Smartfinancial Inc. Q3 FY2024 Earnings Call

Hello all. And welcome to SmartFinancial Third Quarter 2024 Earnings Release and Conference Call. My name is Ezra and I will be your coordinator today. I will now hand you over to your host, Nate Strall, Director of Strategy, to begin. Nate, please go ahead.

Thanks, Ezra. And good morning, everyone. And welcome to SmartFinancial's third quarter 2024 earnings conference call. During today's conference call, we will reference the slides and press release that is available in the Investor Relations section on our website, smartbank.com. Billy Carroll, our President and Chief Executive Officer, will begin our call followed by Ronald Gorczynski, our Chief Financial Officer, who will provide some additional commentary. We will be able to answer your questions at the end of the call. Our comments include forward-looking statements. These statements are subject to risks and uncertainties and the actual results could vary materially. We list the factors that might cause these results to differ materially in our press release and in our SEC filings, which are available on our website. We do not assume any obligation to update any forward-looking statements because of new information, early developments or otherwise except as may be required by law. During the call, we will reference non-GAAP financial measures related to the company's performance. You will see the reconciliation of these measures in the appendices of the earnings release and investor presentation filed on October 21, 2024 with the SEC. And now I'll turn it over to Billy Carroll, our President and Chief Executive Officer, to open our call. Billy?

Thanks, Nate. And good morning, everyone. Great to be with you, and thank you for joining us today and for your interest in SMBK. I'll open our call today with some commentary and hand it over to Ron to walk through the numbers in greater detail. After our prepared comments, we'll open it up with Ron, Nate, Rhett, Miller, and myself available for Q&A. So let's jump right in. We really had a nice quarter and executed on what we've been messaging. We posted net income GAAP and operating of $9.1 million for the quarter or $0.54 per diluted share. I'm proud of the way our team is performing and I'm excited to watch us gain operating leverage as we've anticipated. We had a couple of pennies of boost from a tax strategy as well that we implemented. But even without that, we had an outstanding earnings trajectory. Jumping into the highlights, I'll be referring to the first few pages in our deck, Pages 3, 4, and 5. First and in my opinion, one of the most important metrics, we continue to increase the tangible book value of our company, moving up to $22.67 per share, including the impacts of AOCI and $23.69 excluding that impact. That's a 19% annualized quarter-over-quarter increase, including AOCI movement and 9% excluding it, very nice tangible book growth. Looking at the graph on the lower right on Page 5, you'll see the value increase we continue to deliver for our shares. We again had a very solid loan growth quarter, over 16% annualized and that's coming off an 11% annualized prior quarter. We saw continued growth in new relationships as well as an increase in funding online. On the deposit side of the balance sheet, we used the quarter to reposition some funding. We had an opportunity to exit a public fund relationship we felt had gotten a little larger and a little more costly than we had wanted. So we leveraged our strong liquidity position and utilized a wholesale funding ladder to fill the gap. Net of that account and wholesale adjustments, core growth was over 5%. So when we drill down on deposits, we had a very nice core growth quarter and continue to bring in some outstanding relationships. We also saw our overall costs tick down to 2.54%. Our history of strong credit continues with the metrics holding very low at 26 basis points in NPAs. Both NPAs and charge-offs were just slightly higher than the prior quarter but still extremely low. That movement continues to be a few lingering equipment credits we've worked through in our equipment finance subsidiary. That group continues to be a very profitable arm for us and we anticipate those isolated items slowing soon. Total revenue came in at $44.1 million and net interest income continued to expand with an inflection point we've discussed. We also had a stronger than expected noninterest income quarter that Ron will talk about in a bit. Noninterest expenses were just slightly up at $30.8 million. I still feel very good that we can hold our expense growth to very reasonable levels as we look forward. The operating leverage we've talked about on prior calls is starting to happen as we continue to grow the revenue line with minimal investments on the expense end. Looking at the chart on Page 5, highlighting the operating PPNR slide, the movement up has started after a couple of flattish quarters, looking forward and expecting to see that trend continue. So just a couple of additional high-level comments from me on growth. We're very pleased with the results. On the loan side, we were up $114 million, again, about 16% annualized for the quarter and over 10% annualized year-to-date. Our regional sales teams are doing a very nice job growing our clients. Yields on the loan side expanded with the full portfolio's average loan yield up 15 basis points to 5.95% and our loan mix was almost identical to the second quarter. I mentioned the remixing of the deposit side. I really like the work we've done here, particularly this quarter, leveraging our position of strength to move out of larger chunkier deposits to lower our overall cost and focus on replacing it with more granularity. We pushed the loan-to-deposit ratio up to 86%, which is a nice spot for us. And we also continued to hold our noninterest bearing mix around 20%, not an easy feat in this environment. Our balance sheet pipelines feel very solid. And I'm still holding to our past guidance of mid to high single digits on growth as we look at a couple of quarters, even though we've been able to beat that so far this year. I also think we can pace deposits to organically fund this growth. Also, kudos to Ron and his finance team as well as their tax advisers on executing a nice strategy that should lower our go-forward tax rate. That should be a nice little tailwind added as well. So let me go and hand it over to Ron to dive into the details. Ron?

