SmartFinancial, Inc. (NASDAQ:SMBK) Q4 2022 Earnings Call Transcript

SmartFinancial, Inc. (NASDAQ:SMBK) Q4 2022 Earnings Call Transcript January 24, 2023

Operator: Ladies and gentlemen, welcome to the SmartFinancial Inc. Earnings Release and Conference Call. My name is Glenn and I’ll be the moderator for today’s call. I will now hand you over to your host, Miller Welborn to begin. Miller, please go ahead.

Miller Welborn: Thanks Glenn. Good morning to all of you and we appreciate you joining us today for our Q4 2022 earnings call. We’re excited to be on the call this morning to visit with each of you about our bank. We’ve continued to make great progress on all fronts, execute better every quarter and deliver quality shareholder returns. We thank you for the interest that you all have in our progress, and it’s important for us to hear your questions, comments and feedback. Joining me on the call today are Billy Carroll, our President and CEO, Ron Gorczynski, our CFO, Rhett Jordan, our CCO, and Nate Strall, our Director of Corporate Strategy. Before we get started, I’d like to ask each of you to please refer to Page 2 of our deck that we filed yesterday evening for the normal and customary disclaimers and forward-looking statements, comments, please take a minute to review these.

Q4 was a fantastic quarter for our company and we’re very proud of what we were able to accomplish for the quarter and for the entire year. Our year-over-year 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’m proud of the team for their focus and continued improvements we made during 2022. With that, I’m going to turn it over to Billy.

William Carroll Jr.: Thanks Miller and good morning everyone. This quarter was a great way to close out the year. As you’ll see from the results we continued to focus on growing both revenue and earnings per share. We had discussed our plan for 2022 on prior calls, and these results show how we are executing on transitioning this company in the one that has a very solid core foundation and earning stream. I’ll open my comments referencing our 2022 year in review slide on Page 3 of the deck. This slide details the results of the work our team has been doing. Looking at the compound annual growth rate of these key areas, shows why we have been and believe we’ll continue to be a great company to invest in. Looking at our fourth quarter performance on Slide 4, you’ll see very nice trends in our areas of key performance.

We had great operating EPS for the quarter of $0.76, and Ron is going to dive into those details more in a minute. We had nice expense control coupled with another record revenue quarter. Our loan growth continued to be outstanding coming in at 17% annualized for Q4. There was a slight contraction in deposits as we let some rate sensitive non-core balances roll out of the bank as some competitors pushed rates higher than we wanted. We felt like there was no real spread advantage in keeping those deposits, but we did however, defend our rate sensitive core balances. Ron will discuss our betas in more detail, but we felt good where we entered the quarter on funding and related costs. Holding our loan to deposit ratio at 79% has allowed us to be selective on where we’re increasing those funding costs.

Our efficiency ratio trends are again positive coming in at 61% and I would also like to note the momentum in our non-interest income, especially given the drop in mortgage revenue. We’re excited to see growth in many areas of these lines, including treasury fees, wealth, insurance, and capital markets. Credit remains outstanding within NPAs holding steady quarter-to-quarter at 10 basis points and our ROA and ROE were solid at 1.10% and 16.5% respectively. The next couple of slides detail our markets. I’m not going to spend a lot of time here other than to say we were able to open our Franklin, Brentwood, Tennessee office allowing us to continue our expansion into the Nashville MSA. All of our markets continue to show steadiness. Our company like others continues to watch the economy closely as rising rates will slow some areas, but we continue to be cautiously optimistic even with elevated rates.

I’ll speak more to our outlook in my closing comments, but now let me flip it over to Rhett and let him go into a little bit more detail on lending and credit. Rhett?

