26% of our deposit portfolio. Our current loan-to-deposit ratio was up to 78.6%, a significant change from the 94.8% for the same prior year quarter. Moving on to the right side of the slide. Our net interest income FTE was over $27 million, slightly higher than the prior year quarter's $26.4 million. Our average earning assets totaled $3.3 billion, an increase of $218 million. We reported an interest margin of 3.29%, a decline of 19 basis points from the prior quarter. This decline is primarily related to one, the reduced amount of discount loan and PTPP accretion reported for the current quarter; and two, our elevated liquidity position. During the quarter, our loan and lease yields decreased by 15 basis points to 4.52%, primarily from $1.1 million less in discount loan and PTPP accretion as previously mentioned. Offsetting this decrease was the partial quarter addition of lease income from Fountain, which was 11 basis points accretive to our loan and issuers. For interest-bearing deposits, we had a decrease in funding costs of five basis points to 0.39% with our cost of total deposits for the quarter at 0.29%. For our time deposits during the third quarter of 2021, we will have over $100 million or 20% of our time deposits maturing and repricing at a weighted average cost of 82 basis points. At this point, the majority of our higher-cost time deposits have been repriced. As mentioned in our last earnings call, we believe our core NIM has bottomed. But we are still experiencing elevated cash balances, which increased over $114 million for the quarter, totaling an average quarterly balance of $531 million. This elevated position of excess liquidity has negatively impacted our margin well over 30 basis points. With continued rate uncertainty, we still are being patient with our cash position and deployment. Currently, with our abundant liquidity and favorable funding mix, we are able to strategically move forward with opportunities. Looking forward, we are forecasting a third-quarter margin of around 3.35%. We're estimating to have loan accretion of 12 basis points or approximately $758,000 and estimated PPP loan fee accretion of 30 basis points, approximately $1.9 million. Moving on to Slide 13, operating non-interest income. We had another solid quarter of non-interest revenue. As you can see from the quarters presented, we continue to build consistent quarter-over-quarter favorable growth trends. Our associates continue to place much emphasis on building our non-interest revenue, with us having revenue increase of almost 50% from the prior year quarter. Some of our current activity includes increases in our service charge and interchange fee income, continued increases from investment services with continued growth in assets under management. For our mortgage banking team, we had another consistent quarter. As expected, our Q2 income was steady with revenues totaling $1.1 million. Our pipeline continues to remain strong even with the headwinds from increased building prices, decreased inventory, and delayed projects. We are still expecting similar production as in the past two quarters. Our other income category included additional fee income from our Fountain acquisition. Looking forward into the third quarter, we are up and running with our capital markets initiative and are starting to recognize some interest rate swap fees. Our forecast for the third quarter is to have a non-interest income of $5.5 million. Moving on to Slide 14, you'll find our operating non-interest expenses. Through our growth, our team has continued its discipline around expense management. Over the last several quarters, our expenses have remained relatively consistent. For the current quarter, our non-interest expenses have increased slightly, primarily in our salary and employee benefits expenses and having a full quarter expense from the Gulf Coast team lift-out and two months' expense from our Fountain acquisition. All the other increases in the various expense categories were primarily operational items, stemming from our lift-out and Fountain acquisition, as well as our overall franchise growth. Looking forward, our forecast for the third quarter is having non-interest expenses of around $22 million with salary and benefit expense around the $13.5 million range. Now to finish off the slide, let's touch base on taxes. Our income taxes for the third quarter reported an effective tax rate of 22%. We are forecasting an effective tax rate of 21.5% to 22% for the third quarter of 2021. At this point, I'll be handing over the slides to Rhett Jordan, our Chief Credit Officer, to go over the loan and credit-related info. Rhett?

