FB Financial Corporation
Q3 2017 Earnings Call Transcript

Published: 24 Oct 2017

[Operator:]

Good day, everyone and welcome to the FB Financial Corporation’s Third Quarter 2017 Earnings Conference Call. Hosting the call today from FB Financial is Chris Holmes, President and Chief Executive Officer. He is joined by James Gordon, Chief Financial Officer and Wib Evans, President of FB Ventures, who will be available during today’s question-and-answer session. Please note FB Financial's earnings release and this morning's presentation are available on the Investor Relations page of the company's website at www.firstbankonline.com. Today's conference is being recorded and will be available for replay on FB Financial's website for the next 30 days. [Operator Instructions] With that, I would now like to turn the conference over to Mr. Chris Black of CFO Banking [ph]. Please go ahead.

[Chris Black:]

Good morning. During this presentation, FB Financial may make comments, which constitute forward-looking statements. All forward-looking statements are subject to risks and uncertainties and other facts that may cause actual results and performance or achievements of FB Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond FB Financial's ability to control or predict and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in FB Financial's 10-K filed with the SEC. FB Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation whether as a result of new information, future events or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to comparable GAAP measures is available on FB Financial's website at www.firstbankonline.com. I would now like to turn the presentation over to Chris Holmes, FB Financial's President and CEO.

[Chris Holmes:]

Thank you, Chris. Good morning to everyone and thank you for joining us on this call to review our result for the third quarter 2017. We appreciate your interest in FB Financial. On today’s call, I’ll review the highlights of the third quarter and then I’ll turn the call over to James Gordon, our Chief Financial Officer who will provide some additional comments on our financial results followed by your questions. We're very pleased to report our results for the third quarter of 2017. It's a quarter where most of our key points of execution came together and delivered outstanding performance. We have a strong team of passionate folks across First Bank in our banking segment, our mortgage segment, in our support areas that contribute -- that continued to deliver for our customers and our shareholders. They’re responsible for delivering our excellent results and this quarter is a continuation of what they’ve come to expected themselves every day. So to our team, I’d say thank you and let’s continue to get better every day. And of course, bolstering that team this quarter are over 200 new associates that we’re thrilled to welcome officially into our First Bank family. Those are the associates that formerly were with Clayton Bank and Trust, an American city. The integration has been going smoothly and we have already begun to realize many of the benefits. Now, on the quarter. We reported record lows in deposits, strong growth rates, strong net interest margin, good mortgage results, stable credit quality and efficiency improvement. As to the specifics, we're happy with our annualized 16.7% loan growth this quarter, which excludes the loans acquired from the Clayton Banks. Our loan growth was above our historical range and we delivered not only in terms of the growth, but also in the continued balance in terms of both product and geographic diversity. On deposits, our customer deposit base is one of our greatest assets and those grew 4.8% on an annualized basis from the second quarter of 2017 when excluding the customer deposits assumed in the acquisition. With that said, the current deposit market dynamics are challenging and competitive. We continued to focus on the deposit side of the balance sheet, both in terms of balances in their cost and it's one of our key competitive advantages. Our net interest margin was 4.61% for the quarter, which benefited from accretion, non-accrual interest, and higher loan fees as well as the effects of the merger. But we are focused on employing our relationship based balance sheet to serve the needs of our customers, while maintaining a strong net interest margin. James is going to touch on the NIM in more depth during his comments, but our revised outlook for core NIM going forward is in the 4.2% to the 4.4% range before we consider accretion or any other benefits. On the merger, two of the strategic benefits of the merger, we’re driving operating leverage and increasing the banking segment pre-tax contribution to our overall net income. During the third quarter, we show progress on both of these reporting core banking segment efficiency of 56.2% closer to our stated goal of 55% and moving the banking segment’s core pre-tax contribution to 84% nearly reaching our goal of greater than 85%. We will continue to focus on improving the overall efficiency of our mortgage operations which were 79.9% for the quarter. Our mortgage operations had a strong third quarter and benefited from seasonal growth and contributions across all four of our delivery channels consumer direct, third-party origination, retail, and correspondent. We continue to shift our mix to purchase money financings from refinancings in our consumer direct channel. Overall, we're on track to delivery modest year-over-year increase in our core pre-tax contribution from our total mortgage operations which was our goal for the year. Our asset quality metrics were impacted by the merger. But we're pleased with our continued solid asset quality. NPAs as a percentage of assets increased this quarter driven by the additional other real estate from the merger as well as reporting an option to repurchase certain Ginnie Mae loans originated and serviced by our mortgage operations. With that overview I’m going to turn the call over to James to review our financial results in some more detail.

