FB Financial Corp

NYSE:FBK

Earnings Call Transcript 2018-Q2

[Operator]

Good morning and welcome to FB Financial Corporation’s Second Quarter 2018 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 also be available during the question-and-answer session.

Please note FB Financial’s earnings release, supplemental financial information 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 90 days. At this time, all participants have been placed in a listen-only mode. The call will be open for questions after the presentation.

During this presentation, FB Financial may make comments which constitute forward-looking statements. All forward-looking statements are subject to risk and uncertainties and other facts that may cause actual results and performances 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 reconciliation of 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. Please go ahead, sir.

[Chris Holmes, President and Chief Executive Officer]

Thank you very much, Carla and good morning. Thank you all for joining us on this call to review our results for the second quarter of 2018. We appreciate your interest in FB Financial. On today’s call, I will review the highlights of our second quarter and then I am going to turn the call over to James Gordon, our Chief Financial Officer, who will provide additional commentary on our financial results and that will be followed by your questions.

We are pleased with our results for the quarter, but even more energized by our long-term outlook and the consistency of our team in executing our plan quarter after quarter and year after year. Our team was able to balance strong growth in revenue, loans and deposits, while delivering peer-leading margins and controlling expenses. We grew our HFI loans by 21% annualized from the first quarter and our customer deposits by 17%. The growth came with a 9 basis point increase in our contractual loan yield for the quarter and only a 7 basis point increase in our deposit cost. This led to another net interest margin increase to 4.81%. Adjusting out the benefit of accretion and non-accrual interest collections which is how we measure ourselves internally, our adjusted NIM was 4.61%. With this growth in balances and margins, our adjusted return on average assets climbed to 1.91% and our return on tangible common equity to 19.6%. We are very proud of these numbers and we believe that they show just how exceptional our bank can be.

There are few other things I want to highlight. Next week, we celebrate the 1 year anniversary of closing the Clayton Bank’s merger. When we announced that transaction back in February of 2017, we laid out all the customary financial metrics for our industry like EPS accretion, tangible book value dilution, cost savings, etcetera and all of these were very positive. The transaction actually turned out to be better financially than we had originally modeled with profitability, cost efficiencies and conversion synergies, all surpassing what we had envisioned. Both such shareholders have reaped the benefits and we have multiple quarters since the close to reinforce that our original vision is now a reality. We learned a lot during the integration and have examples where our partners from the Clayton Bank have brought new strengths to the combined company and they have also brought resolve in some areas where we didn’t measure up or we needed to improve. Together, we followed through on our plan and the combined team executed the conversion and integration plans, while continuing to meet challenging growth and profitability goals.

Also this quarter, our mortgage business represented 10% of the company’s adjusted pre-tax income, which is down from 30% in the same quarter last year. This is largely the result of the growth of the bank as the bank’s pre-tax contribution, excluding mortgage retail operations has more than doubled since the second quarter of last year. This is consistent with the plan we laid out in late 2016 growing our bank segment faster than our mortgage segment to maintain a total mortgage pre-tax contribution in the 10% to 15% range.

Our capital generation with our earnings enhanced by the recent federal tax reform continues to support our balance sheet growth and payment of our dividend as we reported tangible common equity to tangible assets at 10.1% and total risk-based capital of 12% for the quarter. Our capital generation gives us flexibility to continue growing our shareholder value through acquisitions, through return of capital to shareholders or through faster organic growth. In the second quarter, we also completed $152 million secondary offering of Mr. Ayers’ shares. With the sale of those shares, his ownership sits at approximately 44% and will likely be there for a while unless it’s diluted through from issuing stock in an acquisition. Mr. Ayers’ involvement in the company has not changed since as a result of the offering.