Thank you, Ron. As Ron noted on Slide 12, our loan portfolio continues to see good diversification across the loan segments with 16% annualized organic loan growth quarter-to-quarter of approximately $87 million and the overall portfolio mix being similar to previous quarters and the same period from the prior year. As mentioned, the portfolio has seen consistent growth this year spread across all geographic areas of our footprint. Our CRE portfolio has seen the most growth during the six-month period year-to-date, moving to approximately 39% of total portfolio outstandings compared to 35% at Q2 2020. This trend has primarily been the result of various owner-occupied and non-owner-occupied commercial projects, restarting that were delayed during 2020 because of COVID. Also, the continued strong housing demand driven significantly by permanent resident relocations into our core markets, as well as corporate relocations into our three business-friendly states, has been a tremendous contributor to the bank's loan and deposit growth opportunities. All in all, a very solid quarter with strong organic loan growth in the portfolio. Slide 15 shows our overall asset quality metrics that continue to trend positively and resulted in one of our stronger quarters historically in key ratios. While we saw our loan outstandings realize solid growth in the first half of the year, our overall credit quality metrics continued to perform very well. Our NPA ratio improved to 0.17%, down from 0.29% at first quarter 2021 and down from 0.31% at year-end 2020. Net charge-offs for the quarter were 0.01%. And the over 30-day past due ratio was down to 0.27%. Classified loans at 0.29% of total loans were also down from prior quarter and year-end ratios. Overall, our asset quality continues to demonstrate solid metrics resulting from continued strong economic recovery in our marketplaces and stays in line with best-of-class levels. Our outlook is positive for the balance of the year, and we expect our historically consistent performance to continue in upcoming periods. As for our PPP loan book, we've seen considerable forgiveness activity in the first half of 2021. As of quarter-end, as noted on slide 16, we had successfully processed and posted forgiveness payoffs on 2,743 applications or 93% of the round one originations, for just over $260 million in balances. We ended the quarter with about $40 million in balances remaining from round one, on which we are actively working with borrowers to complete the forgiveness phases and/or finalize repayment structures on any unforgiven residual balances. We anticipate the remaining Phase 1 unforgiven loans to cycle within the next 60 days, and we'll be actively reaching out to round two clients to begin those forgiveness applications as soon as coverage expires and the clients are ready to submit their applications. Our final round two process generated 1,801 loan applications for total outstanding balances of just over $138 million and roughly $7 million in fee generation. Overall, the PPP projects have proven to be a very successful venture for our company, generating 4,700-plus loans totaling $439 million in balances and $17 million in fee revenue for the bank, all the while creating considerable prospect opportunities for our teams. Now, I'll turn it back over to Ron to talk to you through our allowance position for the quarter.

Thank you, Rhett, for the details. As Rhett mentioned, we are currently looking at the net reserve. We continue to see strong credit quality statistics. For this quarter, we did not need to make a provision and our allowance remains adequate. We could accommodate the provision for organic loan growth due to the improving economic conditions in our area and other qualitative factors. We also do not need a provision for our lease portfolio on the acquisition date, which should benefit our new lease production moving forward. By the end of the quarter, our allowance for originated loans and leases, excluding PPP loans, increased by 0.86%, and our total reserves relative to total loans and leases, less PPP loans, rose by 1.37%. Moving on to our current capital position, our capital ratios are still robust. We experienced a slight decrease from the previous quarter as we used capital for our strong run rate and our Fountain acquisition. During this quarter, we paid $906,000 in cash dividends and did not conduct any stock buybacks as we paused our repurchase program until the acquisition of Sevier County Bancshares is complete. At this point, we are well-positioned. We strongly believe in leveraging our capital and feel we are appropriately leveraged now. We anticipate a gradual increase in capital as we expand our loan portfolio and reduce our cash position. This shift in mix will enhance profitability while slowing overall asset growth and conserving capital. With that, I will pass it back to Billy.

