SmartFinancial, Inc. (NASDAQ:SMBK) Q3 2023 Earnings Call Transcript

SmartFinancial, Inc. (NASDAQ:SMBK) Q3 2023 Earnings Call Transcript October 24, 2023

Operator: Hello, everyone and welcome to the SmartFinancial Third Quarter 2023 Earnings Release and Conference Call. My name is Seb and I will be the operator for your call today. [Operator Instructions] I will now hand the floor over to Nate Strall to begin. Please go ahead.

Nate Strall: Thanks, Seb. Good morning, everyone, and thank you for joining us for SmartFinancial’s third quarter 2023 earnings call. During today’s call, we will reference the slides and press release that are available within the Investor Relations section on 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 our 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 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 may see the reconciliation of these measures in the appendices of the earnings release and investor presentation filed on October 23, 2023, with the SEC. And now, I will turn it over to Chairman, Miller Welborn to open our call.

Miller Welborn: Thanks, Nate. The third quarter of this year has been another quarter of incredibly busy activity for SmartBank. I’m very proud of how our team has remained steadfast to our mission and our objectives for the company. It’s not a secret that our industry has been challenged this year, but we see the challenges as positive opportunities. We’ve made a strong effort to improve every line of business that we operate, and I do sincerely believe we’re poised for a bright future. Our markets remain very strong, and we’re fortunate to be located in the southeastern United States where the economy remains robust. We are very proud of what we were able to accomplish for the quarter. Our entire SMBK team is focused, determined, and very clear of our goals. With that, I’m going to turn it over to Billy.

Billy Carroll: Thanks, Miller. And good morning, everyone. Great to be with you today. I’m going to jump right in this morning and discuss our third quarter highlights. You’ll see most of these on Page 3 of our deck. All in all, a steady quarter for our company. I’ll be discussing primarily non-GAAP operating metrics today. As Ron will provide some details shortly on a bond trade we did in September that had some impact on our GAAP numbers. We came in at $0.43 on operating EPS or $7.2 million in net income. We continue to grow both sides of the balance sheet with both loans and deposits increasing right at 5% annualized. Our loan-to-deposit ratio is staying healthy, right around 80%, giving us nice flexibility on growth. Credit is strong with an NPA ratio of only 12 basis points, the same as prior quarter, with charge-offs continuing at a negligible number.

Our credit quality continues to feel very solid. And a key number we focus on here, a tangible book value moved higher even with the bond trade, now at $21.95 excluding AOCI and $19.94 including it. As I stated, we did execute a well-timed transaction late in the quarter to reposition close to $160 million in available for sell securities. The loss taken on the trade will be earned back in a year, but accelerates our ability to reallocate assets. We like the timing and what the trade did for our forward-looking balance sheet. This, along with the large cash flows coming in early 2024, puts us in a very favorable spot related to cash positioning. Our operating income and margin were slightly below our forecast, driven primarily by heavier funding costs and some movement with balances from non-interest bearing to interest bearing.

I do feel we’ve stabilized and while we’ll continue to see some grind higher on deposits, I feel that delta will be covered by growth and asset yield resets. I believe the net interest income number has floored and we look forward to seeing that line move up from here. All in all, a good quarter where we helped serve, continued adding some outstanding new clients and positioned the company to move metrics north. I’ll close with additional comments in a moment, but let me hand it over to Rhett to discuss the loan portfolio and credit and then to Ron to dive deeper into the numbers. Rhett?

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Rhett Jordan: Thank you, Billy. SmartBank’s loan portfolio continues to grow at a moderate pace, while maintaining a stable and diversified profile with continued strong credit performance. In third quarter, we saw 5% quarter-over-quarter annualized organic long growth spread evenly across the bank’s geographies and across the different segments of the portfolio. The composition of the portfolio was effectively unchanged through this growth cycle, while recognizing a 13 basis point increase in average portfolio yield, which moved up to 5.52%. Our construction portfolio saw a slight decline in outstanding balances, down about $23 million quarter-over-quarter and representing 11% of total loans and 84% of total capital, a little below those same metrics for second quarter.

This was an expected swing as we’ve had several projects under construction moving to the completed stage, while new commercial construction starts were slower in the early part of the 2020 per year than in the same period prior year. Our non-owner occupied non-construction CRE portfolio grew slightly in outstanding balances for the quarter, but held steady at 26% of total loans and the total CRE ratio came in at 285% of total capital, also right in line with the last period. Again, steady performance with diversified production results. Also holding steady were our overall credit performance metrics with NPAs, delinquency and classified asset ratios seeing very little change quarter-to-quarter. While we have a slight increase in total delinquent and non-accrual loan balances since year end 2022.