[James Gordon:]

Thanks Chris and good morning everyone. First I want to recap our strong core operating results for the quarter that’s highlighted on Slide 3. Our diluted core earnings per share were $0.60 and our core net income of 18.5 million, up 22% from last quarter delivering an outstanding term average assets of 1.76% and a return on tangible common equity of 17%. Next, Slide 4 recaps the merger and our product -- on the key targets and assumptions. This quarter, the merger was accretive to our core earnings and ultimately accretive to tangible book value per share that ended at $13.79 versus our previous expectation of 2% dilution. Additionally, the additional capital raise was a strong 9.5% tangible common equity ratio to fuel future growth. We will continue to deliver on our cost savings and other synergies over the next few months and quarters. Slide 5 shows that our year-to-date core return on average assets has risen to 1.62% for 2017 year-to-date as we continue to demonstrate strong and consistent growth in our profitability. This growth in probability is driven by strong loan growth driving our loan to deposit ratio to 96% at the end of the quarter funded by a strong deposit base, strong non-interest income, and a strong fundamental credit quality. Slide 6 presents the core fundamentals being loan yields and low deposit costs that drive our strong net interest margin. At 4.61% reported and 4.3% excluding the accretion in non-accrual interest this quarter, the NIM reflects the increased loan yields from the merger, partially offset by higher deposit costs, which remain controllable. We continue to be well positioned to benefit from rising rates as well. Moving onto the next slide and as Chris mentioned previously, we had great loan growth this quarter. Our year-over-year loan growth has been 73.7% or 14.5% excluding the acquired loans. Moving to our concentration levels of the top right corner, our construction and development concentration inched a bit closer to 100% this quarter. We may cross at around 100% or slightly above at some point over the next few quarters, but we believe that will be a short-term occurrence and remain committed to staying within the regulatory guidance long term. Next on slide 8, our customer deposits were 3.7 billion, up 37% since the third quarter of last year. Going forward, we will focus on growing customer deposits, which excludes brokered and Internet time deposits, primarily from the merger. A large portion of the cash paid to the seller in the merger transaction was a positive to the First Bank, which will likely move down in the coming quarters that will be managed appropriately for liquidity and funding purposes. This quarter, our legacy First Bank deposit cost saw a roughly a 3 to 4 basis point movement upward, well below the expected data, but will continue to be pressured by competitive forces and likely increasing rates in the near term from the federal reserve. Next on slide 9, and as Chris noted in his opening comments, we had an excellent quarter from our mortgage banking operations, as highlighted here on the slide. Our mortgage banking income rose to 31.3 million in the third quarter of 2017, which was up 3.6% on a linked quarter basis and was down 15.2% on a year-over-year basis. As a reminder, we would expect volumes and revenues to decline during the fourth quarter of 2017 and into the first quarter of 2018, based on historical seasonality before beginning to build heading into the second and third quarters of 2018. As previously disclosed this quarter, or prior to this quarter, we began to hedge the MSR asset at the total 63 million assets fully hedged by the end of the quarter. Going forward, we expect less volatility in the MSR fair value changes from interest rates and not exclude the change of fair value from core earnings in future releases. Next on slide 10 is our efficiency and operating leverage. As we’ve previously stated, improving operating leverage and efficiency has been both a short and long term objective of the team. The merger accelerated this process driving our core efficiency much closer to our goal of 55% in the banking segment. Also, the mortgage segment was slightly less than 80% and we will seek to drive it lower as we move forward. On other comment, on our effective tax rate, which was 35.5% for the third quarter based on reported results and was approximately 37.5% on the core earnings and was slightly higher than the expectation, driven by the merger contribution and the lower levels of tax exempt municipal income acquired. Our outlook for the tax rate before any potential tax cuts would be in the 37% to 38% range going forward. Next on slide 11, our core asset quality remains a strength of our operations. Non-performing assets to assets did increase for the quarter with the majority of this increase can be attributed to the merger, which contributed foreclosed assets of approximately 4.5 million, excess land and facilities held for sale of 3.6 million and Ginnie Mae delinquent loans previously sold and currently serves totaling 13.6 million, which was new for the quarter. Based upon the accounting guidance, the Ginnie Mae loans are required to be recorded by the bank, even though the bank has no obligation, no intent to repurchase these loans, which have increased due to growth in the corresponding channel over the last year. Next on slide 12, our capital levels remain strong, enabling future growth both organically and through strategic acquisitions. Our capital structure remains simple, giving us additional flexibility as needed going forward. We are also now S-3 eligible following the one year anniversary of our IPO and in the coming days, we intend to file a universal primary shelf-registration statement and a secondary shelf-registration statement covering the shares and the shares issued in the Clayton acquisition. While neither we nor [indiscernible] has any current intention to accept the capital markets, we consider this to be good corporate health keeping that will enable us to quickly and efficiently assess the capital markets in the future whether in connection with future acquisitions or otherwise. With that overview, let’s turn the call back over to Chris for closing comments and then we’ll open the call to your questions.