Thanks, Billy, and good morning, everyone. I'll start by highlighting some key deposit results. As Billy had mentioned, during the quarter, the bank significantly reduced its exposure to a larger public fund relationship. While this was a tough decision due to our desired support of municipalities where we do business, the account was highly interest rate sensitive and service quality intensive rather than fee-driven. As a result, the bank made a strategic decision to minimize this relationship and pursue temporary, more cost-effective brokered funding. Our total deposits remained flat linked quarter at $4.3 billion, which includes $195 million of broker deposits added to offset the reduction from the previously mentioned relationship. Excluding this relationship impact, deposits grew over $50 million during the quarter and the weighted average cost of nonbrokered production was 3.66%. Total interest bearing costs for the deposit portfolio decreased 3 basis points to 3.20% and were 3.08% for the month of September. Noninterest bearing deposits to total deposits remained relatively in line with previous quarters at 20%. In the future, we anticipate replacing our temporary broker deposits with core deposits as client liquidity balances build and our relationship managers continue to win net new deposit business. Our net interest margin expanded quarter-over-quarter, increasing 14 basis points to 3.11%. This expansion is attributable to several factors, including the previously mentioned deposit repositioning efforts and the favorable 7.40% weighted average yield on new loan originations, resulting in a total portfolio yield increase to 6.02%, which includes accretion in fees for the quarter. Looking ahead, we expect consistent margin expansion into 2025, primarily driven by new loan production, lower yielding fixed and adjustable rate loan amortization and maturities, and the bank's liability-sensitive interest rate position. The bank's balance sheet is in a strong position for enhanced profitability in the event of any future Fed rate cuts. As a result of these factors and current market conditions, we anticipate a margin in the 3.1% to 3.15% range. Our quarterly provision expense for credit losses were elevated primarily as a result of higher than forecasted loan growth and a slight increase in charge-offs, stemming from our equipment finance division. Overall, the bank's asset quality remains very strong with nonperforming loans to total loans at 0.26%. Operating noninterest income for the quarter reached $9.1 million, reflecting solid performance across all categories. Notably, the bank generated significantly higher income from customer swap transactions and investment services, which rose by $940,000 and $579,000 respectively. Operating expenses were $30.8 million, slightly elevated from our previous guidance. The increase was primarily attributable to increases in our performance-based incentive accruals and commissions, and the hiring of several commercial sales team associates. Moving forward, we will continue our focus on expense control as part of our ongoing cost management efforts. Looking ahead to the fourth quarter, we are forecasting noninterest income in the mid to high $7 million range and noninterest expense in the range of $31 million to $31.5 million with salary and benefit expenses comprising $19 million to $19.5 million as accruals for performance-based incentives fluctuate. Additionally, during the quarter, the bank established a newly formed real estate investment trust subsidiary to monitor and manage the performance of certain real estate loans and to create a more tax-favorable structure. The REIT subsidiary will result in a lower effective tax rate during future periods by lowering the bank's state income tax expense. As a result, we anticipate a future corporate effective tax rate of approximately 20%. I'll conclude with capital. The company's consolidated TCE ratio increased 33 basis points to 8% and total risk-based capital ratio decreased slightly by 5 basis points to 11.6%. Overall, we continue to be in a well-capitalized position with an optimistic credit and earnings outlook. With that said, I'll turn it back over to Billy.

