FB Financial Corporation (FBK) Q2 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to FB Financial Corporation Second 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 the 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 call 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 presentation over to Mr. Chris Black, FB Financial's Senior Vice President and Director of Strategic Finance. Please, go ahead.

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 a result -- 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.

Thanks, Chris and good morning. Thanks for joining us on this call to review our results for the second quarter. We appreciate your interest in FB financial. On today's call, I want to review the highlights of our second quarter, and then I'll turn the call over to James Gordon, our Chief Financial Officer, who will review our financial results in more detail. After James' comments, we'll open up the call for your questions. We're very pleased to report excellent results for the second quarter of 2017. We hit or exceeded many of our key goals for the quarter. I want to highlight our strong team across FirstBank that continues to deliver the service that our customers have come to expect. And they are the key in delivering our positive results for the quarter. We reported record loans and deposits, with good growth in loans and continued stability in deposits. The core margin remained above our long-term guidance. Mortgage execution was very positive in the face of less than favorable -- less -- in the face of a less favorable market than in comparable quarters, and the efficiency of the core bank improved. Also I want to highlight our excitement about the pending acquisition of the Clayton Bank that will expand our presence in Tennessee both in new and existing markets, and we remain on track with an expected close of the transaction at the end of the month. We're pleased with our loan growth for the quarter. Our loan growth accelerated in the second quarter and was up to 14.8% annualized on a linked-quarter basis, which is above our long-term range of 10% to 12%. We're pleased not with just the pace of growth, but also we had balance across our markets and balance across all of our loan categories. Our total deposits grew 8.5% year-over-year and we're up 3.9% on an annualized basis for the first quarter. One of the company's greatest assets is its strength and stability of its deposit base and I think this quarter's results demonstrate that. Our current market dynamics for deposits remain challenging and competitive. We've been working with our team on various measures to continue our growth while maintaining our low cost of funding. The industry is going to face funding challenges in the coming quarters, and this is one of our key advantages as we move forward. Our net interest margin was 4.9 -- 4.19% for the second quarter. When excluding accretion on acquired loans our NIM was 4.08%, which is above our core NIM target range of 3.85% to 4.05%. We're focused on deploying our relationship-based balance sheet to serve the needs of our customers, which maintains a strong NIM. James will discuss the NIM in more detail during his comments. We continued to improve our efficiency ratio, one of the key long-term objectives for the company. Our consolidated core efficiency ratio was 70.2% and our banking segment core efficiency ratio was 60.4%, which is basically at our short-term target level of 60%. And we wanted the bank under 60% and then we said we would reset the goal to 55%. With the Clayton closing, that will further improve our efficiency ratio. We'll set a more thoughtful and aggressive goal following the conversion and immigration in the fourth quarter. Our mortgage operations had a great second quarter and benefited from seasonal growth in contributions from all the channels, including consumer direct, third-party origination, the retail end correspondent. In line with our plans, we executed on our shift in the mix of our mortgage operations to increase purchase money as well as bring the correspondent channel to full production. In keeping with the plan, I'm pleased that the bottom line contribution and the overall profitability of the mortgage team continues and we continue to focus on quality initiatives, efficiencies and generating incremental operating leverage out of this business. We also reported continued improvement in our asset quality metrics, which continue to reflect the strong characteristic of our customer base and our market. We've received all the regulatory approvals for the pending acquisition of the Clayton Banks. Our special shareholders' meeting to approve the transaction is scheduled for this Friday. We expect to close the transaction on Monday, May 30-- July 31. We are more impressed with the cultural and business synergies that we've developed and continue to develop with the Clayton Bank folks and the existing FirstBank team. We look forward to wholeheartedly welcoming them at the -- to the FirstBank family in the coming days. Also of note, in connection with the Clayton transaction, we raised $152.7 million in net proceeds from the sale of 4.8 million shares of common stock during the second quarter. James will also add more about this in his comments. With that overview, I want to turn the call over to James to review our financial results in more detail.