We believe we have a great foundation that’s hard to replicate and that we can continue to build on. We are in great markets with a great presence in those markets. We have a strong operational backbone and a delivery network with some density throughout our markets and we have an organizational structure, a business model and a workplace that’s very attractive to talent. On that note, we are excited to announce the expected addition of between 12 and 15 revenue producers over the next few weeks. We are bringing on these customer-facing folks in some of our key markets like Knoxville, Cookville, Huntsville, Alabama and Florence, Alabama and into our FB investment advisory group. We look forward to welcoming these folks to the FirstBank family and anticipate meaningful contributions from them in the years to come. When taken together we think all of these factors provide us maximum optionality enabling us to grow organically, to be opportunistic on potential M&A and to evaluate and execute more strategic M&A opportunities if and when they get presented. Simply put, we like our position.

With that overview, I want to turn the call over to James to review our financial results in some more detail.

[James Gordon, Chief Financial Officer]

Thanks, Chris and good morning everyone. First, I want to recap our exciting operating results for this quarter as highlighted on Slide 3. Our adjusted diluted earnings per share was $0.72 on adjusted net income of $22.7 million, delivering an outstanding adjusted return on average assets of 1.91% and an adjusted return on tangible common equity of 19.6%. Our year-over-year performance was driven by organic growth, the Clayton Bank’s merger and the benefit from the enacted tax reform allowing net income to almost double.

Slide 4 illustrates the underlying fundamental trends of the company’s profitability and demonstrates the consistent performance that we are delivering. Our adjusted return on average assets has risen to 1.85% for the first half of the year as we continue to achieve strong and consistent growth and profitability. This profitability improvement has been driven by a balanced loan growth, a strong margin supported by our low-cost customer deposit base, stable non-interest income, expense control and sound credit quality.

Slide 5 presents the fundamental elements of our strong net interest margin, in particular, our healthy loan yields, fees and low cost core deposit base. Our net interest margin reflects the collective efforts of our team to deliver exceptional service and value to our customers for whom we serve as trusted advisors everyday. As you can see, our net interest margin again was benefited by about 20 basis points of accretion and nonaccrual interest collections. Our base NIM was above our long-term range, which we are now increasing to be in a range of 4.25% to 4.50% to reflect our current expectations. We expect to settle back into that range in the coming quarters as deposit costs pick up due to the current competitive environment in a rising-rate environment also with improving loan yields also benefiting from the rising rate environment. We do remain confident that our balance sheet is well positioned for rising rates overall, and our emphasis on customers deposits will continue to be a strength.

Moving on to the next slide and as Chris mentioned previously, we had outstanding loan growth this quarter, well above our long-term 10% to 12% target range. We certainly don’t believe that 20% will be a new normal for us, and you should see us fall within our 10% to 12% guidance range in future quarters. And given where we are on our loan growth year-to-date, we do expect our full year of growth rate for 2018 to be slightly above the range before settling back in future periods. Our objective remains consistent, profitable and relationship-driven growth, not merely focusing on hitting the quarterly target. However, the permanent CRE financing markets continue to be robust, and we have, and could see continued unexpected repayments in our CRE portfolio. Noting our concentration levels in the top-right corner, we did jump above the 100% construction and development ratio this quarter. While growth in our construction and development portfolio certainly is a factor, disallowance of our growing mortgage servicing asset also played a role. At this point, we are under a Letter of Intent to sell down our servicing assets below our 10% Tier 1 capital limitation, which should free up about $25 million of risk-based capital at the bank, and on a pro forma basis cuts us back down below 100% on capital guidance thresholds. We remained committed to staying in line with the regulatory guidance of 100% on construction and development loans and 300% on CRE loans over the long term.

Now moving to Slide 7, our customer deposits were $3.8 billion, up 41% from the second quarter of last year and up 17.3% on an annualized basis from the first quarter of 2018. We benefited this period from some larger customer deposit inflows, including some of the proceeds from our recent secondary offering. These larger accounts along with the previously disclosed short-term deposits related to our merger, which contributed approximately $8 million in net growth this quarter, could cause some variability in deposit balances going forward. Al-in, we saw a 7 basis point increase in our cost of total deposits this quarter, equating to a beta of 28% relative to the 25 basis point increase in the fed funds target rate during the quarter. As we continue to focus on growing customer deposits in this competitive environment, we expect additional near-term expansion of our deposit betas but we are confident that our steady low-cost funding base will remain a key strength.

