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Edited Transcript of SMBK.OQ earnings conference call or presentation 29-Apr-20 2:00pm GMT

Q1 2020 SmartFinancial Inc Earnings Call

Chattanooga Jun 17, 2020 (Thomson StreetEvents) -- Edited Transcript of SmartFinancial Inc earnings conference call or presentation Wednesday, April 29, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Rhett D. Jordan

SmartFinancial, Inc. - Executive VP & Chief Credit Officer of SmartBank

* Ronald J. Gorczynski

SmartFinancial, Inc. - Executive VP & CFO

* Wesley Miller Welborn

SmartFinancial, Inc. - Chairman of the Board

* William Young Carroll

SmartFinancial, Inc. - President, CEO & Director

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Conference Call Participants

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* Feddie Justin Strickland

Janney Montgomery Scott LLC, Research Division - Associate

* Joseph Anthony Fenech

Hovde Group, LLC, Research Division - Managing Principal & Head of Research

* Kevin Patrick Fitzsimmons

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning. Welcome to SmartFinancial First Quarter 2020 Earnings Conference Call. (Operator Instructions)

Please note that this event is being recorded. I would now like to turn the conference over to Miller Welborn, Chairman. Please go ahead.

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Wesley Miller Welborn, SmartFinancial, Inc. - Chairman of the Board [2]

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Thanks, Kate. Good morning, and thanks for joining us today for our Q1 2020 earnings call.

Joining me today are Billy Carroll, our CEO and President; Ron Gorczynski, our CFO; and Rhett Jordan, our Chief Credit Officer.

Before we get started today, I'd like to refer all of you to Page 2 of our deck for the normal and customary disclaimers and forward-looking statements comments. Please take a minute to review these.

I'd also like to start today by just saying thanks, and that's not a trivial or cursory thanks, but a very sincere thanks to multiple groups of people. First, our team of associates here at SmartBank have put in incredible efforts over the last 60 days, and it's appreciated. To our clients, for their patients as we've juggled hours of operation and a multitude of business challenges, and also to our shareholders and investors for your continued patience and confidence in this team here at SmartBank. To all of you, thank you, thank you, thank you.

Several highlights I'd like to touch on, and then I'll turn this over to Billy to jump in some of the details. First, our net interest income for the quarter was up $1.5 million, strong interest income. Also our earnings for the quarter were very strong. We're very proud of the earnings we have. Our loan growth, we had $99 million of originations this quarter for a net $54 million in organic loan growth, 11% annualized loan growth, strong for the quarter. We closed our progressive transaction on March 1. Great to have that team on board. And finally, our asset quality remains very strong with NPAs at just 31 bps.

We're poised to not just weather this storm, but to be stronger as a result of it and also to gain market share in the quarters ahead as we have really helped a ton of businesses in our markets that other banks either didn't help or wouldn't help with its PPP process.

With that, I will turn it over to Billy to dig in.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [3]

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Thanks, Miller. I'll give some macro level color on the quarter, and then I'm going to hand it over to Ron and then on to Rhett to take a deeper dive into both the financials and the portfolio.

First, a very solid quarter for our company with continued steady organic growth on top of closing our Progressive Financial Group deal, both of which will continue to benefit our financial metrics moving forward. The Progressive transaction is a great addition and solidifies a presence for us in the upper Cumberland region in Middle Tennessee and provides great density addition between Knoxville and the Nashville MSAs. We'll be converting and rebranding this team in early May and are excited to get them integrated.

Obviously, the start to 2020 has been overshadowed by COVID-19, and our SmartFinancial team has really stepped up and handled this situation unbelievably well.

Referencing Pages 5 and 6 of our slide deck, I'm not going to walk through all of this, but we thought it was important for you to see what we've been tackling over the last several weeks as this pandemic took shape. We've been handling this crisis with a great process, coupled with a great passion for our clients, associates and communities. There are some great detail on these slides. So please take an opportunity to review. But bottom line, we've handled this just as Miller and I, our Board and our shareholders would have expected very, very well.

As with most of our peers, these last several weeks have been a lot about the Paycheck Protection or PPP loan production. Rhett will walk through this in a little more detail in a second. But unbelievable work from our team in this program, producing over 1,600 loans totaling $239 million just in round 1.

We have viewed this program as a great opportunity to help our clients, our communities and our company, and we've excelled on all fronts.