The dollar amount has moved in conjunction with our overall capital growth and portfolio growth, and thus, our ratio to total loans and leases has held steady. Approximately 21% of those total outstandings are carried in our equipment finance subsidiary due to some slower activity in some of its smaller trucking clientele. Credit losses for the period were 0.04% with the year-to-date total being 0.06% through third quarter. Loss risk within our classified and delinquency portfolio is expected to be very manageable in future periods, and our allowance is more than adequately positioned to address any realized loss as these assets are navigated through. Our markets continue to report solid housing metrics, continued population growth, and overall stable economic conditions that support small business stability, and we expect solid credit quality results to continue in upcoming periods.

Our allowance did reflect a slight increase from 0.98% to 1% of total loans. But this minimal increase was due to how our CECL model monetized certain impacts of various input factors that occurred during the period. The recommended provision resulted from changes to certain components in the model, such as continued portfolio balance group, movement in unfunded commitments, quarterly net charge-offs, lower unemployment rates, and changes in key management positions. The culmination of the adjustments in each of these factors resulted in the recommended provision that was realized for the period. Overall, loan demand continues to be good, while the loan portfolio continues to maintain stable, solid credit metrics and performance. Now I’ll turn the call over to Ron to discuss deposit composition, liquidity, and other key financial measures.

Ron?

Ron Gorczynski: Thanks, Rhett, and good morning, everyone. On Slide 9, we continue to see our overall deposit levels remain stable as we build our presence and gain new clients in our expansion market areas. We ended the quarter with a loan to deposit ratio of 80%, driven by deposit growth of $47 million, which exceeded our quarterly funding needs and further bolstering our liquidity position. However, we did experienced some upward pricing pressure and mix shift, particularly during the first two months of the quarter, as clients reacted to the Fed rate hike and competitor solicitation. Our total deposit costs increased 31 basis points to 2.20% and were 2.28% for the month of September. Despite upward pricing pressure, our strategy of lagging market rate increases and adjusting rates only as needed for competitive purposes has afforded us some buffer relative to peers.

Looking ahead, we do expect some additional cost migration as clients right size operating accounts and look to maximize returns on idle cash. However, we believe this will occur at a much more muted pace as most of our price sensitive clients have been addressed. On Slide 10, you’ll see that we have updated our principal cash flow schedule to reflect the sale of almost $160 million securities at the end of September. The security sale was comprised primarily of U.S. Treasuries, approximately $100 million of which had maturities in Q1 of 2024 and the remainder of which had a weighted average maturity of 2.6 years. The total weighted average yield of these securities sold was 1.37%. Reinvested at current cash yields, the sale proceeds provide an additional $6.4 million of annual interest income which equates to an earn back just over one year.

Aside from the enhanced liquidity benefits, the securities repositioning provides additional earnings momentum as we move into Q4. Further, our current yield on cash affords us the ability to be patient in our redeployment of the sale proceeds, whether it be methodically reinvesting in securities or preferably funding higher-yielding loan production, both of which would accelerate the earn back on this trade. As you’ll see on Slide 11, even with the securities repositioned during the quarter, we still have approximately $208 million of securities, primarily comprised of held to maturity treasuries, maturing by year-end 2024. Combined with fixed rate and adjustable rate loans, we have over $460 million in assets maturing or repricing by year-end 2024 with a weighted average yield of 4.08%.

While the interest rate environment remains challenging, we are optimistic on future profitability knowing this significant earnings catalyst is on the horizon. Our overall liquidity position on Slide 13, which includes cash and securities, remained unchanged at 22% of total assets. Net interest margin was 2.81%, representing a 12 basis point contraction for the quarter. As discussed earlier, our margin was negatively impacted by increased deposit pricing pressures and mix shift experienced during the quarter. However, we are starting to experience a slowdown in the velocity of money movement and deposit repricing as we move into Q4. In addition, Q3 saw a weighted average cost of new deposit production of 3.59% and new commercial loan originations in the 7.5% to 8% range.

These factors, combined with the enhanced yield on repositioned security proceeds, we are projecting margin stabilization into Q4. Lastly, looking ahead at the next few quarters, we expect operating revenue to remain stable in a range of $38 million to $39 million before returning to our previous $42 million plus run rate in the second half of 2024. We have details of our noninterest income and expenses on Slides 15 and 16. Operating noninterest income was in line with Q3 guidance at $7.5 million, primarily driven by ongoing focus to identify and capitalize on those income opportunities as they present themselves. Looking ahead, we anticipate non-interest income to continue to be in the mid $7 million range. Total operating expenses were $28.4 million.

The slight escalation was primarily to salary benefit expenses increases for incentives and commissions resulting from better than anticipated production and additional costs relating to the new self-insured health insurance program. While our efficiency ratio was at 74%, which is above our internal target, we recognized that it’s primarily a function of the pressures of an abnormal rate environment rather than lack of expense control. Despite this, we continue to be extremely diligent on all expenditures while identifying opportunities to cut or delay expenses. Looking ahead to the fourth quarter, we project noninterest expenses in the 25 — excuse me, $28.5 million to $29 million range and salary and benefit expenses in the range of $16.5 million to $17 million.