Now turning to Slide 8, our mortgage segment contributed $1.9 million pre-tax in the second quarter, and our total mortgage operations contributed $3.2 million when our retail footprint is included. This represents 10.4% of the company’s adjusted pre-tax income. It is down from 29.6% in the second quarter of 2017 and is in line with the 10% to 15% target range that Chris mentioned earlier. Our interest rate lock commitment volume declined to $2 billion in this quarter compared to $2.1 billion last quarter and $2.2 billion during the second quarter of last year. Competitive pricing pressure particularly in the correspondent channel are weighing on both volumes and margin. Our margin was up this quarter due primarily due to change in mix from consumer direct to our retail and TPO channels.

Towards the end of the quarter, we entered into a letter of intent to sell approximately $3.3 billion of loan service with no material impact. We expect this transaction to close during the third quarter. However, the impact of MSR sales also has an anticipated reduction of approximately $30 million of non-interest bearing deposits associated with mortgage escrow account balances. Including the impact of the planned MSR sales, we expect our total mortgage pre-tax contribution including the retail footprint to total between $5 million and $7 million during the last 2 quarters of this year compared to the $9.7 million of pre-tax contribution or down roughly $3 million to $5 million year-over-year that we had in the second half of 2017. This is a further revision to the previous guidance provided in May due to continued volume and margin pressures. However, we also believe that our additional growth this quarter and continued NIM expansion will help offset the lower mortgage contribution over the last half of 2018.

Next, our operating leverage this quarter improved from the prior quarter, moving closer to our near-term goal of 50% for the banking segment. The quarter-over-quarter improvement from 55.2% to 51.7% in our banking segment efficiency ratio was driven by a strong margin, expense control and strong organic revenue growth allowing us to realize increasing operating leverage through scale. However, the addition of the new teams Chris mentioned earlier, may slightly impact that in the near term. Our mortgage segment’s efficiency ratio was relatively flat quarter-over-quarter and is higher than we would like. We have made and are making incremental moves to improve profitability, both revenues and expenses. We don’t currently anticipate any transformational move but rather expect the mortgage efficiency ratio to improve over time as we continue to institute operational efficiency. Our effective tax rate of 26.1% for the second quarter was higher than the first quarter as we did not have significant deductions related to equity compensation, and we also had the impact of the nondeductible secondary offering expenses. Together, these items resulted in an adjusted effective tax rate of 25.5% for the second quarter. As previously disclosed, we continue to believe our full year 2018 effective tax rate will be in the 24.5% to 25.5% range.

As shown on the Slide 10, our asset quality remains sound and provides a strong foundation for our company. NPA to assets decreased for the quarter, as we grew organically and continued to observe enhanced environment. Our loan portfolio remains solid as evidenced by our nonperforming loan HFI ratio of 26 basis points, which is down 4 basis points from last quarter. Next, our capital levels remain strong enabling future growth both organically and through strategic acquisition. Our capital structure remains relatively simple, giving us flexibility as needed to potentially add non-common equity sources. Since the first quarter after our IPO, our tangible book value per share has increased by $4.10 or 35.5% to end the quarter at $15.66 per share, driven by our strong financial results and the accretive merger. As mentioned previously, we were penalized in capital for our large mortgage servicing assets. We have already mentioned our planned sale this quarter should eliminate the deduction above 10% of Tier 1 capital and we estimate that this will free up approximately $25 million of risk-based capital during the third quarter. Lastly, we are pleased to be able to return a portion of our shareholders’ equity in the form of continued quarterly dividend of $0.06 per share, which represents a payout ratio of approximately 9%.

With that overview, I want to turn the call back over to Chris for closing comments and then we will open the call for your questions.

[Chris Holmes, President and Chief Executive Officer]

Thank you, James. We had an outstanding second quarter, continuing to deliver balanced growth and profitability. Our strong performance exceeded our growth and profitability targets and was diversified across our businesses and our markets highlighting the strength of our franchise in Tennessee, Northern Georgia and Alabama. We appreciate your interest in investment in FB Financial and look forward to updating you next quarter on our expectations of continued growth.

