Seacoast Banking Corporation of Florida

Welcome to Seacoast Banking Corporation's first quarter 2023 earnings conference call. My name is Carlos and I will be your operator. At the start of the presentation, all lines will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. If at any time in the conference you need to reach an operator, please press star 0. Before we begin, I have been asked to direct your attention to the statement at the end of the company's press release regarding forward-looking statements. SECOS will be discussing issues that constitute forward-looking statements within the meanings of the Securities and Exchange Act, and its comments today are intended to be covered within the meaning of that 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, Carlos, and thank you all for joining us this morning. As we provide our comments, we will reference the first quarter 2023 earnings slide deck, which you can find at seacoastbanking.com. I'm joined today by Tracy Dexter, Chief Financial Officer, Michael Young, Treasurer and Director of Investor Relations, James Stallings, Chief Credit Officer, David Howdeshell, Director of Credit Risk Analytics. Our first quarter produced another strong period of adjusted pre-tax pre-provision earnings and a solid result in our adjusted pre-tax pre-provision return on assets. While the quarter included the day one CECL impact and other customary merger expenses associated with our most recent acquisitions, our underlying earnings performance and forward-looking capital generation were strong. Quarter over quarter, Q1 highlights include growth in deposits only modest NIM pressure, increased liquidity ratios, a continued robust capital position, strong asset quality, and assets under management increased to $1.5 billion. Additionally, on January 31st, we closed our acquisition of Professional Bank, materially increasing our South Florida market share. As you all know, the banking industry saw significant volatility in March. These events emphasize the importance of Seacoast's granular and tenured deposit franchise and disciplined credit and conservative balance sheet principles. And these events are a reminder of the value of Seacoast's Fortress balance sheet, which has been built over a 96-year history. We are pleased to report we saw no impact to deposits as a result of the three bank failures, and we've added a new slide showing our weekly deposit trends. Our deposit base is stable, providing a significant source of strength. and is supported by a broad set of relationships. Seco has over 270,000 customers across Florida, including retail consumers, small businesses, professionals, small operating companies, middle market operating companies, municipalities, and other public entities. We have always focused on growing and generating franchise value by focusing on relationship-based customer growth and product penetration, and avoiding non-relationship-based transactions and non-core businesses. This strategy has resulted in a demand deposit ratio of 37% of total deposits, which is in the upper quartile compared to the entire industry. We only operate businesses that service and grow customer relationships. We do not run nationwide equipment finance, fintech lending, forward flow arrangements, or other non-franchise generating businesses. Our business model is built solely around servicing and growing consumers and companies in Florida. Over many decades, Seacoast has strived to build diversity in deposits and loan book granularity and to be prepared to manage the company through all types of cycles. Consequently, we ended the quarter with a robust common equity tier one ratio of 12.8%, and a tangible common equity and tangible asset ratio of 8.4%. Illustratively, if we were to liquidate our entire securities portfolio, including the HTM securities, SECO's tangible common equity would still be a robust 7.8%. We also have an allowance for credit loss coverage ratios of 1.54%, and considering the loss absorption, including in the purchase accounting marks on loans, we are backstopped at a 3.67% loan coverage rate. We also operate from a position of strength and liquidity with an 82% loan-to-deposit ratio, which will provide balance sheet flexibility as we move forward. Uniquely, our acquisition strategy has put us in a favorable balance sheet position in the current environment compared to less acquisitive banks. As a result of the acquisitions that we completed in recent months, we have marked one-third of our balance sheet to fair value through purchase accounting, which has brought a large portion of the balance sheet to current market rates. And overall, we continue to see strong asset quality across the portfolio. Seacoast has less exposure to commercial real estate than our peer set, with a consolidated CRE to risk-based capital ratio of only 236%, and exposure to construction and land development of only 44%, all in the attractive Florida market, where the population has grown twice the national rate during the last several years. We have added several other credit slides to the deck to provide further transparency into our book, and Tracy will provide further additional detail on our portfolio metrics in a moment. We discussed on prior calls concerns about liquidity in the marketplace and the prudence required when growing a bank into an inverted yield curve. Anticipating these challenges in the third quarter last year, we began limiting the amount of new production we would originate in construction and land development and commercial real estate, resulting in limited loan growth for the quarter. We expect to continue to favor profitability over growth in the coming periods, which we view as an appropriate choice for this environment. We will continue to take care of our strongest relationships and look at unique customer opportunities as they arise, but our key focus at this point is driving profitability and capital growth with a keen focus on delivering strong risk-adjusted returns. And to conclude, we are pleased to have welcomed the professional bank team into Seacoast this quarter, and we continue operating from a position of significant strength in the nation's most robust state economy. This strong statewide backdrop and our Fortress Balance Sheet position Seacoast well compared to peers will set the company up to take advantage of opportunities as they arise in the coming periods. We will have optionality that others will not have. I'll now turn the call to Tracy to walk through the financial results.

