Seacoast Banking Corporation of Florida

Welcome to Seacoast Banking Corporation's third quarter 2022 earnings conference call. My name is Cheryl and I will be your operator. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. If you have a question, please press 01 on your touchtone phone. Before we begin, I have been asked to direct your attention to the statement at the beginning of the company's press release regarding forward-looking statements. Seacoast will be discussing issues and constitute forward-looking statements within the meaning of the Securities and Exchange Act, and its comments today are intended to be covered within the meeting of the Act. Please note that this conference is being recorded. I will now turn the call over to Chuck Schaefer, Chairman and CEO of Seacoast Bank. Mr. Schaefer, you may begin.

Thank you, Cheryl, and thank you all for joining us this morning. As we provide our comments, we will reference the third quarter 2022 Earnings Slide Deck, which you can find at seacoastbanking.com. I'm joined today by Tracy Dexter, Chief Financial Officer, and Michael Young, Treasurer and Director of Investor Relations. Let me start by thanking the entire Seacoast team for their tremendous effort in recovering from Hurricane Ian last month. All Seacoast branches opened within a few short days, and the group quickly transitioned to assisting our customers and communities. Additionally, the team promptly reverted to closing the Drummond and Apollo acquisitions, and one week after the storm passed, they completed the technology conversion at Apollo, of which I'll say a little more in a moment. I am very proud of their hard work and resilience and for supporting our communities in the face of such a challenging weather event. And to comment further on Hurricane Ian, we reserved a little over $2 million during the quarter related to the storm based on an analysis of our exposure in the hardest-hit counties of Florida this and an outreach program executed by our banking team. The results of the qualitative feedback from our bankers and customers and the quantitative analysis performed by our credit analytics team has been favorable, leading us to believe the impact on Seacoast may be limited given the path of the storm, which primarily impacted southwest Florida, where Seacoast has less exposure when compared to the remainder of the state. We expect to have a more complete understanding of the impact by the end of the fourth quarter, but at this point we believe any impact on our financial results will be inconsequential. Turning to the third quarter results, the Seacoast team delivered another outstanding quarter of earnings while continuing to execute against our balanced growth strategy. The quarter was highlighted by a material expansion of our net interest margin, which, excluding PPP and accretion on acquired loans, increased 29 basis points from the prior quarter, and net interest income increased 32% on an annualized basis. The cost of deposits only increased by three basis points, and annualized loan growth for the quarter was 10%. The company generated $49 million in pre-tax, pre-provision earnings, an increase of 6% from the prior quarter, while achieving a 53% efficiency ratio. Since the start of 2022, the team completed the Sable Palm and Business Bank of Florida transactions, enabling us to enter the highly attractive and growing Sarasota market and to continue to grow our presence in Brevard County. And in early October, we completed the acquisitions of Drummond Bank and Apollo Bank, expanding our presence in North Florida, including Ocala and Gainesville, and expanded our franchise in the dynamic Miami-Dade County market. Also in October, the Apollo and Seacoast teams completed a flawless technology conversion of Apollo Bank, which, despite the disruption of Hurricane Ian, was our smoothest conversion to date. And finally, we announced during the third quarter the acquisition of Professional Bank, expanding our reach further in South Florida. We continue to expect to close this transaction early in the first quarter of 2023. Consistent with our continued focus on organic growth and our goal of being the best commercial bank in Florida, we hired a team consisting of well-seasoned C&I commercial bankers, treasury officers, and credit officers in North Florida, complementing our acquisition of Drummond, and further expanding our reach into Ocala and Gainesville. Additionally, we augmented our commercial banking team in West and Central Florida with several hires from national and regional banks, and we also hired several credit and operational roles as we scaled the franchise. The timing of these expenses came a little earlier than anticipated, but a very strong opportunity presented itself, and the payback period on this investment will be short. I want to take a moment to discuss our credit metrics. Seacoast continues to be a disciplined, conservative lender focused on building a carefully underwritten and diversified portfolio by nurturing full client relationships that bring low-cost funding. As a reminder, our portfolio has been built over the long term with a consistent growth rate while driving diversification by product type, by segment, and by vintage. As a result of this discipline, our credit