Looking at the round 1 pool of $350 billion of banker size would have had a fair share number, somewhere around $50 million. We did almost 5x that amount, just a phenomenal amount of hustle by our SmartBank team.

I'm going to transition now into a few numbers. First, as we reported, we had a $4.3 million net operating income quarter, which included about $2.5 million in COVID-related reserve build that Ron will speak to more in just a moment, and a $2.7 million earnings quarter related to GAAP net income. That equates to $0.30 and $0.19, respectively, per fully diluted share.

Transitioning into the deck, I'll touch on Slides 8 and 9, as we took the opportunity to prudently build the reserve with the uncertainty in our economic environment. I wanted to focus on Slide 8, our pretax, pre-provision numbers. For a better measure of our steady growth. As shown here, a really nice quarter-over-quarter trend. And outside of the COVID-19 related reserve builds are right on track.

Slide 9, you see margin holding really well despite rate cuts during the quarter as well as a flat efficiency ratio as we look to get the Progressive integration done here within the next couple of months. So all in all, results that we're really proud of.

And I'm going to stop there. And I'm going to turn it over to Ron for a dive into the financials, and he'll hand it to Rhett to jump into portfolio in credit, and then I'll close with a few additional comments. So Ron?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [4]

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Thanks, Billy. Good morning, everyone. As Billy had mentioned, wow, what an eventful quarter. In the midst of all this chaos, our teams continue to remain focused on the Progressive acquisition and scheduled conversion next weekend.

Let's start with Slide 10, balance sheet trends. As you can see, we have continued our steady ramp. Along with our legacy growth, the Progressive transaction provided us with $300 million in assets, approximately $190 million in loans and $270 million in deposits. Our tangible book value had increased 8% year-over-year. In comparison with the prior quarter, and due to the acquisition, we did see a slight decrease in our tangible book value, which was modeled and anticipated, and we are looking forward to continue our offered movement in our book value. Moving on to net interest income on Slide 11. We continue to have increases in our average earning assets and liabilities as our company grows, which includes 1 month of Progressive.

We have had another solid quarter of net interest income and net interest margin. Our net interest income for the current quarter was $22.7 million, an increase of $1.5 million from the prior linked quarter. Our tax equivalent net interest margin for the current quarter was 3.90% compared to -- compared to 3.84% for the prior linked quarter, a decline of 6 basis points.

Let me give you some color on some of the components. For our interest-earning assets, our yield on average loans was 5.35% for the current quarter compared to 5.36% for the fourth quarter. Loan yields, less accretion, for the current quarter was 4.98% compared to 5.07% for the fourth quarter, a 9 basis point decrease. This decrease was primarily due to market competition and, to a lesser extent, the Fed emergency rate cuts. Offsetting this decrease was the impact of accretion.

Accretion for the current quarter totaled $1.8 million, an increase of $465,000 from the prior quarter and added over 8 basis points of yield to the loan portfolio. Accretion for the quarter was escalated due to the closing of a loan pool, which caused any remaining discounts within that pool to be immediately recognized.

Currently, our loan portfolio consists of approximately 37% variable rate loans or slightly over $800 million, of which $640 million of these have floors. At the end of the quarter, we had over $400 million of these loans that had hit the floors. We will continue to experience a decline in loan yields as we move forward into the second quarter as we see the full effects of the March rate cuts, then expecting to see some stabilization after that.

Our liquidity investment portfolios have also experienced declining yields due to the current interest rate environment. This negatively impacted our margin 5 to 6 basis points.

For our interest-bearing liabilities, our interest-bearing deposit cost decreased 19 basis points to 1.10% for the current quarter, and our overall total cost of deposits decreased 15 basis points to 0.91%.

During the quarter, we shifted $100 million out of broker deposits into more advantageous wholesale funding provided by the FHLB and the Fed discount window. Overall, we still see opportunities for further rate reductions largely in our time deposit portfolio. We have approximately 25% of our time deposits, both retail and brokered, maturing and repricing during the second quarter.

Given the rate -- given the movement in rates from the Fed cuts, our pricing committee did an awesome job in lowering our cost of funds in our money market and CD portfolios, and we should see our deposit costs trending further downward during the second quarter.

Going forward, our forecasted margin for the second quarter is 3.55%, 3.60%, which includes an estimated 10 to 15 basis points of accretion.

Moving on to Slide 12. Operating noninterest income. We had a great quarter for operating noninterest income. We experienced over 30% increase from the prior linked quarter and over 65% increase when compared to the first quarter of 2019. Our operating noninterest income to average assets reached 44 basis points, a nice increase from our prior quarter.