Thank you, Chuck. Good morning, everyone. Directing your attention to first quarter results, beginning with highlights on slide four. Pre-tax pre-provision earnings continue to increase, with 1% growth quarter over quarter to $46.3 million. Adjusted pre-tax pre-provision earnings increased 7% to $71.1 million, and as a percentage of tangible assets was 2.18%. Net interest income expanded 10% to over $131 million. Loan originations, in combination with purchase accounting accretion, supported a 57 basis point increase in loan yields, and the cost of deposits expanded only 56 basis points. Net interest margin was down only modestly, declining 5 basis points from the fourth quarter to 4.31%. We delivered disciplined expense management, maintaining an adjusted efficiency ratio of 53.1%. Our capital position continues to be very strong, and we're committed to maintaining our fortress balance sheet. Despite the somewhat dilutive effect of recent acquisitions, our ratio of tangible common equity to tangible assets was 8.4%. Also notable, our health and maturity or HTM securities portfolio represents less than 25% of total securities, and if all HTM securities were presented at fair value, the TCE to TA ratio would still be a strong 7.8%. Our credit standards remain disciplined and focused on relationship lending. The growth in loan balances came largely from the acquisition of Professional. Our loan-to-deposit ratio ended the quarter at 82%. Credit risk metrics remain strong, with low levels of charge-offs, non-approval loans, and criticized assets. The company increased borrowings to boost its liquidity position during the quarter, and total borrowing capacity is 163% of uninsured and uncollateralized deposits. Along with these achievements, we continued to execute on our strategic initiatives, including closing on the acquisition of Professional Bank at the end of January. The transaction value of $421 million included $248 million in goodwill, $49 million in core deposit intangibles, and a total loan portfolio discount of $134 million. Operating results in the first quarter were impacted by the day one provision for current expected credit losses on professional banks' loans of $26.6 million and on unfunded commitments of $1 million. Turning to slide five. Net interest income expanded 10% during the quarter, increasing $11.5 million with higher yields and higher loan balances. Net interest margin contracted modestly to 4.31%, which includes the benefit of $15.9 million in purchase accounting accretion. As a reminder, approximately one-third of our assets were repriced to current market rates through acquisition accounting over the last two quarters, repositioning earning asset yields to current market rates. The dilution we've taken over the last two quarters reflects this repricing, but will creep back through income over the coming periods. In the securities portfolio, yields increased 8 basis points to 2.85%, and loan yields expanded 57 basis points to 5.86%. We continue to benefit from a strong, low-cost funding base with 59% transaction accounts, and the 77 basis points cost of deposits remains well below peers. Looking ahead to the second quarter, we expect net interest income to remain relatively flat compared with the first quarter. We expect market conditions and an inverted yield curve to continue to put pressure on the net interest margin in the near term. Moving to slide six, adjusted non-interest income was in line with the guidance we provided last quarter at 20.2 million, an increase of $2.6 million from the previous quarter, and an increase of $4.4 million from the prior year quarter. Our growing deposit base generated a 6% sequential increase in service charges. Interchange revenue was flat coming off the seasonally high fourth quarter and with two fewer days in the first quarter. Wealth management income was higher by 6% from the prior quarter as we continue to successfully add new relationships. The addition of an insurance agency business through acquisition in the fourth quarter added $1.1 million to first quarter results, and other income included an increase in SBIC income and loan swap-related income. Looking ahead, we continue to focus on growing our broad base of revenue sources, and with the benefit of the expanded franchise, we expect second quarter non-interest income in a range from $22 million to $24 million. And as a reminder, the impact of the Durbin Amendment on our interchange revenue will take effect beginning in the third quarter. Moving to slide seven, wealth revenues increased 6% compared to the fourth quarter and 15% compared to the first quarter of 2022. Assets under management have increased 24% from a year ago to $1.5 billion and have increased at a compound annual growth rate of 20% in the last two years. Moving to slide eight, adjusted non-interest expense for the quarter was in line with the guidance we provided last quarter at $81.9 million. Increases from the prior quarter were aligned with the expanded associate base and growing customer base. It's important to note that cost synergies from the three most recent acquisitions will be fully realized in the second half of 2023. Salaries and benefits on an adjusted basis increased $6.3 million reflecting the increase in staff to support Seacoast's expanded statewide franchise and also due to the seasonal effect of higher payroll taxes and 401 contributions. Data processing costs are typically volume-based, and the increase aligns with the larger customer base and higher transaction volume. Similarly, occupancy-related