metrics for the quarter were outstanding with almost zero net charge-offs, declining non-performing loans, and declining criticized and classified loans. Moreover, our relationship-based philosophy and heavier focus on operating companies compared to peers will pay off in the environment ahead by providing a lower deposit repricing, as evidenced by our cost of deposits increasing only three basis points this quarter. CECOS is operating from a position of strength, with capital and allowance ratios at the top of our peer group. During the quarter, our ACL ratio increased to 1.42%, And considering the loss absorption, including in our purchase accounting marks, the company is reserved at a 1.71% coverage rate. Our TCE ratio was 9.8%, and our Tier 1 ratio was 16.5%. Additionally, we believe Florida has the potential to outperform the rest of the country if a downturn materializes, given the wealth accumulation and population growth over the prior few years. Florida has exceeded every state in the nation in attracting affluent, wealthy individuals and corporations during the last two years, adding materially to the state's GDP. And to conclude, considering the continued economic strength of Florida, our carefully underwritten credit portfolio, peer-leading capital levels, and our high-quality customer franchise, we have one of the strongest balance sheets in the industry, providing optionality if a recession materializes. This will allow us more flexibility than most to be opportunistic in client selection, organic growth, and acquisition opportunities. And I'll turn the call over to Tracy.

Thank you, Chuck. Good morning, everyone. Directing your attention to third quarter results, beginning with highlights on slide seven. The net interest margin expanded 29 basis points to 3.67%, and on a core basis, expanded 33 basis points to 3.57%. Loan originations at higher yields and the low cost of deposits we maintained during the quarter supported higher net interest margin. Our asset-sensitive balance sheet is beneficial in this rising rate environment, which will continue to benefit net interest income and the margin in the coming period. Our loan-to-deposit ratio ended the quarter at 76%, leaving us room to continue to fund growth at higher yields in the coming quarters. Our cost of deposits increased only three basis points during the third quarter to nine basis points, We continue to manage deposit pricing on an exception basis, though we do expect to see an increase in the cost of deposits in the fourth quarter given the velocity of rates over the last 120 days. Pre-tax, pre-provision earnings continue to increase with results on an adjusted basis up by 6% compared to prior quarter and 16% compared to the start of the year. We grew loans at an annualized rate of 10% this quarter with the strong commercial talent that we've added to the team in recent periods. I'll emphasize that the growth is in keeping with the bank's credit standards and is a combination of solid production in the quarter and slowing loan prepayments. Average core loan yields increased 20 basis points to 4.3%, and the September weighted average add-on yields reached 5.5%. Credit risk metrics remain strong, with non-accrual loans lower compared to the previous quarter and only $100,000 in net charge-offs. The quarterly provision for credit losses includes the estimate we made at quarter end to provide for losses potentially resulting from the impact of Hurricane Ian, though we've not seen any specific concerns at this point. And overall coverage reflecting economic factors including persistent high inflation and expectations for higher rates. In deposits, while balances were down overall, which I will discuss shortly, average balances in non-interest bearing demand accounts increased quarter over quarter despite the typical summer seasonal decline. Wealth management was a particular bright spot during the quarter, with large wins in assets under management and also our ability to provide existing client relationships with access to higher rates. Notably, we moved $100 million of cash deposits into either money market funds or the bond market to achieve returns for our clients while keeping the funds within the Seacoast relationship. An update on Hurricane Ian. We suffered no notable damage to any of our properties, nor was there any damage to the Apollo, Drummond, or Professional locations. Branches were quickly reopened after the storm, and only a small percentage of loans in our portfolio are collateralized by properties in the most highly impacted areas. Our borrowers so far appear to have fared well. In the allowance for credit losses as of September 30th, we included an estimated $2 million for potential losses having limited information at the time about the economic impact from the storm. Now that we're a few weeks on, we've been able to confirm that for the large majority of our borrowers, things are back to business as usual. As you know, there's been significant activity on the M&A front, including the October closings of the Apollo and Drummond transactions on October 7th, and the announcement of the upcoming acquisition of Professional Bank in South Florida. Closing is expected early in the first quarter of 2023, with system conversion late in the second