Rhett Jordan: Thank you, Billy. As Billy mentioned earlier, solid loan growth continued throughout the year as we ended 2022 with quarter-over-quarter net organic loan and lease growth at a 17% annualized pace excluding PPP loans. For the full 2022 year, the bank saw total loans and leases outstanding grow a little under 20% over year end 2021 with diversification in the types of loans generated, as well as solid geographic dispersion of that growth. As you can see on Slide 7, loan and lease balances outstanding grew over $130 million for the fourth quarter, putting the portfolio total at just over $3.2 billion. The loan portfolio mix has continued to be stable as well and average loan yields continued to rise through the latter half of the year.

Improved interest rates on new loan production and renewals as the year progressed generated gradual increases in portfolio yield with our largest increase happening in Q4, pushing that average yield up 46 basis points quarter-over-quarter, just over 5%. We finished the year on a continued strong trend as December monthly origination average yields were over 6%. Slide 8 shows a balanced and diversified commercial real estate portfolio as well. Our largest segment concentration is in the hospitality sector, driven primarily by positions in our bank’s strong tourism markets in east Tennessee and the Florida panhandle market areas. We feel very comfortable with our positioning in the CRE space as we believe the risk profile of our finance projects, historically conservative underwriting methodology and the market experience of our clientele in this space has us poised to sustain a minor correction in the sector with very little disruption in performance should such an event occur.

And while national economic forecast still indicate a higher probability of recessionary pressure nationally for 2023, we believe the continued population growth and corporate relocation trends happening in our footprint will serve to minimize the impacts of those pressures across our bank’s market area compared to other parts of the country. Even with this relative optimism and our market condition outlook, like many others in the industry, we took some additional steps to implement even more precaution than normal in our credit underwriting procedures throughout 2022 in efforts to more aggressively battle potential impacts of a challenging interest rate environment, continued supply chain disruption and sociopolitical challenges on our client base.

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However, despite those hurdles, we still saw solid performance being reported by our commercial clients throughout the year, strong traffic and demand in our heavier tourism markets and a continued sense of general positivity and optimism for 2023 being expressed by our clientele. As the next slide indicates, our portfolio of credit quality continued to be a strong in Q4 as it has been all year. Slide 9 shows continued stability across all of our core asset quality metrics. NPAs, past dues and classified loans to total loans are all stable quarter-over-quarter and right in line with our metrics throughout 2022. Our CRE portfolio saw a slight decline quarter-over-quarter, and we ended the year just below the regulatory targets in both total and C&D segments.

Overall, our 2022 loan production and credit quality metrics saw extremely strong results due to some very hard work on the part of a great team of associates across our company. Now I’ll turn it over to Ron to talk through our allowance, deposit portfolio and earnings details.

Ronald Gorczynski: Thanks Rhett and good morning everyone. Let’s move forward to Slide 10, our loan loss reserve. During the quarter, we recorded a $788,000 provision related to our strong loan growth. At quarter end our allowance to originated loans and leases was at 73 basis points, and our total reserves to total loans and leases was at 1.13%.

CECL: On Slide 11. Similar to other financial institutions during the quarter, we experienced a decline in deposits. As some of this was anticipated due to our high liquidity position we additionally had customers deploying some of their excess cash into higher yielding security instruments. These deposit outflows as many financial institutions experienced, caused significant pricing competition throughout our footprint, causing rates to increase quickly as our less liquid competitors rushed to shore up their balance sheets. As we stated during the last few quarters, our goal is to be judicious in our approach to raising deposit pricing, but not at the expense of losing good customer relationships. As a result of defending these relationships, our total deposit costs increased 40 basis points to 0.85% for the fourth quarter and was 1.06% for December.

We do anticipate this upward deposit pricing pressure to continue for the next few quarters. Our loan to deposit ratio increased to 79%, up from 72% in the previous quarter. Despite this increase, we’ve remained below our historical loan to deposit ratio levels and are comfortable with both our liquidity deposition and the composition of our deposit portfolio. That said, we do anticipate some mixed shift in the composition of our deposit portfolio over time as clients elect to move cash into higher yielding account types. Onto Slide 12. During the fourth quarter, we deployed much of our excess cash to fund new loan production and cover our deposit outflows. Our overall liquidity position, which includes cash and securities, remains strong at approximately 22% of total assets.