[Chris Holmes:]

Thanks James. We had an outstanding third quarter delivering on growth and profitability. And we’ve made great strides in fully integrating our recent combination with the Clayton Banks. Our strong performance was diversified across our business and our markets highlighting the strength of our franchise in Tennessee, Northern Georgia and Alabama and in our mortgage business. We appreciate your interest and investment in FB Financial and look forward to updating you next quarter on our continued progress. Operator that completes our remarks for this morning's call and we would now like to open the call up any questions.

[Operator:]

[Operator Instructions] It appears our first question comes from Tyler Stafford with Stephens, Inc.

[Tyler Stafford:]

I wanted to start on the margins just given there was a lot of moving pieces with June hike and the Clayton impact. I guess first on the deposit side, can you guys parse out for us the Clayton impact on the deposit pricing I guess pressure that you saw this quarter and how much out of the legacy FB franchise you’re seeing in terms of pricing on the deposit side?

[Chris Holmes:]

Yet Tyler, I’m going to let James talk about some of the moving parts and pieces.

[James Gordon:]

So Tyler, I think a couple, as I said in my comments, absent the merger, our costs would have probably risen in the 3 to 4 basis points range on a legacy first thing basis. So the remaining increase was primarily driven by higher cost and mix of deposits from the acquisition that carry a little over 100 million historically in a more wholesale deposits broker that carry a higher rate and have less - roughly less on a percentage basis and non-interest bearing deposits only add to. So it roughly breaks down, 3 or 4 basis points and then the remaining about 8 basis points would have been due to the mix and contribution of deposits from Clayton.

[Tyler Stafford:]

I didn’t realize you touched on that in your prepared remarks, I missed that sorry. What about the brokered deposits that they added, it's not a huge amount, but would you expect to run that off or would you keep a portion of that?

[Chris Holmes:]

We would expect to not renew it once it matured. We won’t - we’ll keep it until those mature, but our attention would be to turn those into customer deposits once they mature.

[James Gordon:]

We actually between the merger date and the end of the quarter, we allowed about 27 million of brokered that entered that deposits to roll off as well as about $12 million of higher rate public funded CDs to mature and as Chris said, we would expect to replace that hopefully with customer money or other funding sources as we move forward.

[Tyler Stafford:]

And James, you may have touched on this in your prepared remarks, and I missed it also. But did you talk about near-term margin expectations with the full quarter impact from Clayton? And if not, can you?

[James Gordon:]

We have updated our range to say 420 to 440. And that's for the core range that's not including accretion and that’s not including - that’s not including accretion, it’s not including if we come across, if we get a portion and we can get some non-accrual interest and so that’s we’re about 433 on that this quarter and so we think that 420 to 440 is about where we’ll be before those two items.

[Tyler Stafford:]

So the 420 to 440 is apples to apples with the 433 this quarter not the 402 from this quarter, is that - am I hearing you correctly.

[James Gordon:]

Yes that's right.

