Drummond Banking Company (SBCF) Earnings Call Transcript & Summary

Welcome to Seacoast Banking Corporation's conference call regarding the announcement of the proposed acquisition of Drummond Banking and its bank subsidiary, Drummond Banking -- with Drummond Community Bank. My name is Frans, and I will be your operator. [Operator Instructions]. Before we begin, I have been asked to direct your attention to the statement contained at the end of the company's press release regarding forward-looking statements and the risks and uncertainties identified therein, which you should read carefully, as such risks and uncertainties may cause results to differ from expectations. Seacoast will be discussing issues that constitute forward-looking statements within the meaning of the Securities and Exchange Act, and its comments today are intended to be covered within the meaning of the act. Seacoast's abilities to accurately project results or predict the effects of future plans or strategies, including the impact of the proposed merger with Drummond Banking Company, or predict market or economic developments is inherently limited. Seacoast believes that the expectations reflected or implied by any forward-looking statements are based on reasonable assumptions but are not guarantees of performance or results of the success of the proposed merger, and its actual results performance and integration with and into Seacoast could differ materially from the expectations set forth in the forward-looking statements. You should keep in mind that any statements made by Seacoast speak only as of the date which they were made, and that Seacoast undertakes no obligation to update or revise any forward-looking statements. And you are cautioned not to undue reliance on such forward-looking statements. Please note, this call is being recorded. I will now turn the call over to Chuck Shaffer, Chairman and CEO of Seacoast and Seacoast Bank. Mr. Shaffer, you may now begin.

Thank you, Frans, and thank you all for joining us this morning. As we provide our comments, we will reference the merger slide deck titled Acquisition of Drummond Banking Company, which can be found at seacoastbanking.com. With me this morning is Tracey Dexter, our Chief Financial Officer. We're very excited to announce the acquisition of Drummond Banking Company. The transaction represents a continuation of our M&A strategy by providing Seacoast with a low-cost, low-beta, 32-year-old deposit base with deep relationships and new markets across the state, including the attractive and growing Ocala and Gainesville markets. This is a unique bank unlike many we've acquired in the past that were built to be sold at some point. Drummond Community Bank has been focused on building an institution with strong franchise value, that is cycle tested and has been focused on the long run. The transaction adds over $1 billion in assets and generates 8.6% earnings accretion in 2023, with modest tangible book value dilution earned back to over 1.6 years. The model assumes -- the modeling assumptions include the acquisition of Apollo Bank Shares. The transaction merits were affected by the decline in value of the bank securities portfolio due to recent changes in the yield curve. Available for sale securities are marked to fair value through equity, and assuming the declines in value are related to rate and not credit, which we believe to be true here, the value of the portfolio will return over time. With the current lower value of securities, the lower equity creates a higher calculation of tangible book value dilution and a longer earn-back period than would otherwise be the case. The earn back, excluding timing related fair value marks, is only 0.6 years. This transaction allows Seacoast to expand in this attractive market efficiently, bringing our brand of high-quality service and digital products, which will generate greater cost efficiencies and strengthening our ability to achieve accretive organic growth in the future. We've applied this model in our markets in the past. For example, in the legacy Seacoast franchise, we've been able to support the community's banking needs efficiently and significantly expand the use of mobile and online banking platforms for day-to-day banking needs. We have a very similar opportunity with Drummond. We have a playbook that has been developed and refined over the last 8 years that will drive greater mobile engagement across the customer base and deepen and strengthen product usage across the Drummond footprint. We know from experience that we can achieve significant customer satisfaction, while lowering the cost to serve this customer base. The Drummond account profile of 42,000 accounts provides a tremendous opportunity to flex our analytics muscle memory. In credit diligence, we took a detailed and careful approach and came away confident we understand the quality of the portfolio we're acquiring, and placed a conservative mark of 2.47%. The portfolio is relationship-driven to local customers and fits well within Seacoast's credit portfolio. Drummond has also developed diversified sources of fee revenue. Though the transaction metrics presented do not reflect potential revenue synergies, Seacoast will expand these services, which include an insurance agency and a title company, to our entire customer base, including through the use of our customer analytics engine, to further build resilient and diversified sources of fee income. I want to thank Luther Drummond, Greg Drummond and Scott Guthrie at Drummond Bank for their help over the past few months putting together this transaction. And to conclude, this transaction is a strategic expansion that provides additional, stable, low-cost funding and introduces the Seacoast brand to several attractive North Florida markets. I'll now turn the call over to Tracey to provide further details on the combination.