Some of the component highlights. Mortgage banking, as expected for Q1 has set all-time production levels of $584,000 due to the current low rate environment. We have a strong pipeline coming into Q2, but we may encounter some headwinds with the COVID-19 slowdown.

Our investment services income increased over 65% when compared to the prior quarter, primarily from strong production and benefiting from 2019 hiring that was done. Our new arrival to noninterest income is insurance commissions. As part of the Progressive acquisition, we have acquired an insurance agency that services the footprint of Middle Tennessee. We are excited to have the opportunity to extend insurance offerings to our entire SmartBank footprint and look forward for this to be a meaningful noninterest income component in the future.

Going forward, our forecast for the second quarter is having noninterest income at 42 basis points of average assets or $3.1 million.

On Slide 13, you'll find our operating noninterest expenses. For the sake of time, I'll keep this slide at a high level. Our operating expenses have remained steady with some slight elevation during the current quarter, primarily from the Progressive acquisition and, to a lesser extent, overall growth of the company.

Additionally, when comparing to the prior quarter, be mindful that during the fourth quarter of 2019, we had various tax credits that were recorded and not repeated during this quarter.

Going forward, we should see additional efficiencies after the second quarter from the completion of Progressive's core system conversion and integration at the SmartBank. Overall, our noninterest expenses were in line with our internal expectations.

Going forward, our forecast for the second quarter is having noninterest expenses around $17.5 million to $18 million, with salary and benefit expense, approximately $10.8 million to $11 million.

Before we progress forward to the next slide, let's touch base on income taxes. During the current quarter, we took advantage of recognizing some NOL carryforwards that were made available as part of the CARES Act legislation passed during March. These carryforwards were available from a few of our prior acquisitions.

For the quarter, our effective tax rate was 19.6%. Going forward, our forecast for the second quarter is for our effective tax rate to be in the 22%, 22.5% arena.

Our next Slide 14 gives details on our deposits. On the bar chart to the right, you'll see that our deposits have experienced overall steady growth with Progressive being the primary driver of growth for the current quarter. Deposits ended the quarter at $2.3 billion. Our deposit mix remained relatively stable, with noninterest-bearing demand accounts making up over 18% of our deposits.

The lower left portion of this slide shows our cost of total deposits decreasing 15 basis points from the linked quarter and decreasing 19 basis points year-over-year. As I previously mentioned, we will have opportunities to move our cost of deposits further downward.

With that said, I'm handing the slides over to Rhett Jordan, our Chief Credit Officer, to go over loan- and credit-related info. Rhett?

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Rhett D. Jordan, SmartFinancial, Inc. - Executive VP & Chief Credit Officer of SmartBank [5]

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Thank you, Ron. Beginning on Slide 15, you will see that we finished the first quarter with a portfolio distribution profile that has been very consistent for several quarters. Our overall loan portfolio grew by approximately $242 million for the quarter.

As Miller mentioned earlier, we realized $54 million in net loan growth organically, with the remainder attributed to the completion of our acquisition of Progressive Savings Bank in Tennessee. Our loan mix stayed pretty consistent even after the merger with approximately 80% of the portfolio in real estate secured loans further broken down as 22% in consumer real estate, 22% in owner-occupied commercial real estate and 37% in nonowner-occupied commercial real estate assets.

We ended the quarter with CRE capital ratios of 87% and 274% in the respective regulatory guidance segments, still very manageable, consistent with our positioning in recent years and well below the regulatory guidance levels.

Overall, a solid quarter performance led primarily by the merging in of a very complementary portfolio from Progressive Savings that help diversify our geography and improve the granularity of our portfolio with a post-merger average loan size of approximately $205,000.

Moving on to Slide #16. I as Billy mentioned earlier and as our counterparts throughout the industry will attest, the COVID-19 event has been a considerable challenge to manage through and has created significant disruption in the normal daily operations of many of our corporate and consumer clients as well as our bank itself. At the beginning of the event, our management team sat down with our regional credit and production leads and identified the segments of the portfolio we feel might be the most at risk to this COVID-19 disaster.

The result of that discussion identified 5 industry segments or subsets of our portfolio, we felt were at the highest risk of impact shown here on Slide 16. Representing approximately 18% of the portfolio, the typical operating profile of businesses in these areas we felt presenting considerable risk of both near-term severity and longevity of recovery from this interruption, thus requiring some heightened focus over the next several weeks and months to more closely monitor performance and expectations.