Operator, that completes my remarks for this morning’s call and we would now like to open the call up for questions.

[Operator]

Thank you very much, sir. [Operator Instructions] We will now take our first question from Catherine Mealor from KBW. Please go ahead, madam.

[Catherine Mealor, KBW]

Thanks. Good morning and great quarter.

[Chris Holmes, President and Chief Executive Officer]

Thanks, Catherine. Good morning.

[Catherine Mealor, KBW]

Good morning. So, my first question is just on the growth, because the end-of-period growth was obviously fantastic this quarter. Can you just give a little bit more color of what drove it? It seems like it’s really coming more in the Nashville markets and seemed to be a little bit concentrated in the C&I and construction loan portfolios, so just any color about that growth and are there any larger balances within that that also really drove the growth this quarter? Thanks.

[Chris Holmes, President and Chief Executive Officer]

Yes, Catherine. You did note that more growth was towards the end of the quarter, even in one case, on the last day of the quarter and it was driven so actually driven across the geography and across loan types. A portion of it, we had big contributions and one of the things I would say that was really, continues to be exciting for us is Nashville has been – Nashville’s economy has been great for a number of years and Nashville has pretty much pulled the train. It’s been the engine that’s pulled the train for us in growth. And it continues to perform really well and the economy continued to perform really well and it continues to pretty much hit on all the cylinders, but we had really good contributions from other markets as well. We had a really big contribution from – and it was a larger transaction from our Memphis market. We also had one from our Chattanooga market both larger transactions.

So to answer your question, we did have a couple of larger transactions for us in there and large for us in terms of balance that would be something in the north of $20 million, but we don’t do much at all that gets above $30 million, so it would be in that range. And so we had a couple of those during the quarter. And so it’s spread around – and its spread around geographically. So, again those are good signs for us. We are at that size – and I will say this on growth, because we like to perform consistently in that – in a double-digit loan growth and we want to be over 10%. We said we think we can continue to do that. Our size, we are fully capable if we really like the transaction of doing a $30 million transaction and that really helps our growth numbers, but that is still way, way short of our legal lending limit. We feel like doing that. We are still keeping a good diversification in avoiding too much concentration on any one credit. So that did help in the quarter.

[Catherine Mealor, KBW]

Okay, that’s helpful. Thank you. And then want clarity on the mortgage guidance, so does the guidance for the back half of the year include any either positive or negative swing in the fair value of the locked pipeline kind of what we saw this quarter or is that – or was that what is driving kind of the lower I guess the additional guide down in the annual mortgage guide this year? Thanks.

[Chris Holmes, President and Chief Executive Officer]

Well, Catherine, we really don’t estimate the swing in the fair value of the pipeline. The income has driven up really the combined on the interest rate lock commitments. We do breakout the gain and that change in the fair value to provide a little more clarity on the gain on sale margins, but really the income has built up the interest rate lock commitment. The fair value change is really driven by the end-of-period pipeline balances and if you noticed our pipeline was down from quarter-to-quarter, so that causes the majority of that swing. So, the short answer is yes, that’s included, because it’s really based off the interest rate lock commitment forecast over the last half of the year. The component between gain and that fair value really is more of a timing issue than anything else.

[Catherine Mealor, KBW]

Got it. Okay. So you are not – your guidance isn’t necessarily including a large positive swing in that locked pipeline in the back half of the year, would that be a way to think about it?

[Chris Holmes, President and Chief Executive Officer]

Yes, just some incremental volume, but not necessarily in the fair value change per se.

[Catherine Mealor, KBW]

Okay, that’s helpful. Thank you. Alright. Thank you so much. I will turn back to the queue.

[Chris Holmes, President and Chief Executive Officer]

Thank you, Catherine.

[Operator]

We will now take our next question from Peter Ruiz from Sandler O’Neill. Please go ahead.

[Peter Ruiz, Sandler O’Neill]

Good morning, guys. How are you?

[Chris Holmes, President and Chief Executive Officer]

Peter, we are good. Thank you.