costs are in line with the increase in the bank's footprint during the quarter. Amortizing core deposit intangible assets increased during the quarter with the addition of professional banks. Amortization of these assets during the first quarter was 6.7 million, and we expect the full year 2023 amortization to be approximately 28 million. Looking ahead, we expect to maintain our expense discipline with second quarter adjusted expenses, excluding the amortization of intangibles, in a range from 82 million to 85 million. For modeling gap results, we expect the amortization of core deposit intangibles to be approximately $7.7 million in the second quarter. Looking beyond to the third quarter as cost synergies take effect, we expect expenses to step down by $3 to $4 million in the third quarter. Moving to slide nine, the efficiency ratio on an adjusted basis was 53%. As we scale the company and become the leading bank in our Florida markets, we continue to pace our investments with discipline, evidenced by our consistent focus on efficiency. Looking forward to the full year 2023, we expect to maintain the adjusted efficiency ratio in the low to mid 50s. Of note, this does not include expense associated with the amortization of intangibles. Turning to slide 10, loan outstandings were near flat, excluding acquisition, as we continue to see the impact of higher rates on market demand and as we maintain our strict credit discipline. Early in the third quarter 2022, we recognized the potential negative impact on the economy from actions taken by the Federal Reserve in both rates and quantitative tightening. Consistent with our conservative lending strategy, we began to reduce our willingness to originate construction and land development lending and tightened underwriting guidelines on investor commercial real estate. As such, Loan production slowed in the first quarter of 2023, lowering the growth rate and building liquidity on the balance sheet. This also allowed us to be less aggressive in raising deposit rates and better manage our exposure to an inverted curve on the net interest margin. We believe this is a prudent choice given the expectation for further rate hikes and quantitative tightening and will result in loan outstandings remaining relatively flat in the coming quarter. Average loan yields increased by 57 basis points during the quarter to 5.86%, which includes 69 basis points of accretion. As a reminder, the fair value marks on the loan portfolios from Apollo, Drummond, and Professional result in significant accretion-driven income that will be recognized in net interest income in the coming periods. Turning to slide 11, portfolio diversification in terms of asset mix, industry, and loan type has been a critical element of the company's lending strategy. Exposure across industries and collateral types is broadly distributed, and we continue to be vigilant in maintaining our disciplined, conservative credit culture. In the upper right of the slide, you can see that our construction and commercial real estate concentrations remain well below regulatory guidelines and below peer levels. Of note, we've always taken a prudent approach to commercial real estate lending using stressed interest rates to size loans. Turning to slide 12, our loan portfolio is diverse and broadly distributed across categories. Non-owner occupied commercial real estate loans represent 34% of all loans and are distributed across industries and collateral types. Importantly, C&I loans and the related owner occupied CRE, which is repaid through cash flows of the business, not from the sale or leasing of the property, represent 33% of the total portfolio. Turning to slide 13, looking at the broad dispersion of the portfolio in markets across the state, with larger balances in South Florida and Orlando, where business and population growth have been particularly evident. The Florida market has led the country in the past few years in population growth and continues to show strength in the local economies in our markets. On to slide 14, providing some detail on the categories within the investor commercial real estate portfolio. The largest segment is classified as retail with an average loan size of 1.9 million and weighted average loan to value of 52%. This is followed by office where the average loan size is approximately 1.6 million and a weighted average loan to value of 55%. For the investor CRE portfolio overall, the average loan size is 1.5 million and the weighted average loan-to-value is 54%. Diversification across industries and collateral types has been a critical tenant of our strategy, and the low average commercial loan sizes are the result of our long-time focus on granularity and on creating valuable customer relationships. The CRE retail segment targets grocery or credit tenant-anchored shopping plazas, single credit tenant retail buildings, smaller out parcels, and other small retail units, There's no exposure to shopping malls or big box retail. This segment is supported by a very strong Florida economy and is typically anchored by very strong credit or near-credit tenants. These loans have significant equity in them based on our underwriting standards at origination. We have just 12 loans over $10 million, which have tenants in the grocery, financial services, and healthcare industries. We've seen no sign of weakness in occupancy or rental rates. There are no loans on non-accrual, and only one loan that carried past due, and it was less than $1 million at the end of the quarter. The CRE