Thanks, Chuck. Good afternoon, everyone. Drummond has 18 branches and $932 million in deposits at March 31, 2022. Loans of $543 million as of the same date had an average yield of 5.64%. 92% of the bank's deposit funding is made up of checking, savings and money market accounts, and noninterest-bearing demand accounts represent 51% of total deposits. One of the unique aspects of Drummond Community Bank is the quality of the deposit book. We've provided details on Slide 8 of the investor deck. With over 50% of the funding in noninterest checking accounts and an average life of 9.25 years, the deposit beta in this book is very low. Looking back at the last cycle, this deposit book significantly outperformed the Florida Bank average and had a lower deposit beta than Seacoast. Moving on to the transaction metrics with reference to Slide 11. Under the terms of the merger agreement, Seacoast will acquire 100% of Drummond's outstanding shares. Based on Seacoast's closing price of $33.72 as of May 3, the transaction is valued at $173.2 million. The deal pricing translates to 1.91x Drummond's tangible book value and 6.2x 2023 earnings per share when including expected cost savings. We're projecting 40% cost savings, for which we have a very detailed execution plan and have consistently demonstrated the ability to execute these in all prior transactions. Credit assumptions used for modeling were developed following detailed due diligence. Credit quality is strong, and we took a conservative approach to modeling, resulting in a total estimated purchase mark of 4.69%, including the CECL double count. That's a total estimate of $25.3 million pretax mark, which includes $1.3 million in day 1 CECL reserves on PCD loans, $12 million in day 1 CECL reserves through provision on non-PCD loans and accretable mark of $12 million. We conservatively modeled forward loan and deposit growth in the mid-single digits. Using the crossover method, we expect tangible book value dilution to be 2.5% at closing to be earned back in 1.6 years. Of note, the decline in value of the securities portfolio that's marked through AOCI is a large portion of the initial dilution and extends the earn back by about 1 year. Removing the AOCI rate mark, the dilution is minimal at 0.7%, with an earn back of 0.6 years. This is an accretive value-creating transaction that brings us a very attractive, low-cost deposit base and an expanded footprint across the state. We expect the merger to be accretive to earnings in 2023 by 8.6%. Assumptions used the forward rate curve and assumed 8 additional 25 basis point hikes in 2022, 2 of which were announced yesterday, and two 25 basis point hike in 2023. We expect the acquisition to close early in the fourth quarter of 2022 after receipt of approval from regulatory authorities, the approval of Drummond shareholders and the satisfaction of other customary closing conditions. Chuck, I'll turn the call back to you.

Thanks, Tracey. We're delighted to make this announcement. And operator, we're ready for Q&A.

[Operator Instructions] Our first question will be from the line of David Feaster with Raymond James.

I just wanted to start on the fee income side. You touched on this a bit in the prepared remarks. Drummond is bringing a couple of nice fee income lines. Obviously, don't include revenue synergies. But were insurance and title something that you guys were looking at getting into yourselves? And I guess just how do you think about your ability to cross-sell these, the timing of that? And then just any thoughts on how much of the deposits are coming -- are in that insurance business?

We had been looking to -- sorry, David. We have been looking for an insurance business. We had not found something that we could acquire on a stand-alone basis. We wanted to support our fee income revenue sources. It's something we've been sort of focused on now for maybe 1.5 years. That was one of the unique advantages of doing this transaction is Drummond have a really high-quality insurance business that's focused primarily on commercial-oriented insurance activities. And we're super excited. One of the opportunities here is the Seacoast franchise, which is roughly a little over 200,000 customers, we have the ability to drive -- cross-sell into that, and also have about 78,000 businesses that will be available for insurance services. So it provides a basis to start building on. It's a well-run, very profitable insurance business. It's been around couple of decades, and we're excited to bolt it on Seacoast.

That's terrific. Yes, it seems like a real opportunity, especially given the data analytics and everything that you all have.

Exactly.

Maybe touching on the consumer book, just curious what types of loans are in there and your comfort level in the consumer portfolio?

Yes. As you know, David, we've been a long retail bank here at Seacoast and very comfortable in around the consumer space. It's made up of anything that you sort of traditionally would assume, car loans to other consumer loans, et cetera. They also have a small portfolio of fintech-originated consumer lending that we expect to probably just allowed to burn off over the short period that remains. They're generally high FICOs, well underwritten type lending, and we're very comfortable with it, David.