[Peter Ruiz, Sandler O’Neill]

So, I guess just maybe with your comments on loan growth, I am not surprised here to see a little bit of commentary here on maybe a slowdown in the second half. But just with these 12 to 15 revenue producers coming online I guess in the next couple of weeks, it may take a little bit of time for them to hit the ground running, but what does that look like maybe in terms of 2019 growth? Is that just to help refill the bucket and maintain the long-term guidance or is there opportunity to kind to maybe outpace that?

[Chris Holmes, President and Chief Executive Officer]

Yes. As we bring folks on and I would say that 12 to 15, the reason we have got a range there is 12 of those folks are committed and about half of them are already on board. The other half are fully committed, but not announced yet and then we have got just a few others, 3 or 4 that we think we are going to get committed, but aren’t totally yet and that should be a tailwind for us on the production side. We have a few headwinds on the production side as well. And so we consider both of those – that’s where we are coming up with kind of being near our long-term guidance and so that’s when as we consider those folks coming on, there is going to be some expense and then it generally takes a month or two for them to really begin to have a lot of impact on the balances and so could come later this year, could come first quarter of next year.

[Peter Ruiz, Sandler O’Neill]

Okay, that’s great. And I guess just maybe just touching on the NIM, deposit beta is obviously rising for the industry overall. Deposit growth was really strong. I know you had some benefit there from some larger deposit balances coming on. Do you think that your beta can, kind of stay near the current range if you see some continued strong deposit growth? And have there been any other changes outside of those more lumpy deposits that maybe you see some deposit growth dynamics changing at all?

[Chris Holmes, President and Chief Executive Officer]

Yes. So, just specific comment on betas and deposits, actually we do see that beta going higher next couple of quarters. And we have had good customer deposit growth, but we continue to have really strong asset growth and part of the key to our margin is you have also seen that we have let some wholesale funding leave the bank, so we continue to grow that customer funding. And we think just competitively that we are going to have to continue to get more competitive as this quarter goes on and we don’t see that relenting at least in the next couple of quarters and probably much longer than that. So yes, the answer is that deposit beta will go up from where it is in this quarter and we are prepared for that and we think that’s a good investment. And so we are going to continue to grow our deposit base, because that’s what’s going to allow us to grow the asset base. And today, on the beta between our loans and deposits, that’s a pretty good trade. And so we will continue to see that move up. On just deposits more generally, I don’t know that we can tell you anything terribly unique there. I will review the number of transcripts from calls already. It’s competitive. We like our position because of the mixture of both community markets and metropolitan markets, so we like our competitive position to be able to continue to methodically grow the balances there, and we like the fact that we have got both a retail deposit base and a commercial deposit base. So we unlike a lot of banks our size that are strictly a commercial deposit base, we’ve got a retail base as well and so we think that gives us an extra advantage, as we continue to bring on funding, and like I said, make the investment over the next couple of quarters and continue to grow that.

[James Gordon, Chief Financial Officer]

The other thing I would add, Peter, is that we don’t have a significant amount of true indexed deposits there in our base, although that is increasing, given some of the competitive pressures and the near term expectations as the rates are rising, which will also weighed in on our beta moving forward and then we will see the seasonal movements in some of the public funds, which is typically up in the later in the fourth quarter through the first quarter and then against the decline over the second and third quarters and early fourth quarter and then rebuilding but other than that, no real expected major moves, but it will likely cost more to have in-line growth on the deposit side to fund the balance sheet.

[Peter Ruiz, Sandler O’Neill]

Okay, appreciate the color. I will step back in the queue. Thanks.

[Chris Holmes, President and Chief Executive Officer]

Thanks Peter.

[Operator]

[Operator Instructions] Our next question comes from Tyler Stafford from Stephens Inc.

[Gordon McGuire, Stephens Inc.]

This is actually Gordon McGuire on for Tyler how you go?

[Chris Holmes, President and Chief Executive Officer]

We are fine, Gordon. How are you?

[Gordon McGuire, Stephens Inc.]