Thanks, Ron. I want to reiterate again the value proposition with our company, drawing your attention back to Page 7 of our deck. We've been on the road a lot in '24, reminding our investors and our stakeholders of what we've accomplished recently. We are seeing the inflection and the movement in our numbers and we have clear vision of our return targets after absorbing the investments we've made. When you look at the franchise we're building, we're arguably in some of the most attractive markets in the country and have put together a team that is moving this company forward in a great way. What I saw this quarter from our sales teams was really, really good and the by-product of the work we've done this year on our sales and prospecting process. We're now leveraging the functionality of our nCino platform and utilizing the sales force front end to consistently create a stronger prospecting process for our sales team. And we're also leading on the price and profitability systems to coach our teams in the value of full relationships. The regional pricing structure we have and the accountability we're putting on those zones is really starting to bear fruit. We are continuing to look to add sales talent that fits our culture. We've added 15 new sales team members this year and have several currently in our talent pipeline. We're adding some outstanding regional bankers to our team as I believe we continue to be one of the region's banks of choice for great bankers. I also want to mention the execution of our operations group. Our ops teams are doing some great work as they refine our back of the house and move to KPI-driven workflows and management. It’s things like these that people don't see that will be paying big dividends for us as we look ahead. So to summarize, I love where we're sitting. We are executing, growing our revenue line and getting the operating leverage we are expecting. Margin is expanding back. Credit continues to be very sound. And we're seeing great new client growth and the sales energy is outstanding. All said, a very nice quarter for our company as we continue to build a profitable and attractive franchise. I appreciate the work of our SmartFinancial, SmartBank team and the efforts of our nearly 600 associates. This team is continuing to perform well and build a great culture as evidenced by our recent Great Place To Work certification. I'm very proud of what we have going on here at SMBK. So we'll stop there and open it up for questions.

Our first question comes from Russell Gunther with Stephens.

My first question would be on loan growth. So I appreciate all of the color as well as the expectations over the next couple of quarters from mid to high single digits. You certainly outpunched that over the past two. So wondering if you could just share whether it's a sense of conservatism built into the near-term outlook, are you expecting an acceleration or normalization of paydowns that might weigh? Just trying to piece together the outlook relative to what has been a much stronger result over the last couple of quarters?

I'll start, and then I'll ask Rhett to provide some insight too, Russell. Yes, for us, the growth has been very strong. We've had two consecutive successful quarters, even though the first quarter didn't go as planned. Overall, we've experienced two positive quarters in a row. Looking ahead, we always expect potential payoffs and paydowns, and this quarter we managed to navigate that while still achieving great growth. However, we do want to remain cautious about possible additional paydowns. If we don't see many of those, our results could be even better. It's important for us to be conservative in our projections, estimates, and guidance. That said, the sales teams are performing well, and Rhett, you might want to share your thoughts on what you're observing in the pipeline looking forward over the next few months.

Billy, I think you're right on. I mean, our pipelines continue to stay relatively strong quarter-to-quarter. Even as we closed what was in the pipeline, we're seeing consistent new activity rolling into the pipeline for future periods. So we're very optimistic that that trend will continue. I think a lot of that is just supported by strong economics and the footprint we operate in. Our markets are continuing to do well. Our clients are continuing to do well. And so as we progress towards the end of the year in the first quarter, we still are seeing quite a bit of new opportunity requests coming through the different markets. It's very spread across our geography. We're not really concentrated in any particular segment of our footprint. All of our markets are seeing good strong activity. And then on the payoff side, to Billy's point, we had a little higher volume of that earlier in the year than we've seen in really the past quarter. Might we have a few more coming in fourth quarter? It's always a possibility. We do have still a very robust real estate market in our footprint. So our clients are seeing opportunities to sell assets here and there. And so we do get payoffs from time to time, primarily from asset sales by our clients. But we still feel optimistic about these projections.