Our fourth quarter margin was 3.51%, representing a 22 basis point quarter-over-quarter expansion. Our yield on interest earning assets increased by 62 basis points, primarily driven by a 46 basis point increase in our loan portfolio yield, which included 18 basis points of loan accretion. Our loan portfolio yield less accretion for the fourth quarter was 4.87%, and for the month of December it was 5.08%. Our interest bearing liabilities increased 57 basis points driven by increases in our interest bearing deposit costs. Our interest bearing deposit cost for the fourth quarter was 1.18%, and for the month of December was 1.45%. At quarter end our cumulative deposit beta during the cycle was roughly 23%. However, given the previously discussed market environment, our increase in this quarter’s beta is estimated to give us a cumulative beta for this rate cycle of 35% with our total cost of deposits for the first quarter in the 1.3% to 1.35% range.

Giving margin guidance is difficult in this uncertain rate environment, but with that said, we anticipate our margin for the first quarter in the range of 3.3% to 3.35%. During the quarter, operating revenue increased $1.7 million for an annualized quarter-over-quarter increase of over 15%. When comparing to the fourth quarter of 2021, our operating revenue increased $7.9 million or over 21% year-over-year. As operating revenue is one of the primary metrics by which we judge our performance, we are extremely proud of our SmartBank associates ability to consistently grow revenue despite the various ongoing economic challenges. On Slide 13, you’ll find some interest rate sensitivity information. With the sharp rise in interest rates and the deployment of our cash liquidity during the year, our balance sheet has shifted from a modestly asset sensitive to a general and neutral position at year end.

Looking ahead, we anticipate that any small increases or decreases in short-term rates will generally have a limited impact on our net interest margin and net income. As we move into an uncertain 2023, the company continues to focus on strategies to protect income and both in up or down rate environment. On Slide 14, for the fourth quarter, our operating non-interest income increased to $7 million versus $6.2 million in the prior quarter. Our insurance revenues increased due to the acquisition of Sunbelt Insurance, and we also benefited from $700,000 of revenue from our capital markets group. Looking ahead to 2023, we will continue to focus on building steady recurring fee income streams. Our non-interest income forecast for the first quarter is in the $7.5 million range.

Onto Slide 15. Our continued efforts to create operating efficiencies to manage expenses resulted in a fourth quarter operating efficiency ratio of 61%. As we continued our steady downward trajectory, we expect our efficiency ratio for the first quarter to be similar to those of the previous quarters, then in the later part of 2023, getting back to the low sixties range. Our operating non-interest expense was $27.5 million, a 1.2% increase over the prior quarter. This increase was primarily attributable to increases in technology related expenses and professional fees. As we continue to upgrade, invest in and future proof our organization, we fully expect ebbs and flows in various expense categories. That said, we always remain ready to tighten our belt to ensure we head our income targets and deliver on our goal to create shareholder value.

For the first quarter we are forecasting the expense run rate of $28.2 million range, an increase from the prior quarter, primarily stemming from our salary and benefit expenses of $16.8 million. Onto Slide 16, capital. During the quarter, our capital benefited from strong earnings and positive momentum in our AOCI position. As we move forward into 2023, we anticipate building capital at a rate sufficient to fund future growth and continue to build our capital ratios. At quarter end our tangible book value was $19.09 per share; however, excluding the temporary impact of our unrealized security losses, our tangible book value per share was $21.18, representing a quarter-over-quarter increase of 3.7% and a five-year compound annualized growth rate of almost 9%.

With that said, I’ll turn it back over to Billy.