Thanks, Chris, and good morning, everyone. First I want to highlight our core result shown on Slide 3. Our diluted core earnings per share were $0.49 and core net income of $12.9 million, which compares to pro forma core net income of $10.3 million last quarter. Our core return on average assets rose to 1.61%, and our core return on average tangible common equity was 13%. On Slide 4, which shows our pro forma, GAAP reported return on average assets increased 48 basis points since 2013 to 1.32% for the first half of 2017. This graph demonstrates the strong and consistent growth in our profitability that we have achieved over the last 4 years and that we continue to deliver this quarter with the 1.40% core return on average assets, this was up 9 basis points on a linked-quarter basis. The bottom half of Slide 4 shows the key drivers to our profitability. The first graph shows our loan-to-deposit ratio, which has continued to shift with a higher percentage of loan set for sale at 16% and our loan sale for investment at 72% as we have steadily leveraged our core deposit franchise. Our net interest margin continues to be at or above our long-term targets and we continue to work through the challenging interest rate environment. Noninterest income increased 14.7% from the previous quarter, driven by expected seasonal growth in Mortgage Banking income. And finally, our nonperforming assets to total assets was down 20 basis points to 58 basis points from the second quarter last year. Next, and looking at Slide 5 at the outline of our historical yields and cost, as detailed previously, we had another healthy period for NIM, which was 4.19% in the second quarter. Adjusting for 11 basis points in accretion benefit, our core net interest margin was 4.08%, slightly above our long-term targeted range of 3.85% to 4.05%. Our total loan yield was down 25 basis points from the first quarter due to a 3 basis point decline in the contractual rate of loans, 8 basis points on loan fee, 7 basis points of accretion on purchased loans and 6 basis points from syndication fees. Our cost-to-deposits remained -- remains a strength for the company, increasing only 2 basis points in the quarter to 34 basis points, implying a minimal deposit beta at this point. Giving our -- given our 26% noninterest-bearing deposit composition, we expect deposit betas to continue to remain low while we're expecting slight upward pressure as the market continues to adjust to the upward movements at the short end of the curve, given recent Federal Reserve rate hikes. As a team, we remain very focused on our funding structure and view that as a strength. On an overall basis, our loan deals haven't moved with -- move or benefited from the overall rate increases, due primarily to working through floors and the long-term yield curve. However, we expect to benefit in the coming quarters based on the full repricing of the portfolio, with approximately 49% of our loan portfolio now having variable rates. Overall, our balance sheet is positioned to benefit from the current rate environment from a strong deposit base and mix of earning assets. Next, on Slide 6, shows that our loans were up 12.6% to $1.97 billion at the end of the second quarter compared with last year, and we're up 3.7% or 14.8% annualized on a linked-quarter basis. Average loans rose 15.6% on an annualized basis from the first quarter reflecting the increased loan demand we enjoyed from our metropolitan and community markets. The chart at the top right of this page reflects our construction and CRE concentration levels of 86% and 184% of capital respectively, well below the regulatory guidelines, leaving room for growth as needed. On Slide 7, which demonstrates that our total deposit were up 8.5% to $2.7 billion since the second quarter of last year. This growth was due in part to noninterest-bearing deposits that were up 5.2% to $715 million from the second quarter of last year. At the end of the second quarter, noninterest-bearing deposits were 26.2% of total deposits. Our cost of deposits has remained relatively stable over the past year around 30 basis points and was up 6 basis points since the second quarter of last year. Including the noninterest-bearing deposits at the end of the second quarter, we're at approximately $50 million in mortgage servicing escrow deposits, up from $44 million at the end of the first quarter. Now turning to Slide 8, illustrating our Mortgage Banking revenues and activities for the quarter. As Chris noted in his opening comments, we had excellent -- we had an excellent quarter from our Mortgage Banking operations and Mortgage Banking income rose 20.6% to $30.2 million in the second quarter of 2017 on a linked-quarter basis and was roughly flat on a year-over-year basis. In the second quarter, our interest rate locked pipeline volume rose 35% to $2.16 billion from the first quarter, and a -- and our locked pipeline was up 22% to $547 million at the end of the quarter. This quarter's growth benefited from increased volumes across all major channels, including increased purchase volumes and from the continued expansion of our correspondent channel, offsetting declines from the Consumer