And then switching gears to the margin. Another really good result this quarter. You laid out an expectation for the NIM, I believe, of, call it, 3.10% to 3.15%. And I was just curious if that is a near-term fourth quarter projection or does that extend into 2025? And with that, if you could just give us a sense of what your Fed cut projections are as well as how you'd expect the deposit beta to trend as rates reduce?

Ron, do you want to take that?

Yes, our 3.10%, 3.15% margin is for the fourth quarter. As we said last call, our trajectory is such that we're expecting margin expansion throughout 2025 with or without a rate cut. With that said, we're looking at our rates up beta. We probably were in the 45%, 50% range. Our goal, we’ll probably see the same on the downward side. Well, at this point, we're modeling near 40% beta on the way down. We're not giving 2025 guidance, there's still a lot of variables and bouncing items but we still feel very strong about our trajectory going forward.

I wanted to start on fee income. And just obviously, really good quarter on swaps and investment product this quarter. Any thoughts on just the strength of those two items in Q3? And then obviously, with the guidance in the fourth quarter, were those kind of onetime nature transactions or just any thoughts on those businesses specifically going forward?

I'll begin and then pass it over to Ron to discuss the distinction between one-time and recurring items. From our perspective, the investment side has performed exceptionally well. Over the past couple of years, we've successfully added skilled financial advisers to our platform and are getting them aligned with our strategies. We're observing consistent growth in our SmartBank investments group, and we've effectively integrated that into our private banking pipeline, leading to an increase in assets under management. Additionally, we've shifted towards a fee-based approach rather than a transactional one within that sector. We're optimistic that this trend will continue, especially with favorable market conditions. Overall, we remain positive about the investment side moving forward. Now, I'll let Ron elaborate on swaps, as his expertise lies primarily in the capital markets. This area is slightly influenced by interest rates and the movements of certain curves, which can affect the length of terms for securing attractive fixed rates. Ron, would you like to share your insights on swap fees and what we might expect in the future?

Right now, we did tame down our noninterest income projection. We did have an excellent third quarter. Swaps for Q3, we had a lot of opportunities due to our loan originations and the shape of the inverted yield curve led us to place more swaps. We won't be doing $1 million plus in Q4. We do have a pipeline but not as strong as what we've seen in Q3. So other than that, we don't see any other opportunities at this point that will really lead to a higher noninterest income as what we've seen in Q3.

Regarding deposits, can you discuss your efforts to increase core deposits in place of some brokered CDs? Additionally, have you already reduced deposit rates, and what are you observing in terms of competition in your key markets?

Yes, I'll address that and anyone else can jump in. I believe we've observed that we feel confident in our capacity to grow deposits. As I mentioned earlier, we experienced strong core deposit growth this quarter, although it was somewhat concealed by changes in our mix. Our sales teams are doing well in attracting funds across both sides of the balance sheet. At the start of the year, we had a favorable liquidity position, which we have been able to utilize in 2024 while looking ahead. We aim to maintain a balance in growing deposits while being mindful of the prevailing rate environments. Currently, we notice some instances of elevated pricing from certain competitors, but overall, many markets appear to be stabilizing. This allows us to lower our rates. We anticipate being able to continue this trend if the Federal Reserve implements cuts. Our focus will be on achieving growth while maintaining appropriate rate levels. Ron, do you have any insights on the day-to-day deposit pricing efforts that you’re overseeing?

Yes, we think we're finishing up on the deposit promo now. We took the opportunity to lower some of our high-tier deposits, and we didn't get much client pushback. Again, we are really still in market rates. Our reductions are roughly in line with Fed cuts and we haven't really got much pushback on that. And again, the momentum of the sales team on where deposits are coming from is pretty positive.

And Brett, I want to add that we've been discussing this a lot while we begin our forecasting for 2025. We're committed to maintaining our focus on this and enhancing our incentive plans. We remain quite optimistic as our team members, particularly the bankers we've brought on board, grasp the importance of selling across both sides of the balance sheet. I'm also really pleased with how this is progressing and the outlook we see ahead.

Starting on loan pricing here. Just kind of curious, we've had a fair amount of volatility in the five-year and obviously, expectations around more Fed rate cuts. Curious as to where you're seeing new loans priced today and any color you can give there?