[Tyler Stafford:]

And then just last one from me around Clayton cost savings. Did you guys or how much did you recognize this quarter and what would be your timing for the realization of the remaining cost saves.

[James Gordon:]

Tyler, this is James. So the total cost sales were about 4.3 estimated at the 20%. We are roughly about 40, we realize about 40% of that. It will have the majority at least set in motion to begin realizing at the first of the year following our conversion closing of approximately branches and other things by the end of the year as well as the, just in the contractual not expansion of the business in interchange revenue, which will be about 300,000 to 400,000 increase a quarter going forward following the conversion - converting systems and putting them onto our interchange contract will have a benefit on that as well. Some of that will be offset like some of the reinvestments we’ve talked about in branches and technology as well. But all of that should be roughly baked in heading into 2018.

[Tyler Stafford:]

There should be a 300,000 to 400,000 interchange revenue increase once the conversion takes place. And that will start I guess beginning of the year?

[James Gordon:]

Yeah, we have a little bit at the end of the year, but it will only be for a month or so and we should be able to start realizing that at the beginning of 2018.

[Tyler Stafford:]

And then 2Q, just on the cost savings side, 2Q ‘18 would be a - it be your expectation that it would be a pretty clean quarter in terms of run rate.

[James Gordon:]

That’s right. We should have everything to start in 4Q.

[Operator:]

Our next question comes from Catherine Mealor with KBW.

[Catherine Mealor:]

So first of all, on the efficiency ratio, you came down a lot in the bank segment to 56% this quarter and we, clearly to your comments previously, have some additional cost savings. Can you think about what efficiency ratio you’re targeting from here as we think about both the higher margin and the cost savings continue to come in. are you now in the mid 50s range as a target.

[Chris Holmes:]

And I’m going to talk about the two segments versus overall. So if you go back the last quarter, we were [indiscernible] maybe last quarter. And so that banking segment has been consistently trailing down, we said it would and it has. And we knew when we [indiscernible] so we had two months, this month so that got down to 56, just little over 56%. And so our 55% - we will achieve that we've set – what we said was first goal was to try to get it under 60 and as soon as we get under 60, the next goal would be to get it under 55. So we think we’ll achieve that sooner rather than later. And then we will continue to drive it from there. We haven’t named any other target other than to get it under 55%. But we’re going to continue to drive it down. That will continue to be a focus. We’re still actually improving some operating processes and some reporting from the core conversion that we did in 2016. And then we’ll continue to - we’ll get to the stated cost savings out first quarter ’18, but as we continue to get refined operations from our combination will Clayton that will help as well. So ’18 should be a year, where we really holding our operating model, feel like we’ve got appropriate measurements and accountabilities to consistently improve that.

[Catherine Mealor:]

And then one more question on the margins. So if we look at the contractual interest rate on your kind of core loans that went from 463 to 508. Can you just walk us through that increase, I'm assuming a lot of that is just from Clayton Banks coming over at a higher yielding loans. How much of that came from the June hike and then just help us directionally think of where that can move to. Are there factors that could bring that lower with dynamics in Clayton or is that a level that you think can continue to grow assuming we're in a higher rate environment?

[James Gordon:]

Catherine, this is James. I think the majority of the movement came from mix. So we probably had seven or eight basis points pick up because of the rate movements as we've seen over the last couple of quarters from that, kind of the legacy First Bank side, so most of that was driven by the direct yielding portfolio brought over from the merger. It will have some upward movement with one more month of them being included in the margin going forward. I don’t think we’ll see a whole lot more movement up in the near term from the rate environment. It seems the competitive pressures are pushing our loan pricing in some areas and not in others. We still see a lot of longer term fixed rate commercial product in five, seven, and even ten years in 3.5% to 4% range to pressure that. So I think all have balanced that 508 will be roughly the run rate going forward. And obviously that strips out the a lot of the noise from non-accruals.

[Catherine Mealor:]

Got it okay.

[James Gordon:]

It should settle in a little bit higher than that but not a lot higher.

[Catherine Mealor:]

And then as we think about over time, I mean over time as we model your margin, I mean that rate, you're clearly not growing, you’re not growing incremental loans at a rate higher than 5% right now I presume. So over time, I would assume that that starts to kind of compress and normalize as your loan portfolio grows and becomes I guess less weighted towards Clayton’s higher yielding asset classes, is that a fair assumption?