Direct channel. As a percent of total volume, our purchase volume rose to 64% in the second quarter compared with 60% in the first quarter of 2017 and 42% in the second quarter of last year. One item that I want to clarify on our Mortgage Banking income, is the net fair value adjustment, which is primarily related to our interest rate locked commitment generation, the first step in our revenue generation activities within our mortgage operations. This ultimately turns into the gain on the sale of the loans in future periods, as the loans were closed and sold into the secondary market. As we reported last quarter, we elected the fair value treatment for mortgage servicing rights and this resulted in a $1.8 billion valuation decrease in the second quarter of 2017. We have now implemented various hedging strategies on an MSR portfolio which we believe will mitigate those fair value fluctuations in future periods. Our outlook for mortgage volumes for the second half of 2017 is to remain steady in the third quarter and seasonally decline into and throughout the fourth quarter. We reiterate our prior guidance for 2017 volumes to increase over 2016 on a full year basis, resulting in a bottom line contribution for the full year 2017 that is relatively flat versus 2016. Currently, we are on track on both of these targets for the first half of 2017 as we previously outlined. Next, on Slide 9, which outlines our overall operating leverage and efficiency, which continues to be a focus of improving on our operating leverage and efficiency as we move forward. As Chris mentioned, our efficiency ratio was in the low to mid-60s for our Banking segment during most of last year and improved to 60.4% in the second quarter, which we view as a positive in moving forward on our long-term target levels. Our Mortgage segment has improved over the past 3 quarters and was 78.3% in the second quarter of 2017. We expect our operating efficiency to improve as we move forward, based on the economy to scale we expect to achieve with the Clayton acquisition as well as investments we made in upgraded systems and growth from our legacy markets. We believe we have existing capacity to grow our business in our metropolitan markets, creating additional operating leverage. Our excellent loan growth this quarter highlights our opportunities to leverage our existing banking infrastructure as we move forward in future periods. We also expect to gain further efficiency in this business as we continue to fine-tune their operations going forward. Also, our effective tax rate was 36.9% for the second quarter and was in line with our previously forecast of approximately 37% for the remainder of 2017. Next, on Slide 10, our asset quality remains strong and showed improvement from last year based on lower nonperforming assets to assets, a consistent decline in classified loans and our net recovery position in the second quarter. Since the second quarter of 2016, our nonperforming assets are down 20 basis points to 58 basis points at the end of the second quarter 2017. Classified loans are down $6 million, a decrease of over 6% to $36 million during the same time period. Our loan loss reserve to loan sale per investment was 1.18% at June 30, 2017, and our net charge-offs to average loans were in net recovery position or the second quarter in a row. We continue to expect recovery opportunities to moderate but view trend as a testament to our overall team on the collection of previously charged-off loans. Going forward, we expect our loan loss reserve to loans to stay around 1.2%, excluding the impact of the Clayton Banks acquisition. Next, on Slide 11, as Chris highlighted in his comments, we completed a common stock offering of approximately 4.8 million shares during the quarter, raising about $152.7 million in new capital. I also wanted to outline our projections for average diluted and period-end share accounts over the next couple of quarters, given the moving pieces and timing of the Clayton Bank acquisition. In the second quarter we had period-end shares of $28.968 million and weighted average today shares of $26.301 million. Upon issuing Clayton Holding company 1.521 million shares at closing, we expect to end the third quarter with approximately 30.6 million shares outstanding and have weighted average shares of 30.5 million diluted shares for the quarter -- for the third quarter. Similarly, for the fourth quarter, we expect to end the quarter and the year with approximately 30.5 million shares outstanding and have a weighted average shares for the fourth quarter of approximately 31.1 million. The table on the left-hand side shows the positive effect that additional capital had on our key capital ratios. Shareholders' equity to assets rose 44 basis points to 15.2%. With all of our Tier 1 related ratios, we're up 500 basis points compared with the first quarter due to the capital raise. All of these key measures were well above the amounts required for the regulatory agencies to be a well-capitalized institution of the highest rating. With that overview, I want to turn the call back over to Chris for closing comments, and then we'll open the call for your questions.