I'll start and then guys, just any anecdotal color you can give. Obviously, with the cut, we've seen a little bit of a reduction in ongoing yields. Overall, we're doing a pretty good job of holding the right levels. I think, obviously, competition is going to impact that. The Fed cut had a little bit of an impact. So we're seeing especially the variable rates, pricing on spread, the variable numbers are coming down a little bit. But overall, we think we continue to hold reasonable levels. Ron, I don't know if you've got any color on kind of what you're seeing kind of going on here just in the last few weeks, but a little bit lower, I think, but overall, still pretty solid.

Yes, as I referenced for the quarter, originations were in the 7.40 range. But for September, we're probably 10 basis points less. So we'll probably see that. I do believe for probably the remainder of the quarter, we should probably see an above 7% range. So we'll see a little bit of decrease in rates, but not looking at much at this point in time.

We're currently finalizing our forecasting and budgeting for 2025. We're focused on ensuring growth, and while we anticipate some overall costs due to inflation and contract increases, we expect these to be minimal. The main increases we foresee in 2025 will likely be related to talent. Overall, we believe we can manage our expenses within a reasonable range as we prepare for 2025, allowing the balance sheet to adjust with rates and let the lower-rate assets mature and amortize. Looking ahead to the latter part of 2025, and even into 2026, we are optimistic about our operating leverage. Ron, do you have anything else to add?

No, you covered everything. I view it as a percentage of expense to net revenue; we will be creating operational leverage throughout 2025 and beyond. Operationally, we are in excellent condition. As you mentioned, it's all about our ability to execute.

Good quality bankers are always being recruited and welcome.

I think that's an excellent point, Miller. Steve, we are indeed very selective in our recruitment, as we have always been, and we will continue that approach. We are constantly on the lookout for great opportunities to bring in individuals who align with our culture. We have had some success in that area this year, and I believe we can keep that momentum going forward. Therefore, we will continue to invest in key talent.

I guess, on the financial side, just moving forward, you talked about a lot of any potential expense growth would come from new hires, which obviously should produce revenue as well. Is it fair to think about expense growth similar to the last couple of years, like 6%, 7% range? Again, I know you're not trying to give guidance. But is that just kind of a fair ballpark of what the franchise should trend towards over the long term?

Ron, do you want to kind of put your thoughts around that?

Yes, exactly that. Probably 5% to 7%, that's a good goal, a good range for that.

And then on the CRE concentration, I think if I was looking at that correctly, maybe up to 288%. Does that limit potential CRE growth from here at all or does it make you push into other verticals more so than you would have up to this point? Just curious if that's a headwind at all to future growth.

We've taken the advantage to add some good real estate loans to the portfolio over the last couple of quarters and we see that. I'll let Rhett give some color there, Stephen. But yes, overall, I don't view it as a headwind. Obviously, when we're doing that and we have we're going to continue to do it. We want to make sure that it's not transactional real estate that it's full relationship type of CRE lending, which we've been able to do and, again, making sure it's priced accordingly. But Rhett, do you want to give any color kind of on CRE growth? I think we anticipate having a little bit more of that and we see a little bit in the pipeline. Do you want to give any feedback?

Yes, I would say that we probably will see the metric tick up a little from where it is here today. And we do certainly focus on managing that within the Fed guidance; that's always been a target of ours. And some of the growth is just the timing of different projects. We do have projects that we'll be completing funding and then either paying off as they sell it down or eventually transition out. So we are, I would say, maybe a little bit of back-filling there, knowing some of the projects that will transition out of the buckets in the near term. But I do think we'll still continue to see activity. The other upside there is because of the opportunities that we're seeing in space, it also adds to our ability to continue to be very staunch in our credit standards. I mean we're picking the best apples on the trees, so to speak, on the opportunities we're funding. So we feel very good about what we are putting.

And then just the last thing for me. I know we've talked about in the past and past calls, trying to reach towards a $50 million operating number for Q3 '25 in that range. Given the current environment, maybe where the Fed has moved, do you think there's any sort of timing impediment to getting to that number or do you still think that's an achievable path forward in the medium term?