[James Gordon:]

Yeah, I think that's a fair assumption. I think you got it correct.

[Catherine Mealor:]

And lastly just on mortgage, can you help us, fourth quarter we understand it will be seasonally lower. But can you kind of help us think about how you’re thinking about mortgage volumes and margins as we move into next year.

[James Gordon:]

I’ll start by saying good execution on mortgage by our team in what we have planned to this year. And we have planned for volumes to be down in some of our delivery channels picked up by the corresponding channel that’s been executed well. We’ve seen a little lower margin in the mortgage business this year. And a lot of it next year, seasonally we’re going to be down fourth quarter, we’ll be down in the first quarter. But in terms of growth expectations. A lot of that is going to be tied to what happens with rates and what happens – just what happens with rates. Wib is on the call, Wib Evans and Wib I’m going to let you comment further on just that we’re thinking about our next year for mortgage, what we’re thinking.

[Wib Evans:]

So Catherine what I would I tell is that we continued to develop our corresponded channel and so we will see that line of business up a little more than others. For the most part we expect 2018 to be relatively flat to slightly up on most of our channels. We’ll focus on the retail side; we’ll be focused on our footprint business. And so we’d probably see a little bit of growth in that. But for the most part, we’ll slight to relatively flat.

[Chris Holmes:]

Really similar to this year.

[Operator:]

[Operator Instructions] It appears our next question comes from David Eads with UBS.

[David Eads:]

Obviously you're talking about a really good organic loan growth this quarter. You also mentioned if you look at loans plus loans held for sale, the loan deposit ratio is now at 96%. Can you just talk about to how high you’re comfortable of that going and sort of where you think the trajectory for organic growth on loan side and the deposit side goes from here?

[Chris Holmes:]

Sure. Good questions. And we've been thinking about that a lot recently. So we have historically guided for 10% to 12% and we’ve been over that 12% for most of the year, pretty much all the year. And that held through this quarter. As we think that loan growth going forward, that 15% roughly where we are is not something you're going to see the next couple of quarters. We're going to be back in that range and probably even the lower end of that range. If we had to guess from a few things. One is exactly what’s mentioned, loans to deposits are now quite higher. Keep in mind that 96% does include our held for sale portfolio. So if you interpret that held for sale portfolio out, it’s 84%. So we’re not concerned about that. Because of the held for sale portfolio, we could take it higher, we desire to take it higher, but this is getting to a range where we feel pretty comfortable and we feel like our probability is good. There are two or three other factors I think that’s impacted over the next couple of quarters. One is just the continued integration of Clayton in the American City, so that, as you do that, typically you will create some payoffs in there and so we will likely experience some. It is just a reality of what happens whenever you’re merging -- combining two companies together. Second one is just the credit environment. The credit environment has been really good. We're fortunate to be in really good markets. The fact of the matter is things are a little racy out there in some places. And while we may be driving a Ferrari that we can drive down the highway at 120, we think going the speed limit is very prudent right now and so we are choosing to make it go a little slower than some others, because we think that 10% to 12% is a responsible rate, given kind of what we see in the credit environment. So that’s going to come from some higher standards there on the credit side. We also mentioned the regulatory guidelines. We’re going to stay within our 100% on construction. We're getting closer to that. We’ve got plenty of room on CRE guideline, but we're getting closer on that 100% risk based capital on construction and so that’s another place where we are cautious and aren’t doing as much as we have been. And then you've got the natural seasonality that hits in the fourth quarter, we’re thinking it will slow down on the loan side and on the first quarter, things are – sometime, it will start the year a little slower. So we think the 10% to 12% is going to be a much better range for the -- at least for the next couple of quarters and maybe even beyond on that. Also just maybe on the deposit side, deposits are a strength for us. The market right now has gotten quite competitive and we’re faring well. So -- but we want to continue to fare well, but we think that pricing is going to get even more competitive. It's been a while since we've emphasized deposits over loans. And if you go back just two quarters ago, we were 70% on our loan to deposit ratio, if you just considered our held for investment portfolio, we were at 70%. So it’s been a while since we’ve got to emphasize deposits over loans and so that’s as we begin to stretch some muscles that we haven’t had to stretch much lightly, that will take a little time. So with all of these things, we think that the margin -- we feel pretty good about the margin. They’re actually quite good, the margin in our business, but we also want to be realistic on the derivative side of our business and we think we’re going to continue to grow at really good rates, but probably about 15% on the loans side and then we’ll be ramping up on the deposit side.