Thank you, James. We had a very good second quarter with solid growth in loans and deposits. Our strong performance was diversified across our product areas and our markets, highlighting the strength of our franchise in Tennessee, Northern Georgia and in Alabama. As in past quarters, our banking operations continued to grow our core earnings. In the latest quarter, in addition to loan and deposit growth, we benefited from a continued strong net interest margin. We also continued to benefit from lower costs related to our stable asset quality. Our mortgage operations had a good quarter. We believe we have further opportunities to enhance the mortgage operations and to improve their efficiency. We look forward to our combining of our operations with the Clayton Banks in the next quarter. Since we announced the proposed acquisition, the First Bank and Clayton teams have spent considerable time together, and we are very positive about our potential as one bank, one team. The Clayton Banks operate in very good markets and have demonstrated their ability to effectively compete and grow their operations. We expect the combination of our markets, our customers and our associates to be significantly additive to our results. We believe they will be a solid contributor to building shareholder value going forward. We appreciate your interest and investment in FB Financial. We look forward to updating you next quarter on our progress in integrating with the Clayton Banks and our expectations of continued growth in the second half of 2017. Operator, this concludes my remarks for the morning's call, and we would like to open the line for questions.

[Operator Instructions] And we'll go to David Eads, UBS.

Maybe if we start on loan growth, really good quarter, it seems like the growth is pretty broad based. I think, James, you mentioned higher demand, can you just kind of talk through us some of the more specifics of what was causing -- I mean, is it just increased enthusiasm by customers? Or is there anything else going on that caused demand to pick up this quarter?

Yes, David, good morning, this is Chris. And I don't think it's -- you've heard us say 10% to 12%, and if it's above that we don't get terribly excited -- If it's above that by a couple percentage points, we don't get terribly excited, and if it's below that by a couple percentage points, we don't get terribly upset because we've been in that range for a long time. And so when we look at anything specific, I'd say it's pretty much -- it's not specific, I think it's across the board with all types of customers, all types of markets and all types of products. There -- we have had some construction lending that has occurred over the last, I don't know, probably 4 quarters and we've had some draws on that. That helps some when you get some of those, but other than that, it's pretty normal activity that's broad-based across existing customers, it's adding some new customers. Again, there's some CRE in there, there's actually quite a bit of C&I in there, there's some construction draws in there, and let's say, it's come across -- we've seen it, primarily driven by our metropolitan markets. And Nashville really leading the pack, Memphis has also had a really good year. And then we have -- and then our community markets probably had a better second quarter than they did first. So does that help? James, you had any other color to that?

Frankly, it's just been across, and I think that's demonstrated by the mix of the portfolio, stayed relatively unchanged by categories over the quarter.

I would also -- a lot of the times you'll hear the word chaos interjected, usually not when you're talking about growth like this, but we've -- we get payoffs just like everybody else and we factor that in when we talk about those -- that normal 10% to 12%. And we had some payoffs during the quarter as well. So, I'd say, it's -- and we'll get some next quarter, so it's just a normal part of the business, but we have those mixed in there as well.

Right, and that's helpful. Maybe just kind of staying on that payoff point, you talked about the construction growth, is that -- you expect that's going to continue at sort of a similar pace? Or is there going to be a point where you kind of come to the end of draws and maybe some of those get refinanced elsewhere and you might have a -- have that growth kind of turn around a little bit?

Yes, it certainly could. We've got a couple of projects, I guess, that -- specifically, that started growing up that I can think of in the second quarter, and so had draws throughout the second quarter. But again, it's a normal part of the process. And when we think about the pipeline, we're adding some today as well that won't start growing until third or fourth quarter. And so, again, the 14.7%, 14.8% is a little above what we have typically run but it's -- but the pipeline remained pretty good. And so I don't see that as being where we have a big tumble down the road because, I'd say, it's pretty steady. We have seen, I will say, in a marketplace, banks are a -- perhaps more -- ourselves, we've been this way, a little more cautious on construction, particularly with certain asset classes. And so -- and we've seen now that from some other banks that are, I'd say, as cautious as we are there. And so you could see some slowdown in the marketplace, but our pipeline is fairly steady. Again, no big bubbles in it and no great depressions in it.

Great. Now maybe moving over to NIM, couple of moving pieces this quarter. You -- the core NIM is still a touch above the guidance range, can you give us any sense of where that might go from here? It sounds like you might have a little bit of upside from the June rate hike and maybe a little bit just higher levels from the loan syndication fees and what have you. So is there potentially a little bit of upside? Or how should we think about that next quarter?

Yes, and I will comment first on -- that our -- that contract rate as -- and of course, I'd say, we disclosed quite a bit of information there just -- and so you -- to dissect that. It's helpful to us, and we think it's probably helpful to you. And so as we -- we haven't seen -- and we get -- we've been asked about this not only on these calls but we get asked about this a lot, as to what are you seeing in terms of the impact of the rate increases? Particularly -- we probably get asked more on deposit betas than anything, but if you think about loan -- the loan side, it's not unlike the deposit side, and frankly, we haven't seen a lot of that translate -- the rate increase, we haven't seen a lot of that translate into dollars of more interest income. That being said, we have seen, particularly with the last increase, a little more of at least -- and I have to give this almost anecdotally because we don't have the numbers, we feel like we're seeing a little more upward movement in contract rates, just hadn't shown through on the numbers yet. And -- but we do think that there is some upside, and I don't want you to go -- I don't want that to relate to -- to cause you to go running away in jubilation, but we do see some upside there in the coming quarters on both the loan side, on the interest income and the rate that we get on the loans, if we look again at what's coming down the pipe and if we just kind of a look at the trends monthly. But we also see some increase in the cost of deposits. We've kept the cost of deposits, we were up only 2 basis points for the quarter. So we see some increase in the cost of deposits, so we do see the rates translating to now the both increases in our loan yield but also our deposit costs. James?

