SmartFinancial, Inc. (NASDAQ:SMBK) Q1 2023 Earnings Call Transcript
SmartFinancial, Inc. (NASDAQ:SMBK) Q1 2023 Earnings Call Transcript April 25, 2023
SmartFinancial, Inc. beats earnings expectations. Reported EPS is $0.68, expectations were $0.6.
Operator: Hello. And welcome to the SmartFinancial First Quarter 2023 Earnings Call. My name is Elliot, and I will be your coordinator for today’s call. I would now like to hand over to Nate Strall with SmartFinancial. The floor is yours. Please go ahead.
Nate Strall: Thank you, Elliot. Good morning, everyone. I am Nate Strall, Director of Corporate Strategy, and thank you for joining us for SmartFinancial’s first quarter 2023 earnings conference call. During today’s call, we will reference the slides and press release that are available within the Investor Relations section of our website, smartbank.com. Chairman, Miller Welborn will begin the call followed by Billy Carroll, our President and Chief Executive Officer; Ron Gorczynski, Chief Financial Officer; and Rhett Jordan, Chief Credit Officer will also provide commentary. We will be available 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 results to differ materially in our press release and 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 April 24, 2023, with the SEC. And now, I will turn it over to Chairman, Miller Welborn to open our call.
Miller Welborn: Thanks, Nate. Good morning to all of you and we appreciate you joining us today for our Q1 2023 earnings call. We are excited to be on the call this morning to visit with each of you about our bank. We continue to make great progress on all fronts and execute better every quarter and deliver quality shareholder returns. We thank you for the interest that you have in our progress and it’s important for us to hear your questions, comments and feedback. The first quarter of this year has been an interesting and challenging quarter for the banking industry, but at the same time, a very rewarding quarter for our company. SmartBank has been very focused on our clients, and we have had hundreds, if not thousands, of conversations with our clients and others in the communities we serve.
These conversations have allowed us to tell our SmartBank story and also to share with others about the strength and the importance of the community banking system in the Southeast. We are very proud of what we were able to accomplish for the quarter. Our Q1 2023 versus Q1 2022 increase in earnings for the bank was strong and I also believe we executed much better than most of our competition for the quarter. I am proud of the entire team for the focus and continued improvements we have made this quarter. With that, I am going to turn it over to Billy.
Billy Carroll: Thanks, Miller, and good morning, everyone. Well, what a way to start 2023 for our industry. But as I tell our team all the time, challenges can open a lot of doors, and I believe, as you will see as we walk through the state of our company, SMBK is positioned well to navigate the current environment. Rhett and Ron will dive into the details on credit, balance sheet and earnings momentarily, but I wanted to hit on some key numbers and some key points to open our call today. We had a very solid quarter to start the year. You can refer to page three of the deck for some of those highlights. We reported $11.5 million in operating earnings, equating to $0.68 per share, noting year-over-year revenue growth of 15%. Our balance sheet growth was solid for the quarter, growing deposits, $152 million or 15% annualized and loans $53 million or 7% annualized.
We experienced some of the same pressure on NIM as many of our peers, as some competitors were forced to push deposit rates higher than we really wanted, but we stayed competitive on those clients and didn’t allow funds to move for clients we deemed core. All in all, I felt we held our own as it relates to deposit betas. I also felt extremely good about us finishing the quarter with no borrowings or additions to brokered funding. Prudent use of those funding vehicles is absolutely fine, but to go through a quarter like our industry has and for us not to tap either shows the strength we have built in our balance sheet over the last several years. To that point, our model is showing its value in a time like this. We built this company through acquiring some great core funded community banks with nice granular deposit bases over the last several years and we have coupled that with strong commercial banking talent obtained through lift outs in recent years.
We have a unique ability to pivot and the lean on strengths of both strategies in a time like this. We have also got some great balance sheet flexibility with about 36% of our bond portfolio coming back to us in cash in the next 18 months. This is a huge reinvestment in earnings opportunity that Ron will discuss in a moment. Our credit quality remains outstanding with NPAs maintaining at 11 basis points and we continue to feel very good about our loan book. There’s been a lot of talk about CRE and office exposure of late. There’s minimal office exposure in our book and what we have is strong, leveraged appropriately with outstanding positions. I don’t think I would trade any of them, well, maybe except to reprice a couple with today’s rates, but Rhett is going to dive into this more in a moment.