Pretty well. So going back to the mortgage guide, I’m trying to pick apart how much of the lower guide came from the MSR sales versus a more muted gain on sales outlook and I know James you mentioned pressured volumes and margins in your prepared commentary, but it looks to me, if I back out the MSR sales from the fee line, it could account for pretty much all of the lower guide so arguably, it seems like the gain on sale outlook to be flat? So I guess my first question would be did that guide in May include or anticipate a similar MSR sale?

[James Gordon, Chief Financial Officer]

Yes, so we had our previous guidance really starting from the year included 1 or 2 MSR sales this was probably more of a cumulative, just dynamics in the market getting to kind of 1 sale we may have 1 sale later in the year, depending on the market and the capital level but those were really have been anticipated really heading into the year so the revised guidance this quarter really had very little to do with the MSR sale.

[Gordon McGuire, Stephens Inc.]

Got it. And then just I guess on that point, for the gain on sale piece, volumes were flat this quarter I think your margin improved some so I wonder if you could provide some additional commentary on those flat volumes and any outlook, or would you expect those to rebound next quarter?

[Wib Evans, President, FB Ventures]

Gordon, this is Wib Evans, and I would tell you that we expect to continue to see pressure our retail group continues to outperform kind of our expectation, but our correspondent group is not and so, we don’t see those volumes changing much at all, and it’s a mix issue for us if we sit here and continue down the road that we’re on today with our correspondent growth and performing at the levels that they are, we would continue to see that margin look about like it looks today obviously, it would pick that up and get that turned around, latter part of the year the overall sale margin will go down just purely from a mix perspective.

[Gordon McGuire, Stephens Inc.]

Got it. And then just lastly...

[Chris Holmes, President and Chief Executive Officer]

And we did have a change in the mix this quarter from primarily consumer direct as I noted in my comments to TPO and to retail, which obviously that tradeoff is very positive, particularly when retail is increasing.

[James Gordon, Chief Financial Officer]

Yes, trade-off to the margins, gain-on-sale margin.

[Chris Holmes, President and Chief Executive Officer]

Yes, to the gain-on-sale margin.

[Gordon McGuire, Stephens Inc.]

Perfect. And relative to the $1.8 million in amortization of the MSR this quarter, what do you think the impact from the sale could be in future quarters and kind of how do you think about forecasting that within your pre-tax contribution guide?

[James Gordon, Chief Financial Officer]

It probably will be. So that we are selling roughly one-third of the portfolio, so I would say, it should drop by roughly about 30% or one-third somewhere in that range, given the relative mix of that portfolio and our overall portfolio, so somewhere in that 30% call it 30% range, $500,000, $600,000 drop in the change in the fair value.

[Gordon McGuire, Stephens Inc.]

And would that just build as you grow, obviously excluding any said future sales, that amortization would just build as you grow the servicing portfolio over time?

[James Gordon, Chief Financial Officer]

Yes, I mean it’s going to stay relatively if you look at it, it stays relatively consistent over the last, call it, 3 quarters in terms of the percentage and roughly the balance so because that also is net of our hedging call it that’s not all just pure amortization, so it’s kind of couple of moving parts but the biggest part is kind of the decay in the actual balances overtime payouts, etcetera.

[Gordon McGuire, Stephens Inc.]

Sure. And then last one for me real quickly on the NIM, the origination fees came up pretty substantially this quarter, I think drove a good bit on that core NIM expansion I assume it was just form the high production this quarter, but would you expect, as 3Q kind of gets back towards your guidance range, would that would you expect that to kind of normalize?

[Chris Holmes, President and Chief Executive Officer]

Yes, Gordon, you read it well. That’s exactly right.

[Gordon McGuire, Stephens Inc.]

That’s all I had guys. Thank you.

[Operator]

As there are no further questions at this time, I would now like to turn the call back to our speakers for any additional or closing remarks.

[Chris Holmes, President and Chief Executive Officer]

Very good. Thank you once again for joining us on the call. We are proud of the team and proud of our company and look forward to you joining us again next quarter. Thank you very much.

[Operator]

Ladies and gentlemen, this will now conclude today’s conference call. Thank you all for your participation today. You may now disconnect.