FB Financial Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. FB Financial is a Tennessee bank holding company operating FirstBank, with 45 branches in Tennessee, north Alabama and north Georgia, and a mortgage business operating across the Southeast and nationally online. Unless noted otherwise, dollar amounts below are in millions.
Financial results and condition
- Earnings: Net income was $9.8 million, down from $14.6 million a year earlier; diluted EPS was $0.40 versus $0.85. Pretax income was $15.2 million versus $15.6 million. The comparison is affected by the company’s September 2016 conversion from S corporation to C corporation status: Q1 2016 reported net income excluded federal income tax, while pro forma C corporation net income for that quarter was $9.8 million and pro forma EPS was $0.57.
- Revenue and margins: Net interest income rose 16.6% to $30.3 million; tax-equivalent net interest margin increased to 4.28% from 4.03%. Total noninterest income was essentially flat at $31.1 million. Mortgage banking income was $25.1 million, compared with $24.5 million.
- Expenses and profitability: Noninterest expense increased 12.3% to $46.4 million, led by higher salaries, commissions and benefits ($29.0 million, up $5.2 million). The GAAP efficiency ratio worsened to 75.67% from 72.57%; adjusted tax-equivalent efficiency ratio was 73.29%. Return on average assets was 1.25% versus 2.03%; return on average equity was 11.87% versus 23.79%.
- Credit: The company recorded a $257,000 reversal of provision for loan losses, attributing it to improving asset quality and a large recovery on one credit. Net recoveries were $1.4 million; the allowance for loan losses was $22.9 million, or 1.20% of loans. Nonperforming loans were $9.3 million (0.49% of loans), and nonperforming assets were $17.8 million (0.56% of assets), down from $19.1 million at year-end 2016.
- Balance sheet and liquidity: Total assets were $3.17 billion, down from $3.28 billion at year-end, mainly because loans held for sale declined $142.3 million. Loans held for investment grew 2.8% to $1.90 billion; deposits rose 1.1% to $2.70 billion. Cash and cash equivalents were $129.6 million, versus $136.3 million at year-end.
- Cash flow: Operating cash flow was $147.3 million, compared with $13.2 million in Q1 2016; investing activities used $29.9 million and financing activities used $124.1 million. Cash declined $6.8 million during the quarter. Mortgage loan originations and sales substantially affect operating cash flow.
- Debt and capital: At March 31, the balance sheet showed $44.6 million of long-term debt and $18.1 million of repurchase-agreement funding, with no short-term borrowings (versus $150.0 million at year-end). Total deposits were the primary funding source. FirstBank reported a 11.52% CET1 ratio, 12.42% total risk-based capital ratio and 9.36% Tier 1 leverage ratio; the filing states the Bank and Company met applicable capital requirements and the Bank was well capitalized.
Material changes and notable items
- Loan growth and higher loan yields, fees and acquired-loan discount accretion lifted net interest income. Acquired-loan accretion was $1.2 million, and syndicated loan fees were $0.4 million.
- Mortgage originations increased to $1.35 billion from $749.8 million, supported in part by expansion of the correspondent channel. However, management reported that rising rates, a slowing housing market and a changed origination mix were pressuring mortgage margins; the rate-lock pipeline was $449.0 million at quarter-end, versus $532.9 million at year-end.
- Effective January 1, 2017, the company elected fair-value accounting for mortgage servicing rights (MSRs). The election increased opening retained earnings by $615,000 after tax. MSRs were $47.6 million at March 31; the quarter included a $501,000 fair-value decline. A sale of servicing rights on approximately $1.09 billion of serviced loans closed April 7, 2017, producing a $17,000 gain and approximately $248,000 of transaction costs.
- On February 8, 2017, FirstBank agreed to acquire Clayton Bank and Trust and American City Bank for an announced value of approximately $284.2 million. The banks had approximately $1.20 billion in assets, $1.07 billion in loans, $929 million in deposits and 18 Tennessee offices. Closing was expected in Q3 2017, subject to regulatory and other approvals. The company reported $487,000 of related first-quarter expenses and expected approximately $10 million of merger and acquisition costs through the rest of 2017.
- Management cited increased personnel, technology, public-company and growth-related costs. The filing reports no material changes to the risk factors in the 2016 Form 10-K and says pending ordinary-course litigation is not expected to result in material liability.
Risks, controls and outlook
- The company described sensitivity to interest rates and mortgage activity. Its model projected that a 100-basis-point rate increase would raise net interest income by 3.1% in year one and 4.7% in year two, while reducing economic value of equity by 0.9%; a 100-basis-point decrease was projected to reduce year-one net interest income by 8.8% and EVE by 9.2%. These are modeled estimates, not guidance, and depend on assumptions about balances, customer behavior and prepayments.
- Credit risks include real estate and construction exposure, borrower performance and collateral values. Management noted that actual loan losses could differ from estimates used in determining the allowance.
- Disclosure controls were concluded to be ineffective at March 31 because of a previously reported material weakness involving mortgage transaction recording and timely reconciliation of mortgage loans held for sale and related clearing accounts. Management said system and process changes were made and believed they were sufficient to remediate the issue, but remediation required sustained testing. Management nevertheless concluded the financial statements fairly presented the company’s results and position.
- No general earnings guidance was provided. Management’s forward-looking commentary included the expected Clayton acquisition timing and costs, and its view that higher mortgage rates and a smaller pipeline could weigh on mortgage production and margins.
Investor verification points
- Track whether the mortgage accounting and reconciliation material weakness is formally remediated, and whether disclosure controls improve.
- Verify Clayton acquisition approvals, closing timing, final purchase terms, integration progress and actual costs against the expected approximately $10 million of remaining 2017 costs.
- Monitor mortgage origination margins, rate-lock pipeline, serviced-loan balances and MSR fair-value assumptions as rates and prepayment expectations change.
- Assess the persistence of loan growth and net interest margin gains, including the contribution from acquired-loan accretion and syndication fees.
- Review credit trends, especially construction and commercial real estate classifications, recoveries, nonperforming assets and allowance coverage.
- Interpret year-over-year net income and EPS in light of the 2016 S corporation tax treatment and the higher share count following the 2016 IPO.