Yes, I would say a couple of things on that. As we burn through the floors, which were now down to around $50 million in floors that are in the money, if you will, that' down from $300 million a year ago when all the rate increases started, so we burned through most of that. And I think the initial response to rate increases are a little bit of tightening in spreads, which has happened on the variable rate side, but we -- as the portfolio is fully repriced now with roughly 49% in the variable bucket, we should see some lilt in that loan yields and the 5 to 10 basis points in the coming quarters, based on the period-end weighted average rate of the outstanding portfolio. Some of that will likely be, as Chris said, eaten up by some trends upward in the deposit cost, but net-net that should benefit the net interest margin. Then the second opportunity just to -- it's -- all of that's on kind of a FirstBank stand-alone basis, so obviously, we're -- we'll be blending in the Clayton Banks this quarter. And with their higher-yield portfolios, slightly offset by our higher cost of deposits, we still believe that could have a 10 basis point pick up on the overall NIM expectations, relative to our 3.85% to 4.05% range that we're giving. So I think a couple of opportunities there to continue to move that forward and take advantage of the rate environment that we're in.

[Operator Instructions] And we'll next go to Catherine Mealor, KBW Investments.

Maybe just 1 follow-up on the loan yields. Can you update us or to quantify the percentage of your variable rates that are impacted by floors? And how many more hikes we need to see to grow farther through that?

Okay, Catherine, on -- at the end of the quarter, we had about $50 million in floors and some of those are much higher floors. So we've pretty much eaten through the floors at this point, so they'll be a relatively nonfactor going forward. As long as rates continue to move forward, it would be a slight benefit as they -- if they move forward in a significant way. But it'll take another 75 basis points or something on those floors, those are kind of what I call the core kind of floors that are left so a very minimal impact going forward on that front.

Okay. And then 1 question on the mortgage margin. The gain on sale margin declined this quarter as we've been expecting, just given the mix shift that you're seeing in the correspondent business ramping up, but can you -- can I take us a bit back and think about that gain on sale margin? And is it mostly just on the mix shift? Or are you also seeing overall pressure in just mortgage margin overall as well?

Yes, Catherine, Wib Evans, who is here with us, and I'm going to let Wib address that.

Okay. Just can you let...

Yes, so, Catherine, what we're seeing -- yes, Catherine, we have seen a little bit of pressure on the margin, since year-end especially, and I would say about a quarter of that margin compression is due to that, the rest of it is due to the mix on the correspondent growth.

Okay. And so, really, if you think about your forecast staying the same, it feels like you're getting just a really more -- even though your margins are compressing, you're getting a little bit more volume and so all-in bottom line is feeling good? Or is it more on the expense side that's keeping your bottom line contribution flat year-over-year?

Well, a little bit of both. Obviously, with March compression on most of our senior channels or legacy channels, we're experiencing a little bit lower profit margins on those channels. But our correspondent business continues to ramp up and we just started that mid-last year. And so as we do that, our expense level is going to be a little higher. Also, margins are lower on that business and so you'll see -- it takes -- we've had some falloff in our Consumer Direct business and expect to continue to see that throughout the rest of the year. And so I think the guys -- as James mentioned, we expect to be flat year-over-year, relatively flat year-over-year on the profit side yet volumes to be up a because of that correspondent growth.

And I just want to comment, one follow-up comment on that because I think it's significant by these -- by the mortgage and the whole management team, but late last year, there was a lot of conversations about declining mortgage volumes and what -- and the impact that, that would have. And we spent some time talking about the correspondent channel, which we brought on in 2016, ramped in the second half of 2016 and into 2017, and said we thought that, yes, volumes in existing channels would be down some but that, that volume should make up for that and keep us reasonably close on a contribution basis for mortgage. And the reason I highlight that because that's exactly what the team has executed. And so bringing that on had the desired effect. And then the shift, also a very conscious shift to more purchase money versus refinance, again, which -- and has caused a decrease in the Consumer Direct or the online channel for us. And so good execution on what the team had planned to do, going back to mid- '16 and keeping that contribution relatively consistent. And we also said that, that was the goal versus having -- we've had 2 or 3 years -- 4 years, I guess, of pretty rapid growth in the mortgage department, and it was to continue to focus on some quality initiatives, continue to focus on some efficiency initiatives and so that team is executing well.

[Operator Instructions] And there appears to be no additional questions in the queue at this time.

Very good. Thank you all for joining us. We appreciate your support and good quarter, and we look forward to the next one. Thanks, everyone, have a great day.

And that does conclude today's conference call, we thank you all for joining us.