As you can see on pages four and five in our deck, we operate in some of the country’s best markets with great growth opportunities and population inflows. That, coupled with our historically strong credit culture, gives me great confidence in the strength of our bank. As a wrap opening comments, a couple of other highlights for the quarter. First, we merged their two insurance agencies and converted them into a common core system. We rebranded the agency SBK Insurance to capitalize on our company’s strong brand position, but still to maintain independence and autonomy. I remain extremely excited about the future of this business line and we are now synced up and ready to grow. Our Fountain Equipment Finance subsidiary continues to perform very well.
We increased our outstandings in that line of business to over $128 million up from the $55 million when we acquired it back just a couple of years ago and recently added new team members in Birmingham and Atlanta. Lastly, we just announced the addition of an outstanding group of financial advisers in our SmartBank Investment Services team in our Dothan, Alabama market. Dothan has been a great market for us from a commercial and private banking standpoint and this investment team is a great addition. Our wealth program now has over $1.2 billion in assets under management. All in all, a really good start to the year. So let me hand it over to Rhett and then on over to Ron to dive into some details and I will close with some additional comments in a moment.
Rhett?
Rhett Jordan: Thank you, Billy. For the first quarter of 2023, the bank saw total loans and leases grew at roughly a 7% quarter-over-quarter annualized pace. As you can see on slide six, the portfolio mix saw very little change with total loans outstanding of just under $3.3 billion. Average loan yields continued to rise for the latter half of the year in 2022 and we saw that continued yield improvement through first quarter. As we ended the reporting period with average portfolio yield at 5.57%, our strongest quarter yield since 2018. Improved interest rates on new loan production and renewals, coupled with our short-term variable rate loans continuing to generate stronger yields were all contributors to this improvement. Slide seven shows a balanced and diversified commercial real estate portfolio as well.
Non-owner-occupied non-construction represents 27% of the bank’s total portfolio with our largest segment concentration continuing to be in the hospitality sector, representing roughly 33% of all non-owner-occupied loans. As Billy referenced in his opening remarks, office space is a segment of the sector that has had considerable question about long-term viability and pressure on occupancy rates in a post-COVID business operation environment. However, our office segment represents a very manageable 14% of the overall non-owner-occupied CRE portfolio. This limited segment is also well diversified across our geography and very granular and scale. None of our geographic regions represent more than 30% of the office portfolio exposure with the average loan size being roughly $1 million.
We have a diversified tenant profile across the portfolio as well with our largest segment being medical offices at 36% of the segment. The relationships on solid debt coverage profiles, very strong performance and an average loan to value across the space of just over 50%. In the construction segment, the space is also very strongly diversified by product segment and by geography with no more than 32% of the segment held in any one of our geographic regions and an average loan transaction for approximately $450,000. As we stated previously, we feel very comfortable with our positioning in the CRE space, as we believe the risk profile of our portfolio has continued to demonstrate solid performance and our overall credit metrics are strong with only 0.19% of the CRE segment balances impacting the over 30-day past dues position for the quarter end and 0.20% of the CRE segment balances carrying a classified risk rate.
As the next slide indicates, our portfolio of credit quality was consistently strong quarter-over-quarter. While we did see some slight increases in some of the metric balances over fourth quarter 2022 results, a large portion of that was the result of transitioning our allowance method to the CECL model and the subsequent loss of applicable credit discounts in the acquired loan pool, as well as transitioning a few former PCI loans into a non-accrual classification in conjunction with the applicable accounting change. But despite these slight dollar increases, slide eight shows solid performance amongst our core asset quality metric ratios. NPAs past dues and classified loans to total loans are all in line with fourth quarter 2022 and consistent to our metrics throughout last year.
Our CRE portfolio ratio has continued their downward quarter-over-quarter trend from 2022 and we continue to see the segment below regulatory targets in both total and C&D segments. Overall, our first quarter loan production was lower than recent quarters as predicted, but credit quality metrics continue to hold steady. We are cautiously optimistic about the near-term outlook and believe that should the economic challenges that are forecasted to become reality. Our footprint’s regional outlook is expected to perform above average compared to other parts of the country. We believe that will be beneficial to our client base and navigating the next few quarters which, coupled with our conservative historical underwriting standards, will keep our portfolio performing strongly.