However, we still feel confident in our outlook because throughout the recovery cycle over the past several years, we have continued to maintain several key fundamentals in our portfolio management efforts, such as maintaining a diversified portfolio, both geographically and across segments, requiring hard upfront equity positions at origination in real estate transactions, strong market level leadership of both sales and credit with long time market familiarity, conservatively structured loan transactions for term, amortization and covenant maintenance and granular portfolio positions both regionally and whole bank with an average loan size of approximately $209,000.

We believe these key factors will success -- will make successfully managing through this event considerably more positive for our company.

As we referenced earlier in the presentation, we proactively compiled a series of payment modification options that we made available to clients very early in the life cycle of this event in an effort to provide us calming and effect on the near-term challenges as possible. Our lending teams reached out to clients in these aforementioned segments as well as other larger exposure relationships to offer words of encouragement and to let them know that SmartBank was here to help them in every way possible. This allowed us to very early on identify clients with direct impact to their business operations as well as those who are beginning to see some negative impact and expecting things to worsen as the closings and stay-at-home orders expanded.

As you can see on Slide 17, as the closures mounted across our primary 3-state footprint, the volume of request for payment assistance increased significantly, and by April 24, our number of accommodated transactions had grown to 629 with total balances outstanding of $509 million or roughly 21% of our total portfolio.

As expected, hospitality and food services clients have led the way in modifications, representing approximately 5% and 3% of loan portfolio balances, respectively.

We believe that our proactive assistance to our clients early on, coupled with those portfolio management characteristics I mentioned previously, will assist us in working through this exposure position successfully.

The other component of the COVID-19 event that has utilized considerable resources and significant time and focus has been the implementation of the Paycheck Protection Program segment of the Cares Act. Knowing that everyone on the call is intimately familiar with that program and its purpose and intent, I won't bore you with another dissertation and just go into our bank's involvement in the program. We viewed participation in the program as a significant opportunity to assist our clients, our community and our company and shareholders.

Looking at Slide 18. As of the completion of the first round of PPP funding commitments, SmartBank had processed and closed roughly 1,700 loan applications totaling $239 million. Of the applications we processed, our primary 3-state footprint of Tennessee, Florida and Alabama represented roughly 95% of total applications authorized. We processed 493 applicants combined across the 5 key impacted industry segments I mentioned earlier for just under 30% of the total applications. Ironically, we processed at least 1 application in each of the 20 primary NAICS code description segments. The mix of the loan amounts generated approximately $9 million in fees to the bank, a very tiring yet rewarding experience for our team, and we began submitting another 500-plus applications on Monday when the second phase of PPP funding commenced. We are continuing that process today and are cautiously optimistic we will get most of these applications submitted in the second phase.

Obviously, the COVID event has made predicting future credit metrics results challenging. But as you can see on Slide 19, through the end of the first quarter, our asset quality performance continues to track strong and positions us with a very sound base. Our NPA ratio was 0.31% of total assets at quarter end, up slightly from the Q4 2019 level based primarily on the inclusion of other real estate assets acquired through the Progressive Savings merger, but still about half of peer set.

Net charge-offs for the quarter were 0% and below peers as well. Our allowance measured 0.63% at the end of Q1 2020 and coupled with our remaining fair value discounts on the acquired loan portfolio, which totaled about 1.3x our allowance balance, our quarter end position provides us a very strong support to potential increases in credit risk metrics that may arise in the aftermath of the COVID event.

Now I'm going to turn it back over to Ron to talk a little more about the reserve positioning. Ron?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [6]

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Thanks, Rhett. Let's touch base on our reserves, Slide 20. There's much detail on this slide. We wanted to include some tabular information relating to our originated and acquired loans as well as the corresponding allowance and discounts. Just a reminder that we are on the incurred loss model. For the current quarter, our allowance for loan losses increased by $3.2 million or 31% from the prior linked quarter. This increase included an additional $2.5 million associated with the economic factors caused by the COVID-19 pandemic.

Focusing on the bold right-hand columns, our overall allowance of total loans increased to 0.63%. Our overall discount to acquired loans was up 3.33%. And with the combination of the allowance of discounts, our overall coverage to total loans is up 1.43%. We feel our coverage is at reasonable levels at March 31, and our allowance for loan losses is trending appropriately.