William Carroll Jr.: Thanks, Ron. As you can see we’re really hitting a nice stride, and as Ron mentioned in his guidance, we continue to be well positioned. I do feel that we will see a slowing of loan growth a little as we start the year, particularly for us as we had some clients accelerate some closings into 2022 that we had to pay for Q1 2023. With that said, I feel our loan growth outlook is still solid, but in the current environment, I’m more comfortable with a mid-to-high single digits growth in the loans from a forecast standpoint for the year. We’re also positioning to handle this rate environment with a heightened focus on non-interest bearing and low interest bearing deposits. We’ve ramped up our treasury platform and resources and continue to make this area an emphasis for the bank.

Now that we’ve digested the lift-outs from late 2021 and early 2022 that added six new markets to our bank, we’re looking for more opportunities to add talent to our team. We’re in continued conversation with bankers that can add balances to both sides of the balance sheet and feel good about our prospects to bring on more sales team members in the coming quarters. I was very pleased with the performance and growth of both our Fountain Equipment Finance Group and their SmartBank investments wealth platform. We are expecting continued upside from these groups in the coming year. This coming quarter we’re also merging our two insurance agencies and excited to watch this company take off in 2023. Again, a very nice upside for revenue generation as we get its foundation set.

We continue to make investments that are accretive to growing our value and are staying focused on those singles and doubles that will create a great core franchise. To close, again, a very successful year for our company and a big thank you to our SMBK team. Our group continues to execute while building an outstanding culture. It’s a great time to be involved in this company, so I’m going to stop there and open it up for questions.

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Q&A Session

Operator: Thank you. Our first question comes from Brett Rabatin from Hovde Group. Brett, the line is now open.

Brett Rabatin: Hey, good morning everyone. Thanks for taking the question.

William Carroll Jr.: Good morning, Brett.

Brett Rabatin: I wanted just to first appreciate all the guidance as usual. I wanted just to start on the balance sheet. You obviously have been able to use your liquidity to fund the loan growth in the past year. Maybe any thoughts just on how much liquidity you think you might have left on the balance sheet now, the balance sheet grows from here, I would assume we kind of pivot from the balance sheet growing more in relative to the past few quarters?

William Carroll Jr.: Yes Brett, I’ll let Ron kind of dive into a little more color on details, but yes, you’re right. I think we’ve kind of gotten to the spot where we’re holding the liquidity that we feel like we need for a bank our size right now. So that’s kind of our comments on the growth that we see from here, we feel pretty comfortable about being able to fund that and increase those deposit balances accordingly as we see the loan growth opportunities. But Ron, you got any, you want any additional color you want to add to that?

Ronald Gorczynski: Yes, in the near-term, I think, well cash and securities will probably remain stable and we will fund much of our loan growth with our deposit growth. No real wholesale changes until we probably get into 2024. We do have quite of amount of $250 million of treasuries that will be maturing during the first six months. So we may have some strategy to deploy some balance sheet strategies or ideas, but up until now we’re kind of going to keep, I think we are looking to remain stable where we’re at today.

Brett Rabatin: Okay, that’s helpful. And then I wanted to just talk about commercial real estate. I think a lot of investors are kind of concerned about it and maybe loans that were made at lower rates and as the market re-prices those, what those will look like? Can you give us any color on how you’re looking at commercial real estate and just what you’ve done to maybe insulate your portfolio from any of the challenges that folks are talking about? Thanks.

William Carroll Jr.: Yes Brett, I’m going to let Rhett kind of dive into that, but just kind of anecdotally, I mean, it’s something we talk about a lot and then we’ve been watching and obviously do quarterly reviews, annual reviews for clients looking at that, during some shocks, and we still feel extremely comfortable about the quality of our loan portfolio, even with a little high rate environment. But obviously it’s changing. It’s obviously changing the way we’re looking to underwrite newer credits. It is, it’s probably looking for a little more cash into certain deals today, a little more equity in some of these just to kind of hedge against potential up rates. But Rhett, you want to maybe kind of dive into kind of how you’re walking through that analysis with the team?