Now I will turn it over to Ron to talk to our allowance, deposit portfolio and additional earnings details.
Ron Gorczynski: Thanks, Rhett, and good morning, everyone. Let’s move forward to slide nine, our allowance for credit losses. On January 1st, we officially adopted CECL. In conjunction with the adoption, we added $8.7 million to our allowance, increasing it to $32 million bringing our ACL to total loans to 0.99%. Additionally, we had $10.2 million of fair value discount that was transferred to an unamortized fee account, which will be subsequently recognized over the life of the loans. We also recorded a $3.1 million unfunded commitment liability. The adoption resulted in a reduction to equity net of tax of $6.6 million. On to slide 10, our deposit portfolio increased by $153 million or over 15% annualized for a quarter ended loan-to-deposit ratio of 78%.
This impressive growth is directly attributable to the deep client relationships built over time by our outstanding relationship managers even as we have continued to be judicious in our approach to raising deposit pricing. That said, significant pricing competition from less local competitors has caused rates to increase quickly. Our total deposit costs increased 71 basis points to 1.56% for the quarter and was 1.76% for the month of March. We do anticipate this upward pricing pressure to continue, albeit at a more moderate pace throughout the remainder of the year. On slide 11, we provide a detailed look at the composition of our deposit portfolio. A few takeaways we would like to highlight. Our average deposit account balance is $39,000, spread across approximately 87,000 accounts with our average commercial and consumer account balances being approximately $103,000 and $23,000, respectively.
Approximately 74% of our deposits are either guaranteed or collateralized. We have approximately $964 million in public funds, of which $550 million is guaranteed through reciprocal deposit programs and the majority of the remainder is collateralized by pledged securities. And lastly, our total reciprocal deposits totaled almost $800 million, which includes the $550 million of public deposits previously mentioned. Overall, we are extremely fortunate to have such granularity in our deposit base as we have intentionally built our business around serving the needs of a diversified range of clients across a broad spectrum of industries and geographies. Moving on to slide 12, in light of the recent events, we have added some additional information regarding our liquidity position.
We currently have over $1.6 billion of liquidity, consisting of cash, unpledged securities and collateralized lives of funding available from the FHLB and discount window, representing over 1.4 times coverage of our uninsured deposits. More broadly, during 2021 and 2022, we adopted a conservative approach to deploying excess liquidity, opting to hold cash in short-term securities to fund future loan growth rather than deploying to longer term securities. While this approach was to the detriment of our short-term earnings, we are now, unlike many of our peers, not beholden to a large underwater securities position. Instead, we now have sufficient funding without the need for costly borrowings or wholesale funding. On slide 13, at quarter end, our securities portfolio was at $880 million with a 69% AFS, 31% HTM mix of securities, an effective duration of 3.1 years.
Our strategy to invest in short-term in 2021 and 2022 is now set to provide significant earnings tailwinds as over $307 million of principal will be returned to our balance sheet over the next year. This $307 million is currently yielding 1.8%, redeployed at a current market rate of 5%, results in earnings stack of over $9.8 million in additional revenue. On slide 14, you will see that this quarter, we had an increase in both cash and more notably, securities. As one may think, why are we buying securities at this point of time, simple, we took advantage of a unique opportunity to purchase approximately $50 million of SBA floating rate securities at a deep discount from a distressed institution. These securities have a three-year average life with yields in the mid-6% range, and at quarter end, had an unrealized gain of over $1.7 million.
Our first quarter net interest margin was 3.31%, representing a 20-basis-point quarter-over-quarter contraction. Our yield on interest-earning assets increased by 47 basis points, primarily as a result of an increase in our base loan portfolio yield and 37 basis points of loan fees, which included 18 basis points or $1.4 million of loan fees associated with an acquired loan that paid off. For the quarter, our loan portfolio yield less fees was 5.20%, and for the month of March, it was 5.27%. Our interest-bearing liabilities increased 85 basis points, driven by an increased deposit costs, which totaled 2.05% for the first quarter and for the month of March was 2.27%. At quarter end, our cumulative deposit beta during the cycle has been approximately 28%.