Yes, I definitely think so. As we forecast, if rates remain stable, it could present a slight challenge. However, the $50 million revenue target we mentioned publicly is still our goal for the end of next year, and we feel positive about it. We need to keep executing on leveraging our balance sheet and increasing loans and deposits. Currently, I don't see any factors that would lead us to modify our target dates.

I wanted to get into, kind of, the net customer gains you've had this year because it clearly seems that you're picking up market share if you look cumulatively over the last three, four quarters. And just kind of curious on how you see that and kind of how that can evolve the next year?

Yes, that's a great observation, Chris. We are indeed continuing to gain share across all these areas. Much of this success stems from our sales efforts, which we have worked hard to enhance. The strategies we implemented throughout this year are beginning to yield results. We're actively assessing all our markets and regions to identify targeted clients. Some of the sales cycles may be lengthy, but we are diligently pursuing clients who are not currently in our pipeline, and we feel optimistic about including them in our pipeline by 2025. Therefore, you can expect to see our markets continue to gain share and grow. Rhett mentioned an important point: this growth isn't solely from new clients. We've invested significantly in several newer markets over the past few years, and those areas are performing exceptionally well. Our established markets are also holding strong. As we continue to strengthen our brand and franchise in these markets, especially given our current scale, we believe we can approach various situations from a position of strength. This is proving beneficial for us, and I am confident that we can keep gaining share.

Christopher, I appreciate you mentioned that and calling that out, because we have done a good job of client acquisition, and working on clients on the sales side gets a lot of credit. But I want to give a thank you to the ops side, because the sales side couldn't do what they do with the scale they do without that op support and supporting them tremendously. But it's a great team effort for sure.

Yes, the situation in several of our Upper East Tennessee counties is quite dire. While we don't have offices in those areas, we do have clients there, and we are observing some of the peripheral impacts. From our perspective, we don’t expect any direct consequences. I initially thought we might experience some direct effects, and we did have some delayed payments, which led to a slight increase in past dues due to these issues as we approached the end of the quarter. Moving forward, our focus will be on how to support the ongoing efforts in that region. I spoke with a client foundation yesterday that is actively working there and has made their fundraising efforts very public. They have successfully partnered with several great fundraising organizations over the past few weeks. Our role will primarily be to help facilitate these initiatives. From a balance sheet viewpoint, we might see a bit of short-term deposit growth from these funds, but thankfully, that money will be directed back to assist those in need.

I want to ask a follow-up about the margin. Your repricing schedule slide is very informative, and it seems we can analyze the loan yields from that. Regarding the deposit cost, I appreciate your insights into the cumulative beta being around 40% over the cycle. Could you provide any near-term commentary on deposit costs, particularly where spot rates stood at the end of the quarter and what you are observing in specific deposit categories with the first 50 that adjust?

Ron, do you want to jump in on what we saw during that first cut and maybe some spot rate color?

We've managed to take a step back. Our deposits are 24% of our deposit base indexed to an index. The remaining 14% is an internal index. So we have about 40% of our deposits that will move with rate changes, and we achieved that without facing much pushback. We expect to continue this as we move forward. Much of this is market-driven, and we need to pay attention to our competitors and their pricing strategies. Right now, we plan to apply the same approach going forward, managing and monitoring our customer accounts to ensure outflows do not occur due to rate changes. Overall, I believe we are in a solid position moving forward, particularly if there are rate cuts, to maintain our deposit portfolio's stability. Our new production for September was 3.81% but that did include broker deposits. So it was 3.81% without brokered deposits, so I think as we ramp some promos near the end of September from the relationship exit. So I don't have any spot rate going forward, but we are seeing the deposit rates going down accordingly.

And just given the amount you have indexed, would it be fair to model that 40% beta to show up pretty quickly, or how much of a lag do you feel like is in that?

No, we will show pretty quick on that, they will not be alive with that 40%.

Thank you very much. That ends our Q&A session. We do not have any more questions, so I will hand back to Miller for any closing remarks.

Thanks, Ezra. We appreciate each of you, investors, analysts, and associates, for your continued support. We look forward to finishing '24 strong. And feel free to reach out to any of us if you have any further questions or comments. Have a great day.

Thank you very much, Miller. And thank you, everyone, for joining. That concludes today's call. You may now disconnect your lines.