With all that said, we have recorded an appropriately sized provision this quarter, and we'll expect to record similar amounts as or if needed, going forward.

Moving on to Slide 21. This gives us a current snapshot of our capital position. Over the last year, we continued to maintain a solid capital position. During 2019, we initiated our first quarterly dividend, and during the first quarter of 2020, we started repurchasing our company shares from the open market.

During the current quarter, our acquisition of Progressive had minimal impact on our capital ratios.

Fast forward to today, as we took advantage of the share buyback opportunity, we are not currently active in buying back our shares at this point. We have also just declared another regular quarterly dividend to our shareholders.

As of March 31, 2020, our current capital position remains strong and well above the well-capitalized benchmark. With our strong capital ratios as well as our outstanding credit quality, we are well positioned to move forward into the COVID-19 environment.

Moving on to Slide 22, liquidity. We decided it was prudent to bolster our on-balance sheet liquidity by significantly increasing our cash positions and increasing our overall off-balance sheet funding sources. We also intend to fund the majority of the Payroll Protection Program (sic) [Paycheck Protection Program] loans with the Fed's PPPLF facility. We view this as an ideal funding match and provides relief for our regulatory leverage ratio.

And lastly, our earnings profile on Slide 23. Some good information here, but let's focus on the third bullet. Our overall revenues continue to increase quarter-over-quarter, year-over-year. We continue to provide sound building blocks as our company grows.

With that, I'll hand it back over to Billy.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [7]

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Thanks, Ron. Appreciate it, guys. To summarize, another quality quarter for us. And as you heard Rhett discuss, we've got a really good handle on the portfolio and the team will closely monitor it, staying in contact with our clients as their economies all start to restart. We feel good about our loan book, conservative LTVs, seasoned solid borrowers. The pace of the recovery will determine how that will play out, how long we will need to play a little more deepens than we normally would. But that said, we will continue to evaluate opportunities in this environment.

One opportunity was -- and we've touched on it a couple of times, the PPP opportunity was a tremendous one for us. Our quick response to the request, not only from our clients, but for a number of prospects that we had been quoting has been a real positive for us and should yield some great new relationships.

I can't tell you how proud I am of this team hearing the comments from our clients, seeing social media posts about how our hard work made the difference of whether they kept their staff on payroll. It's times like these when you solidify yourself as the bank in a market. And I think we did that in a big way in a bunch of hours.

Our company is positioned very well to handle the current environment and excel as our markets restart.

So I'll stop right there, and we'll open it up for some questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Fitzsimmons from D.A. Davidson.

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Kevin Patrick Fitzsimmons, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [2]

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It's Kevin Fitzsimmons, guys. So listen, I appreciate all the detail and all the -- and I do acknowledge the different basis that some companies are using for measuring and calculating the reserve, right? There's some bigger companies using and adopting CECL. You guys are not subject to that, and I don't blame you for not rushing in to do that. But I'm just curious about like internally, your own thinking about this, whether -- given how folks are so focused on reserves and capital as opposed to earnings, did you really debate or wrestle with the subject of using more of your healthy pretax, pre-provision income to bolster that reserve?

Just recognizing that optically, your reserve ratio looks low, right? You did make the point that when you take into account the purchase discount, that takes it up to a certain level. And that's just, I think, a factor of how you -- your company has been built up, right, with active M&A. But was that -- I'm just curious if there were a lot of -- was there back and forth on whether to put a bigger qualitative factor in there, deploy more of that earnings to get that up as opposed to -- I guess the approach is more of like we're going to base it quarter-by-quarter going forward based on what we see more in the near term in front of us.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [3]

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Yes. And Kevin, I'll take that, and then I'll flip it over to Ron and let him give some color. Yes. I mean, obviously, there was discussion around the COVID-related portion of that this last quarter. To me, and I think the consensus around our table was obviously, we want to recognize the fact that there's something going on, but there is still so much to be determined. And yes, we could have. We could have added more to it. But from our standpoint, and Ron will get into the detail related to our calculation and our qualitative factors, we felt like, at this time, what we did was prudent, obviously, could have done more. Obviously, with the capacity, the income tailwinds that we're going to have throughout the remainder of the year, yes, we'll have the ability to do more if needed. We just didn't feel like it was appropriate to overload in a time where we really don't know what the next month or 2 will hold. So...

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [4]

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You have to be able to justify and back it up.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [5]

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Yes. And I think, Ron, you might speak just kind of the analysis piece of how we measured it.