[David Eads:]

That’s very helpful. Maybe, can you just elaborate a little bit on the credit comments you just made, I mean, things are getting a little bit racy. I mean is that mostly in theory, in multifamily or is there any more broad or kind of where exactly are you seeing some kind of pricing conditions.

[Chris Holmes:]

There's nothing specific that’s urged that comment and so don’t read any more into it than I mean, it's just -- when you get into expansion, it's just been for the longest expansions in history. We've seen a lot of real estate and continue to see a lot of real estate loans being made, whether that’s multifamily or just office or whether it's hospitality or anything else. And so, what we will see is particularly on the terms, we see pricing getting really thin. We’re seeing maturities getting longer. We see a little bit of things that you typically will see. We will see relaxation of personal guarantees for instance, which is -- can be a hot button for us. And so, we see more and more of just all of those things that calls us to back office some opportunities that we could -- frankly we could get, but we just backed off just because of typically those terms.

[David Eads:]

All right. Thanks. And just quickly on the other consumer loans, now, it’s about 7% of the total loan book after the deal, where do you think that's going to go, is that going to kind of trend a little bit lower, just as you're doing more origination elsewhere? Are you looking to grow that book, what should we think about that portfolio.

[Chris Holmes:]

Yeah. So, we like the segment, but it is frankly not easy to grow. The growth you’re seeing this quarter comes from our MH Retail portfolio, which we like. It's -- we have a good team in MH. I will say this, on the MH team that’s come over with the Clayton combination, we pretty much are -- Jim Clayton and Kevin Kimzey run that business. They know it really well. They’ve got a great team and we’ve been pretty much hands off and they continue to do what they’re done. We have been out with them to visit communities and frankly are impressed than when we struck the deal. And so we want them just continue to do what they're doing. That's grown a little bit, the MH Retail piece of that consumer and we like that and so we want to continue to grow it, but slowly. And Kevin and his team will do that. And then the other pieces frankly are a little tougher because they’re traditional retail and we've been growing more on the commercial side than the retail side and so that has -- that segment frankly hasn't been a big growth segment for us. We would like more. We like it, but we haven't been growing that much in the home equity segment and then just consumer loans that ranges from everything from boats to RV to cars, we haven't grown it that much, however, we like it and we’ll continue to grow.

[David Eads:]

All right. And just last one, you guys made a couple of comments about the capital position and kind of giving opportunities for M&A, so I just wonder if you could comment on how you guys are approaching M&A now that the Clayton deal has been closed.

[Chris Holmes:]

Yeah. Sure. So the M&A market is one where we continue to see a fair number of opportunities and I guess first off, saying the closing of Clayton, it is closed, that’s all right. The conversion is very important and so that’s really an area of focus over the next several weeks here, the next 6 to 8 weeks, we are intensely focused on that. We do continue to have dialogs with other companies that have approached us through one channel or another and so we're active there, we're having balance there and are actively working at opportunities. In terms of what those look like, if you go back to the criteria that we've always said, we're just doing what we said we would do there, we’re looking at things, mostly in footprint or actually in footprint that could expand our footprint some if we did them, but that would be because we got something in footprint that also had something outside of our geography. We're looking at banks that have solid deposit franchises. We’re looking at things that are accretive to both earnings and capital and that's -- those are really the things we look for. Operating leverage is important to us. We want to generate operating leverage with, as we consider acquisitions.

[Operator:]

[Operator Instructions] It appears we have no other questions in the queue at this time. I would now like to turn the conference back over to our speakers for any additional or closing remarks.

[Chris Holmes:]

Okay. Thank you, everyone for joining us on the call. Thank you to all of you that had the questions. We appreciate your interest in FB Financial and we look forward to updating you on our status again next quarter. That’s it.

[Operator:]

That does conclude today's conference. Thank you for your participation.