quarter of 2023. Turning to slide eight. Net interest income expanded 8% during the quarter, adding 6.6 million with higher yields and a shift in asset mix. Net interest margin expanded 29 basis points to 3.67%, and excluding PPP and accretion on acquired loans, which introduced significant variability, net interest margin increased by 33 basis points to 3.57%. In the securities portfolio, we've continued to pace our investments of excess liquidity and yields increased 38 basis points to 2.36%. Core loan yields expanded 20 basis points to 4.3%, and in September, add-on rates averaged 5.5%. We continue to benefit from a strong, low-cost funding base with 65% transaction accounts at September 30th And this strength was further enhanced in October with the acquisitions of Apollo and Drummond Banks, which have similarly longstanding granular relationships. Looking ahead, we expect net interest income and margin to continue to benefit from rising rates. In the fourth quarter, we expect the core NIM, excluding purchase accounting accretion, to expand to the high 390s. We expect net interest income in the fourth quarter in a range between $115 million and $120 million. Moving to slide nine. Adjusted non-interest income was $16.5 million, a decrease of $0.8 million from the previous quarter and a decrease of $2.6 million from the prior year quarter. The decrease from the prior quarter and prior year is largely driven by lower mortgage banking activity impacted by rising rates and limited housing inventory. I'll point out that wealth revenue overcame third quarter market conditions to remain flat with the addition of significant new relationships. Other categories were generally stable with increases in SBIC investment income offset by lower loan swap related income and lower SBA gains during the quarter. Looking ahead, we continue to focus on growing our broad base of revenue sources and with the benefit of the expanded franchise, We expect fourth quarter non-interest income in a range from $18 million to $22 million, which is inclusive of the operations of both Apollo and Drummond. Moving to slide 10, adjusted non-interest expense for the quarter increased $5.2 million to $56.9 million. Included in the quarter are approximately $2.6 million in unique expenses, including the provision for unfunded commitments, elevated recruiting costs, and project-related expenses that are not expected to recur in the coming period. Salaries and benefits increased 0.9 million, reflecting successful recruiting, particularly with the addition of new commercial banking talent. All in, there were 15 new commercial bankers and treasury sales professionals, including a new team in Ocala. Expansion and support functions reflects the acceleration of investments to scale the growing organization. Non-interest expense includes the provision for credit losses on unfunded commitments, reflecting modeled results of changes in economic factors. In other expense, $1 million of the increase from prior quarter relates to a gain in the prior quarter on the sale of an REO property, causing a decline in the comparative results. Also included within the other category are non-recurring charges related to investments and initiatives in the third quarter. Not reflected in adjusted results is $900,000 in write-offs of certain leasehold improvements. We took the opportunity during the third quarter to purchase two branch properties that we had been leasing, which will lower ongoing occupancy expense by approximately $300,000 annually. Looking ahead, we expect to maintain our expense discipline while continuing investments to support growth. We expect fourth quarter expenses, scaling with the growing size of the organization and excluding the amortization of intangible assets, to be in the range of $72 million to $77 million, inclusive of the operating results of both the Apollo and Drummond entities. As a reminder, the full benefit of cost synergies on both the Apollo and Drummond transactions will not be recognized until the second quarter of 2023. On slide 11, the efficiency ratio on an adjusted basis remained flat quarter over quarter. As we scale the company for growth and become the leading bank in our Florida markets, we continue to pace our investments with discipline, evidenced by our consistent focus on efficiency. And looking forward to the fourth quarter, we expect the efficiency ratio to be in the low to mid 50s with the addition of both banks, and then we'll move lower from that point forward as we execute against the cost synergies of the combined organization. Turning to slide 12, highlighting the continued diversity of our exposure and concentration levels well below regulatory guidance and the peer group. This diversification highlights our disciplined approach to managing concentrations. Construction and commercial real estate concentrations remain well below regulatory guidelines. Turning to slide 13, loan outstandings increased 161 million or 10% excluding PPP on an annualized basis. The commercial pipeline increased to 530 million at quarter end. and includes a number of loans where closings were delayed into the fourth quarter due to the disruption of the hurricane in the last few days of September. Average core loan yields increased by 20 basis points during