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [6]

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Yes. I mean, Kevin, we -- this was a challenging discussion. The incurred loss model was not meant to predict what had happened. CECL did. So when we came to quarter end, we were hamstrung by what do we report versus what we know is going to happen. We did take the opportunity to take advantage of more of the current unemployment, GDP growth, inflation, information and kind of what was going on in our forecast, but it was -- we had a healthy debate. And obviously, we expect our qualitative factors to increase through this quarter, not knowing where they're going to end by the end of the year. But I don't know if you need to know the pieces. I know you're familiar with the incurred loan loss model. But yes, we had a very healthy debate on this topic.

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Kevin Patrick Fitzsimmons, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [7]

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And I guess the way we should look at it at the end of the day is you're just -- it's being kept in capital versus being transferred to the reserve, right, which effectively is what CECL bus at this point in the cycle.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [8]

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Yes. And what you're -- we're saying is, you -- gosh, you looked at a lot more of the financials that I do, the ones I've looked at. It's just different takes. I think for us, yes. We -- at the end of the day, we feel strongly about our ability to manage our loan book through this, especially with the guidance we've been giving, the ability we've had to do some things through the regulators, to -- with some of these deferrals and interest onlys. And yes, there's just still so much uncertainty as to really how quickly the economy will restore. We just didn't think it was prudent to overload the reserve here in this first pool.

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [9]

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And we have -- those are thanks to the positive effects of the PPP money that in the numbers you will see.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [10]

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Yes. But to your point, yes, it's in capital, and as we said, we should have a nice earnings tailwind this year with some of the fee income. We've been able to kind of anticipate accumulating through these programs. So we've got the ability to add more as and when needed.

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [11]

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And Kevin, just to finalize some of our comments on this is that we started with a lower base. Our credit -- excuse me, our credit quality and our historical losses are so low, even though we're not as a percent of portfolio, similar to a lot of the banks, but our -- we started from a much lower point. So we -- again, we feel comfortable on the amount we put in for this quarter.

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Kevin Patrick Fitzsimmons, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [12]

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No, that's a good point, Ron. That's a fair point. You guys mentioned a couple of times, PPP is the way we should be thinking about this as the balances flow into average loans in second quarter, they flow out in the third quarter, it's dilutive to the margin in second quarter. And then does the fee, have you guys figured out whether -- are you going to have the fee come in through the margin, most likely in third quarter, maybe into fourth quarter? Is that how you see it playing out?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [13]

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Yes. The way we're looking at it, Kevin, is I think we will -- it'll definitely go through the margin. And probably -- more practical, it's probably going to be a fourth quarter event. I think the overload with SBA and everything else, we're kind of looking -- I think fourth quarter is probably more appropriate than third at this point.

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Kevin Patrick Fitzsimmons, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [14]

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Okay. And Ron, real quick. I think you had said the margin guidance for second quarter 3.55% to 3.60%. Can you -- what's the core margin versus contribution to -- oh, did you say 10 to 15 of accretion?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [15]

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Yes, 10 to 15 Yes. Yes, sir.

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Kevin Patrick Fitzsimmons, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [16]

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Is included in there?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [17]

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Yes, it is.

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Operator [18]

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Our next question is from Feddie Strickland from Janney Montgomery and Scott (sic) [Janney Montgomery Scott].

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Feddie Justin Strickland, Janney Montgomery Scott LLC, Research Division - Associate [19]

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Just curious, how the deferrals transition out into full pass rated credits and deteriorate to criticize. I guess what do you guys need to see to make that move? Are you going to be looking a lot of these deferrals at June 30? Will we see more of a reevaluation in third quarter? Just kind of wondering what the timing on that is. I know there's some regulatory guidance there, too. But if you could just elaborate.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [20]

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Yes. Rhett, you want to jump in on that one?

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Rhett D. Jordan, SmartFinancial, Inc. - Executive VP & Chief Credit Officer of SmartBank [21]

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Sure, I'd be happy to. Yes, Feddie, we basically took the approach of clients that requested modifications due to the COVID event. The way our internal risk rating alignment is set up, we have a watch category that we really have specifically in position for what we call short-term events of atypical type transactions that maybe create some, I guess, question as to future credit risk. And so we've taken the position as each client that we have talked with has requested a modification, we place those into our watch category for purposes of tracking. And then we are implementing a program with our relationship managers and our regional credit teams basically to all clients that have requested modifications, commercial clients that is, to basically do a monthly check-in, and we'll be updating some information at the account level and then reviewing that in our monthly credit management team meetings.