And finishing off on Slide 17. We had minimal change to our capital ratios from the prior quarter, even with the loss associated with the securities repositioning. We remain in a strong, well-capitalized position and, most importantly, continue to execute on our primary mission to grow and defend tangible book value. With that said, I’ll turn it back over to Billy.

Billy Carroll: Thanks, Ron. As you can see with our trends, we are positioned well in playing offense. With the stabilization we’ve discussed and more clarity on the rate forecast, we are diligently focusing on building the revenue number back after absorbing these rate increases. I remain confident in our ability to execute on that front. My outlook on loans is still fairly bullish as we are continuing to see nice pipelines. We are lending and feel that we can continue this same mid-single digit pace. With that, deposits need to be growing at the same pace, and I feel we can fund that growth internally as well. As Ron discussed, we are continuing our internal focus on efficiency and expense control, and I do believe expense growth should be fairly well contained.

We are looking to add revenue producers within existing markets. In due field, we can make some of those additions in the coming quarters, but any expense growth there should be offset by increased revenues. Miller and I spent several days on the road again this quarter, continuing our market roundtables and meeting with clients and prospects throughout our footprint. The bank’s momentum in these markets is outstanding and continues to gain steam. I see tremendous opportunity for our company as there are a number of changes happening in our industry. We’ve chosen a path to continue to do what we’ve done successfully in the past, investing with an eye on long-term revenue and EPS growth. Again, overall, I felt a good quarter where we helped serve, held credit, grew loans and deposits, grew tangible book value, and set us up as we look forward.

As these rates settle, our loan balances grow and reprice, plus our ability to utilize the outsized cash flows coming in early next year, our company is positioned very well. I’ll close with a huge shout out to our 600 plus outstanding associates that we have in this company. These team members continue to build a phenomenal culture and it’s greatly appreciated. I’m going to stop there and open it up for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from Thomas Wendler at Stephens Inc. Please go ahead.

Thomas Wendler: Hey, good morning, everyone. Just thinking about the $106 million security sale and then the $184 million of securities maturing by 2Q 2024. With these increased cash balance that you guys are likely to see, could we see loan growth maybe over that mid-single digit range?

Ron Gorczynski: Thomas, it’s really — it’s possible. I think we’re positioned to grow loans at whatever pace we can find them. I think it’s just a function to find the right ones in this sort of an environment. But we’ve had a lot of success doing that. So we’ve got the capacity to do it. We’ll just continue to — we’re going to continue to get out there and grind and dig and find good credits to add to the books, but it’s possible. But I still like kind of giving the environment that mid-single digit forecast for us going forward.

Thomas Wendler: Okay. No, I appreciate that color. And then just kind of staying on that with all of these earning assets kind of repricing coming up through 2Q 2024. NII stay in kind of — had floored from here. How are you thinking about NIM moving forward?

Ron Gorczynski: Yes, at this point, Thomas, our margin has been difficult to forecast, as many others. This quarter, we did experience higher betas and modeled. It increased to 39% from 32% from the prior linked quarter. We were projecting 36%. As we move forward, we do expect some compression, but some of our repricing will minimize that effect. We’re just going to say our NIM is stabilized and we’re projecting like results for Q4. We do see our NIM getting better throughout 2024 as we get to the second half. But right now, we’re just going to say we’re going to be stable for a while.

Thomas Wendler: All right. I appreciate all the color. Thanks for answering my questions, guys.

Billy Carroll: Thanks, Thomas.

Operator: The next question comes from Stephen Scouten at Piper Sandler. Please go ahead.

Stephen Scouten: Yes, good morning, everyone. Thanks. I guess one question just on the securities repositioning — Good morning. The securities repositioning trade, I’m just kind of curious on the dynamic. It sounded like a chunk of that was maybe already set to mature in the first quarter. So kind of what drove that, given the short duration there, or was more of the actual loss content, I guess, related to some of the longer dated portion of that trade?

Billy Carroll: You may start — Ron, you want to go ahead.

Ron Gorczynski: Well, I’ll start now. I think we wanted the ability to re-price as many assets as we can earlier. So that really facilitated the thought of the trade. We were on course to let these mature naturally, but given the modeling and the earn back and we thought it was a pretty good move on our part to go ahead and just recognize this loss and to get their earnings are the key to keep our name stabilized.

Billy Carroll: Yes, and the one I’ll add, Stephen is, when we — as we timed this right around when the — I guess right around the last Fed move. And so kind of given where the market was, we just felt like rates were going to continue to stay elevated. So we felt like timing was good. In hindsight, it was. And so it just seemed like a good time to do it. Yes. The bulk of that was going to mature going into early next year anyway. So it really wasn’t too big of a risk for us anyway.

Stephen Scouten: Okay. Got it. That makes sense. And then obviously, I know you kind of spoke to the fact that it’s more interest rate driven, the efficiency ratio, than it is really expense driven. But I’m sure you’re not really content with, I think, 60 basis point ROA this quarter. So what are the clearest levers you feel like you can pull to kind of move earnings back to a level you might start to be more comfortable with in the maybe near to medium term?