Thanks, gentlemen. And to add a little more color from my standpoint as I close, our markets are all performing extremely well. And I wanted to take a minute for a couple of statistics, because I do believe one of the biggest differentiators is our collection of these great smaller metro markets. We're seeing just phenomenal trends in these zones. Our Sevier County Tennessee market, which is the Pigeon Forge-Gatlinburg tourism area, had gross sales receipts that were up 46% in Q1 2021 compared to Q1 2019, just phenomenal growth in our tourism zone. In our Mobile-Baldwin County Alabama market, looking at population trends, we are seeing solid growth with every graph that we look at moving up and steeply to the right, just phenomenal growth from a population standpoint in those zones. Chattanooga's MSA, for example, has reported historically low home inventory, down 50% from last year, as more people are relocated to this outstanding city. And we're seeing these same types of trends in Knoxville, Murfreesboro, and Tuscaloosa. The Southeast is poised for great continued growth, and it's one of the reasons you are seeing us pivot a bit as we look to more commercial banking lift-out opportunities. Auburn, Alabama is a great example of this. It is a perfect market for our company, a rapidly growing small metro MSA with one of the South's best universities. The team we've added there of well-trained sophisticated bankers will quickly become additive to our franchise. We want to do more of this and continue to explore these lift-out opportunities as a strategic focus for the coming quarters. Our loan pipelines continue to be robust and are equally distributed across all of our markets. Like everybody, we're finding some payoffs and paydowns with excess liquidity. But we feel we can keep growing at a solid high single-digit pace or maybe even better, as we demonstrated this quarter. It's a very exciting time to be part of this company as an associate and as an investor, and we're positioned well to be opportunistic moving forward. So I'll stop there and we can open it up for questions.

Thank you. We will now begin the question-and-answer session. And the first question comes from Brett Rabatin with Hovde Group.

This is Ben Gerlinger stepping in for Brett. I wanted to mention that you have a lot going on right now. The new Auburn team is developing, the Gulf Coast team is improving and contributing more than initially anticipated. Fountain has had a good quarter leading into the second quarter results, and you have Sevier County coming up next quarter. Despite all these activities, you're still achieving consistent loan growth, and your margins appear to be strong, especially with the guidance suggesting growth ahead. I'm curious, if you exclude Sevier County, which might bring in around 300 net loans—though that could be a bit optimistic—do you have an estimate for what the total loan balances will look like by the end of the year?

Total loan balance. Ron, do you have that handy or got something you want me to circle back with Ben? And I think we've got a healthy average in terms of…

Yes, I think it will be around $2.4 billion to almost $2.5 billion. We're not expecting much growth in loan balances. Instead, we are looking at a trade-off between the remaining PPP loans and our originated portfolio. Let me get back to you on that; I need a moment to find the exact figures.

But you are right there are a bunch going on around here and pretty energetic...

Yes, I'm sorry. $2.52 billion is what our figure represents, excluding Sevier County.

Okay, great. That's really helpful. You all clearly have a good understanding of how quickly the Gulf Coast and Auburn teams' investments are attracting new resources.

I think it's important. We have been thrilled with what we have seen from these lift-out opportunities thus far, which is why I'm mentioning our interest in seeking additional opportunities like this. We are in a great position now, as our size allows us to take on more of these initiatives. I believe we are well positioned to leverage these outstanding bankers and serve the middle-market clients they had.

Right. Yes absolutely. I think it's a great opportunity for you guys. And then, that kind of goes into my next question, with these lift-outs, should that be kind of viewed as the go-forward plan of inorganic growth, I guess you could say? Or do you guys see the potential for more acquisitions?

Ben, I'll take that. You can chime in. I think we're always looking for opportunities. And I think we're an opportunistic group, an entrepreneurial group we always have been. But I do think at this time, and I make the comment, I think you're seeing us pivot a little bit. I think our company now that we've got this thing up will be $4 billion in assets give or take after the acquisition. Our earnings streams are really starting to kick in. We've got the ability to really grow our company in a more sophisticated way. And so, we'd love to do more of that. I think you would see us focus near-term on a little more of that versus M&A. But strategic M&A, if presented, would be something that would interest us.

Yes. I would say that recently, especially following the announcement last week regarding one of our Nashville partners, our phone has been quite busy. I would also agree with Billy that we are looking to add sales team members, explore lift-out opportunities, and enhance the markets we are already in, in addition to those initiatives.