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Feddie Justin Strickland, Janney Montgomery Scott LLC, Research Division - Associate [22]

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Got you. That's helpful. And just one more for me. Just thinking about the new business opportunities. I know you guys said PPP led to some of that. Is there any more color you can give on that? Is some of that coming from frustration, maybe some customers who went to big banks and weren't able to get any traction with them on PPP? Is that driving some of the new customer relationships? I was just wondering if you can give a little color on that as well.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [23]

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Yes, that's exactly it. We -- this was really just a great opportunity for us on a number of those fronts. So like I said, there's a lot of the larger banks, in particular, just really struggled to get a lot of clients into a pipeline early. And so we -- our team, Greg Davis, our Chief Lender, put together an outstanding process that mobilized a team about 25 of our staff members that just started working right out of the gate. And so we were able to confidently go and get people into our pipeline.

So where they may have ran into a wall or didn't have a -- couldn't get a contact at of one the larger banks. We were able to say, yes, we would take that application and that really continued on for that 10-day process during round 1, and we were very successful. We were able to get really all of our clients that had completed packages through in round 1 plus a number of these prospects. And they've done the same thing in round 2. It's funny, just while we were sitting here, I got an e-mail that came in from a Knoxville CPA that we were helping a client of theirs yesterday, and got them into the pipeline, got them processed. And just a reply to heard me about thanks so much. I can't believe how quick you all work to get these things handled.

From now on, I'm referring all of our clients to SmartBank. So it's really just that type of information that we're getting really across the whole footprint. So I think a lot of it is -- and it's probably -- I think I know a lot of banks did a good job with this program. I just think we really took advantage of it as an opportunity to show how we can do business, and I think it will pay some nice dividends.

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Wesley Miller Welborn, SmartFinancial, Inc. - Chairman of the Board [24]

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Yes, I think it's a perfect example of what a good community bank can and should do. Great way for us to show our markets, a bank that's big enough to make a difference, but small enough to give that personal service. And our guys, we're not afraid to work 24/7 and push these through. They weren't going home at 5, 6, 7, 8:00 at night, and it will reap dividends for us down the road.

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Rhett D. Jordan, SmartFinancial, Inc. - Executive VP & Chief Credit Officer of SmartBank [25]

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We got quite a few of our nonclient applicants in our market areas came from referrals from our clients that we had helped. So it goes a long way as well, getting that getting that vote of confidence from the customers of our bank that we took care of them in such a fine way that they refer to those that weren't banking with us at the time.

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Operator [26]

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(Operator Instructions) Our next question is from Joe Fenech from Hovde Group.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - Managing Principal & Head of Research [27]

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Billy, just -- and Miller, I guess -- well, everybody, just on PPP, I know you just kind of touched on it again. The banks I've seen, they seem to have been all over this. Most of them have like a relative, either Fintech or technological or digital advantage or they were very active with the SBA previously as a preferred lender. You're saying it was more of a quicker response and an ability to mobilize more quickly. Was that it? Or were there other aspects to this that really drove the result? Just trying to kind of get a handle on it because it is just such an outlier in terms of the success you guys have had compared to other banks, really of any size.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [28]

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Joe, I'll tell you. We were -- we've done some -- we're an SBA preferred lender. We have not -- we've done a fair amount of that work. We did not have the automated online systems. I'll tell you, our work is just flat hustle. That's it. I mean our -- if their folks jumped on this team of 25 or 15-plus hour days for 10 straight days. I mean I think we took Easter Sunday off. I think that was it. And...

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Rhett D. Jordan, SmartFinancial, Inc. - Executive VP & Chief Credit Officer of SmartBank [29]

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Some took Easter Sunday off, not all.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [30]

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Some. I mean Greg stayed in it. But I'll tell you, it -- just hustle really was the difference in that and just really working our tails off to get those things through the...

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Rhett D. Jordan, SmartFinancial, Inc. - Executive VP & Chief Credit Officer of SmartBank [31]

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Yes. I'm not going to talk against any of the fintech because we obviously love fintech, but we looked at a couple of those and did some analysis and just decided to put together an internal program and buster tails and it's just downright hustle.