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Looking ahead, we estimate our second quarter cumulative beta to be approximately 32% and we are modeling a cumulative beta of 36% by the end of the year. Our margin and rate guidance should be taken with the understanding that we are in an extremely dynamic market and any guidance is subject to change rapidly. That said, we are modeling second quarter loan yields in the 5.60% range, interest-bearing deposit costs in the 2.35% range and net interest margin in the range of 3.05% to 3.1%. Given these margin projections, coupled with the non-interest income and expense projections, we will discuss momentarily, we anticipate maintaining operating revenue in the $42 million range. On slide 15, you will see that we experienced an extra sensitivity shift from a generally neutral position at 12/31 to a slightly liability sensitive position at quarter end.
This shift was primarily driven by the movement of approximately $90 million of existing money market deposits from sheet rate to an index pricing rate, and additionally, new money market growth of approximately $75 million also at an index price rate. To counter this impact, we are not only reinforcing pricing disciplines in our markets, but also looking at various balance sheet strategies to ease some of the funding pressures. On slide 16, our operating non-interest income remained flat quarter-over-quarter. While our first quarter results were lighter than expected, the slowdown was attributable to decreased capital markets and wealth management activity, both of which are heavily impacted in times of market volatility. As markets steady, we expect our entire platform to return to stable reoccurring income production.
Looking ahead, we anticipate our non-interest income to be in the $7 million range for the next several quarters. On slide 17, you see we did a great job in managing our operating non-interest expenses, coming in better than our quarterly guidance and virtually unchanged from the prior linked-quarter. While the efficiency ratio did rise to 64% for the quarter, it was a result of external market pressures on revenue rather than internal expense increases. Looking at next quarter, we are forecasting expense run rate in a $28 million range, with salary and benefit expenses of $16.9 million, which represents a full quarter of merit increases and associated taxes. As we said before, longer term, we do expect ebbs and flows in various expense categories as we reinvest in our ability to acquire and serve clients and ultimately drive shareholder value.
On slide 18, capital. During the quarter, our capital benefit from strong earnings and positive movement in our AOCI position. As we move through 2023, we fully anticipate generating earnings at a rate sufficient to fund growth and build our capital ratios. While we continuously monitor our capital levels and are prepared to adjust quickly if needed, today, we are well capitalized and strategically aligned to deliver strong ROEs and tangible book value growth. With that said, I will turn it back over to Billy.
Billy Carroll: Thanks, Ron. As you can see from Ron and Rhett’s comments, we are seeing some of the same impacts that everyone is doing with this cycle, but our positioning remains very sound, while we adjust real time to what’s happening in our markets. I am hoping we will see funding pressures ease a bit, but we are prepared to defend our base. Loan yields are starting to edge up and repricing loan maturities will continue to help bolster asset yields, but as Ron alluded to, we will probably continue to experience a flattish margin environment for the near-term and we are fine with that and find the whole serve for a couple of quarters as we get some market clarity. I do feel we will continue to see and grow and believe mid-single digits on both loans and deposits is a fair outlook.
This is the time where we do plan to keep it in the fairway, but we will still continue to take swings. We are seeing some nice opportunities in areas where others may be pulling back, and our team is levering those to grow full relationships. We are definitely open for business. There’s no doubt this is an unusual time, but disruption creates opportunities. So we are going to continue to play offense prudently and cautiously, but sometimes it’s just harder for map to work on deals in an 8% prime rate environment. But when they do work, we are going to take a look at them. We are continuing to handle this rate environment with a heightened focus on non-interest-bearing and low interest-bearing deposits. We have ramped up our treasury platform and resources and continue to make this an area of emphasis for the bank.
We are also continuing our focus on our non-interest income areas like investments in insurance. While recognizing the industry headwinds, I firmly believe what investors want in a time like this are banks with a history of strong credit, flexibility in their balance sheet and management teams that can capitalize on uncertain markets. Check, check and check for SMBK, plus the loyalty our clients have shown their bank has been so reassuring and confirms that what we are book -- we are building isn’t just deposit and loan transactions, the strong relationships from very strong advocates. Our earnings momentum remains solid as we continue our focus on revenue and EPS, and our business model and culture have us well positioned to be opportunistic.
We continue to remain very bullish about our future. And to close, just a big thanks to our SMBK team for continuing to do such a great job for this company and for taking such great care of our clients. I will stop there and open it up for comments.
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