Okay. Great. And then, my final one was, just on the new additions to the Gulf Coast team and the Auburn team. If you look at your loan portfolio, is there any sort of specialization across the board? Or is it more so just complementing what you already have and growing the portfolio at a consistent rate?

Yes. Rhett, do you want to kind of cover that kind of based on what you're seeing coming out of those markets?

I wouldn't necessarily use the term specialization when it comes to my understanding of industry segments. However, I can say that these teams bring a much broader commercial and industrial portfolio from their previous institutions. We believe this will play a significant role in shaping their future loan production, which won't be limited to any specific industry segment but will align more with that type of production.

That will be sophistication?

I wanted to focus on loan growth, particularly regarding the Auburn team. Could you share the size of the loan portfolio that group managed at their previous institution?

It's a bit challenging to determine an exact figure due to the various areas they were overseeing. However, this group likely managed around $0.5 billion in total. I mention this because I don't anticipate an immediate shift to that level. Nonetheless, they handled a substantial portfolio that we believe we can continue to leverage for growth.

Most of my questions have been asked and answered. But I figured on this topic, which seems to be a main theme here, the lift-out strategy, when you look geographically any particular regions that would be higher priority in terms of either adding teams to where you already are or Southeastern markets where you don't have a presence where you'd be very interested in entering via team? And on a side note, I want to throw out metro Nashville given last week's announcement, whether that would be high up there on the priority and likelihood in terms of being able to get some teams given some potential merger disruption there?

Our primary focus will be on the Southeast, with plans to build density in Arizona, Tennessee, Alabama, and Northern Florida. Nashville has always been on our radar, and we are interested in adding density in and around the metro area, though not necessarily in Nashville itself. Our team has been performing exceptionally well over the last few quarters, which could help us expand into the South Nashville market if the opportunity arises.

Density, density, density with a couple of markets that you're probably very well aware of. Absolutely all of the above.

Okay. Great. That’s all I had. Thank you.

Thanks, gentlemen. I'm excited to see that momentum and growth continue. Our guidance remains strong as we look ahead, and we appreciate your interest in our company.

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

Hey, good morning.

Good morning, Feddie.

Hey, good morning, Feddie.

So just wanted to start in the deck you mentioned that the Auburn team handled some health care banking relationships. Forgive me if I missed this, but more specifically is that more like managed care or individual family practices? Or is that kind of all of the above?

It's a good mix. Auburn has some appealing medical components in the market. What we've observed from that group is a nice balance of various aspects, so there isn't any significant concentration or specific niche to focus on, particularly in relation to the medical field.

Got it. And then just switching gears. I'm curious what you're hearing on the equipment finance business. I guess, more specifically, we've heard some other banks talk about supply chain constraints. And we've all kind of heard about supply chain constraints. Is that playing a role there? And could that maybe mean more upside to that business down the road as those constraints work themselves out? Or is it not really playing as much of a role for them?

For the Fountain team, we focus on heavy equipment, and we had a productive strategy session last week. We're noticing that the supply chain is impacting us, particularly because we're primarily involved in used equipment financing. The tightening of supply chains for new equipment is affecting the used market, similar to trends in the auto industry. We believe that as supply chains improve, the situation will get better. However, we are currently facing some challenges due to low inventory. On the positive side, in Southeastern markets, there's significant growth and demand for small excavation companies, which are actively seeking equipment. This has led to an increase in our volume, and our production numbers have remained strong.

With our levels.

Got it. I appreciate the additional color guys, and congrats on a great quarter.

Thanks, Feddie.

Thank you, Feddie.

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

Hey, good morning guys.

Hey, Kevin.

Hey, Kevin.

Most of my questions have been asked and answered. But I figured on this topic, which seems to be a main theme here the lift-out strategy, when you look geographically any particular regions that would be higher priority in terms of either adding teams to where you already are or Southeastern markets where you don't have a presence where you'd be very interested in entering via team? And on a side note, I want to throw out metro Nashville given last week's announcement, whether that would be high up there on the priority and likelihood in terms of being able to get some teams given some potential merger disruption there?