the quarter, with the September weighted average add-on yields reaching 5.5%. Importantly, since the majority of our variable rate loans are tied to prime, and the prime rate didn't reset until the end of September, we can compare ending portfolio yields at September 30th to those at June 30th. Ending portfolio yields increased 35 basis points to around 4.5% at September 30th. Much of the benefit then of third quarter rate movement will be seen in the fourth quarter. Loan yields will continue to benefit from the higher rate environment, and we expect core yields in the fourth quarter, excluding purchase accounting accretion, to expand meaningfully to the 470s range. Also in the fourth quarter, we expect loan growth to continue with an annualized growth rate in the high single digits. Turning to slide 14, in the investment securities portfolio, the average yield increased during the quarter by 38 basis points to 2.36%, with purchases concentrated early in the quarter near 4%. The value of the portfolio continues to be negatively affected by higher rates. We will opportunistically seek to redeploy portfolio runoff and take advantage of higher rates while prioritizing the utilization of cash for loan production. Turning to slide 15, deposits outstanding were $8.8 billion, and I'll take a moment to address the decline in deposits. The team did an excellent job managing our deposit costs this quarter, with our cost of deposits increasing by only three basis points. Deposits declined by $423 million, with $100 million that moved to wealth AUM, $110 million decline in public funds, as municipalities moved funds to the state's investment program. $41 million was time deposits, and $25 million was brokered deposits. So when you look at the components of the outflows, only about $150 million exited the bank, with some impact from rate sensitivity and a general absorption of liquidity in the market, but not otherwise inconsistent with our typical seasonal trends during the Florida summer period. I'll remind you that our deposit book is primarily small business and consumer operating accounts in keeping with the relationship nature of our business model, and these accounts are typically less rate sensitive when compared to other deposit funding categories. Transaction accounts represent 65% of total deposits, and the strength of the deposit base, we think, will start to show up as a differentiator amongst the peer group. On deposit pricing, we expect the competitive environment to become increasingly dynamic. We have a very strong deposit base and expect that we'll continue to outperform our peers on deposit data, while we do expect to see our own cost of deposits start to increase at a faster pace than in the third quarter. Moving to slide 16, the allowance for credit losses increased during the quarter by 4.6 million to an overall 95.3 million with an increasing coverage of three basis points to 1.42%. The provision this quarter was 4.7 million. We remain watchful of inflation pressures and are carefully considering the impacts of higher rates on the economy, though our credit metrics remain very strong and continue to improve. We'll continue to take a conservative approach to provisioning and have considered the potential for losses related to the impacts of Hurricane Ian in the estimate. On to credit metrics on slide 17, we're seeing sustained positive trends with net charge-offs near zero, non-performing loans decreasing to 0.32% of total loans, and the percentage of criticized loans to risk-based capital moving lower this quarter. We continue to assess the environment and the factors that might affect loan performance, and this quarter, the allowance for credit losses is modestly higher at 1.42% of total loans. Turning to slide 18, our capital position continues to be very strong. Tangible book value per share is $15.98, a decline from last quarter that's attributed solely to the decline in accumulated other comprehensive income, the result of recording increasing unrealized losses in the securities portfolio. Without the year-to-date impact of securities valuations on AOCI, tangible book value per share would have been $18.92. The ratio of tangible common equity to tangible assets increased to 9.8 percent and remains among the highest in our peer group. Regulatory capital ratios were not affected by changes in securities valuations. The Tier 1 capital ratio was 16.5 percent and the total risk-based capital ratio was 17.5 percent. And finally, on slide 19, a longer-term look at tangible book value per share. Over the last five years, we've achieved a compound annual growth rate of 8% driving shareholder value creation. And without the impact of securities valuation declines impacting AOCI, that compound annual growth rate was 11% over the five-year period. Our growth outlook remains favorable, evidenced by growth in commercial loans driven by the expansion of our commercial banking franchise. Rising rates will continue to have a material positive impact on net interest income and margin in the fourth quarter. All this on a foundation of strong liquidity and capital, positioning us to maximize opportunities and continue to execute on our strategic growth initiative. We look forward to your questions. Chuck, I'll turn the call back to you.