office segment targets low- to mid-rise suburban offices across Florida. There are no high-rise office towers and little exposure to central business districts. We have only nine loans over $10 million, which are financial services, health care services, legal firms, and other local professional services. We've seen no sign of weakness in occupancy or rental rates, There are no loans past due or on non-accrual at the end of the quarter. Moving on to credit topics on slide 15, the allowance for credit losses increased during the quarter to an overall $155.6 million, with an increase in coverage to 1.54%. The provision in the first quarter was $31.6 million, which included $26.6 million in day one provision on the professional bank loans. The allowance for credit losses, combined with the $216 million remaining unrecognized discount on acquired loans, total $371.6 million, or 3.67% of total loans that's available to cover potential losses. Moving to slide 16, looking at trends in credit metrics. We remain watchful of inflation pressures and the broader economic environment, and are carefully considering the ongoing impacts of higher rates on the economy. though our credit metrics remain very strong. Charge-offs were 14 basis points annualized during the quarter and have averaged five basis points in the last four quarters. Non-performing loans represent 0.5% of total loans, and the percentage of classified assets to total assets was 1.03%. And in the allowance, we continue to assess the environment and the factors that might affect loan performance, In this quarter, the allowance for credit losses moved higher to 1.54% of total loans driven primarily by the addition of professional banks. Moving to slide 17 and the investment securities portfolio. The average yield on securities increased during the quarter by eight basis points to 2.85% and changes in the yield curve during the quarter benefited the portfolio values reducing the overall unrealized loss position by approximately $35 million from the end of the prior quarter. Given our strong capital position, we've kept the majority of our securities in the available for sale classification with less than 25% classified as held to maturity. Turning to slide 18 and the deposit portfolio. Deposits outstanding totaled $12.3 billion which includes the addition of $2 billion in deposits from the professional bank acquisition. Transaction accounts represent 59% of overall deposits, which highlights our longstanding, relationship-focused approach. The cost of deposits increased this quarter to 77 basis points, with the dynamic changes in the industry and the competitive landscape. Our expectation is that the cost of deposits will continue to increase with higher rates though the extent of the impact is difficult to predict with certainty. That said, we continue to expect to outperform peers as the environment serves to highlight the strength of our low-cost deposit base. On slide 19, the bar chart shows the addition of balances in higher rate categories that affected the overall mix during the quarter. Seacoast continues to benefit from a diverse and granular deposit base, with the top 10 depositors representing less than 5% of total deposits. Our consumer franchise contributes 40% to overall deposit balances, with an average balance per account of only 22,000. Business customers represent 60% of total deposits, with an average balance per account of only 101,000. Our customers are highly engaged, with the majority having 10 or more transactions per month, Customers of Seacoast have had their banking relationship with us an average of nearly 10 years. And we have a peer leading level of non-interest bearing deposits, representing 37% of the deposit base. This provides significant strength in maintaining deposit costs over time and reflects the granular relationship nature of our franchise. Moving to slide 20, with a focus on the stability of deposit balances during the quarter. Despite industry headlines and the failure of three banks in March, our relationship-driven approach with business operating accounts and a longstanding business and consumer base demonstrated notable stability during the quarter, something we think says a lot about the strength of the franchise and the strong relationships we have with our customers. On slide 21, demonstrating our significant capacity to fund potential outflows. The bar on the right identifies balances above the FDIC insured limit, excluding public funds accounts that have collateral backed protection. Uninsured and uncollateralized deposits total approximately 3.9 billion, which, if needed, would be fully funded by Seacoast's cash and borrowing capacity at the Federal Reserve. Beyond that, Seacoast has an additional nearly 2.5 billion in sources of liquidity above the 3.9 billion. We've not used and don't plan to use the Federal Reserve's new bank term funding program. And finally, on slide 22, our capital position continues to be very strong and we're committed to maintaining our fortress balance sheet. You can see the somewhat dilutive effect of the acquisitions in the last two quarters on tangible equity. While those measures will return over time, we're committed to driving shareholder value creation. In summary, Considering our strong capital levels, prudent credit culture, and high-quality customer franchise, we have one of the strongest balance sheets in the industry, providing optionality if a recession materializes, and to continue building Florida's leading community bank. Chuck, I'll turn it over to you.