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William Young Carroll, SmartFinancial, Inc. - President, CEO & Director [32]

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Well. We weren't -- Joe, we weren't looking to really -- we wanted to keep this and we did. We kept it within our market. We kept it with our client base. We didn't really lever it to go outside of our zones. We use this to help our clients and then to also help some folks that we wanted to be our clients. And that's really where we put 100% of the focus. This round 2 as well. I -- we've really used this round. I had a number of relationships and some friends with some in nonprofit groups here in our East Tennessee region that a lot of smaller nonprofits that just couldn't figure out how to get into the pipeline in the first round and they -- I had a couple of those folks reach that to me, that word spread. I think we picked up 30 or 40, really quality, small nonprofits. Here in East Tennessee that we got into a pipeline. So we're also trying to build a lot of community goodwill on this and helping some of these businesses and nonprofits that just didn't have mechanism to try to help them, too.

So a lot smaller, a lot more granular in the second round, but I think we're probably building a lot of goodwill here in this second round as well.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - Managing Principal & Head of Research [33]

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Okay. No, that's helpful. And then, guys, is a simpler way to think about the PPP impact, roughly a 3% net yield on the overall balance and then a fair way to model it is to maybe assume that roughly 3/4 of the balance is forgiven, which means it's brought into income this year? Is that -- I know that's not -- whatever you say is not necessarily, I'm not going to take it as a prediction. From our standpoint, though, is that kind of a fair way to model it at this point?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [34]

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Yes. We kind of -- we're kind of looking at it. Yes, 3% is fair. I think we're -- I'm not sure we'll get to 75%. We're kind of looking at 70%. So you're right there. So yes, I think that is fair, but maybe 70% again, I don't know if we'll hit that 75% mark, but we'll see.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - Managing Principal & Head of Research [35]

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Okay. And then last one for me on the provision for what it's worth, what you all did seems largely consistent to me with the others that haven't adopted CECL. So I'm not sure there's a valid comparison at all with larger banks that have adopted CECL and the size provisioning may took. So I guess, with these deferrals and the guidance from the regulators, though, we're hearing it could be extended beyond the initial phase here. So you all might not see and all the other non-CECL adopters might not see problem assets enter into the problems phase until late this year. So specifically, can you give us some help on what are the key factors you'll kind of be looking to that will guide your reserve building over the course of this year?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [36]

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Yes. We use the national -- first we look at the national economic forecast. As I said, inflation, GDP growth, unemployment, that's going to be the fast-moving one. They're all rated. There's a nominal -- an aggregate rate we use for those. And then we compare it to our local forecast to make sure they're in line. If there's any deltas, we will take care of that. And then we jump into our loan portfolio specifics, whether it's concentration, loan-to-value changes, any type of, again, loan deterioration and some of the -- if there's any other regulation factors that come into play. So those are just a few of the components we use, but it's not one item that's going to drive our allowance. It's just a homogeneous amount of other qualitative factors that are rated. So yes, it will obviously -- next quarter, it will go up, our qualitative factors, the amount of reserve. Now where it goes from there, I guess, it's meant to be seen.

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Joseph Anthony Fenech, Hovde Group, LLC, Research Division - Managing Principal & Head of Research [37]

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Okay. And what was the date, Ron, roughly where you had the cutoff to determine the full factors for the first quarter?

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Ronald J. Gorczynski, SmartFinancial, Inc. - Executive VP & CFO [38]

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I think it is -- Yes, we did use 3/31. We probably got into a little bit of April. Like our unemployment rate that we used was 5.1%, little bit higher. So really slightly right after the end of the quarter because we had to close up and go forward. I think the national -- I don't even know where the national unemployment rate is today. It's probably north of that. But so I would say week after -- first week of April.

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Operator [39]

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At this time, we have no more questions. So it concludes our question-and-answer session. I would now like to turn the conference back over to Miller Welborn for closing remarks.

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Wesley Miller Welborn, SmartFinancial, Inc. - Chairman of the Board [40]

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Thanks again, Kate. We appreciate you joining today, I will say. And again what great energy we have as a team, lots of effort in all our departments. We're continuing to be engaged and involved not only with our clients but helping a ton of small businesses in our market. And I can't emphasize enough, a point Ron made earlier about tangible book value growing 8% year-over-year. We feel like that's very strong. We will continue as a team and as a Board to work and strengthen this company every day. That's not most days or some days, but every day. We're going to get up in the morning and make this bank stronger, and we appreciate you joining us today. And talk to you soon.

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Operator [41]

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