Okay. Okay. And then as you look at your footprint, maybe just back a bit, the Apollo deal takes this deeper into Miami, you've got the de novo expansion into Jacksonville and Naples. This is contiguous with your markets, really kind of rounds out one of the areas that you didn't have exposure to. And fortunately, you guys did it again with scale. Just as we look at the rest of the state, if you think about your priorities with future expansion, is it primarily infill in existing markets? Or I mean, are there any other markets that you feel like you need to expand into? Is the panhandle and other parts of North Florida, something that you're interested in?

There's still more to be done, David. I would say our key focus really is Jacksonville to Miami, the entire portion of Central Florida, including some of the markets in and around kind of the Orlando area, as well as there's still a fair amount of room to fill in down in Southwest Florida. So I still think we've got plenty of opportunity out ahead of us and more to be done, but those are the key markets will continue to work on filling in and bolting on to. One of the benefits, David, as you know, is we really haven't had to leave the state to find high-quality growth. The growth has been moving here, particularly over the last 2 to 3 years. It's been nothing short of remarkable with the amount of inbound population growth, and it continues. And so continuing to consolidate market share in the state, I think, is the best strategy for us and something we'll continue to be focused on.

Our next question is from David Bishop with Hovde Group.

Chuck and Tracey, just remind me, going over the $10 billion mark. Remind me what the impact of the Durbin amendment is when that occurs? And now that you've done the -- you've got the pending 2 deals getting close to the $13 billion mark, is there sort of an optimal balance sheet or size you're targeting in the near to intermediate term?

Yes. We have talked about the impact of Durbin and regulatory costs and estimated that at about $9.2 million annually pretax. So the impact, certainly -- as we continue to provide scale to the organization, we work to offset that impact. We were successful in offsetting about 60% of that EPS solution with the addition of Sabal Palm Bank and Florida Business Bank in January, and then adding Apollo to the model pushes us over the top to fully offset those estimated costs. And so higher regulatory and Durbin-related costs are crossing [$10 million]. We've created the offset for that even before we get to this transaction.

Yes, David, I would say we cleared that on Apollo and this is additive above that. And at this point, I think we've dealt with the Durbin issue.

Got it. And that takes place -- that starts impacting next year, correct, in terms of the revenue run rate?

Right. It will take effect in the second half of 2023.

Got it. And then, Chuck, just maybe a holistic question here. You noted in terms of layering and your successful mobile banking initiative and the community banking efforts. Given just sort of the low deposit beta, obviously, they have a very strong deposit franchise low beta, do you spend as much time sort of on the customer deposits due diligence in terms of sort of exporting your expertise to Drummond to make sure there's not a greater-than-usual deposit attrition that could taint their deposit base?

Yes. Great question, David. No, that's actually what is very, very attractive about this franchise. We spent a fair amount of time in looking at the deposit portfolio. The bank is 32 years old, and as you can imagine, with that type of seasoning and the portfolio, it is a lot of checking accounts and there's incredible value in that. And we're able to run a fair amount of analytics on the portfolio, and we know that we can drive much stronger mobile penetration into this portfolio. We also know that we think we can drive greater cross-sell. And there's just a lot of upside to bringing on this portfolio. It's a low deposit beta, performed incredibly well in the last cycle because it is just made up with thousands and thousands of just consumer and business operating accounts. And so we're excited to bring it on. It's a portfolio that looks a lot like legacy Seacoast, if you were to sort of look at our portfolio of customers, particularly in and around kind of the Treasure Coast and Okeechobe markets here that we've always operated in. And we just -- we see great value in the deposit portfolio. I mean I think that is the big strength of this bank that we're buying. The history of the Drummond family and Drummond Bank in that market has been there many years, even before this bank was started. And so it's a long-time, well-seasoned portfolio. I think it will perform incredibly well for Seacoast. And I think it's an incredible opportune time to buy this kind of franchise right now with rates going up.

Great. Appreciate that detail. One final sort of housekeeping question, Chuck or Tracey, you may not have the number off your top of your head, if you do, I can circle back. Average loan size of Drummond relative to Seacoast, I would imagine pretty granular, similar to you all.

Yes, we'll have to get back to you.

Yes, we'll go back to you. We -- what I can say is we know it's much lower than Seacoast. So it builds into the granularity at Seacoast.

Our next question is from Brady Gailey from Keefe, Bruyette, & Woods.

Is there any way to size what the revenue synergy could be as you guys -- you talked about insurance title, I think they also have wealth management. I know it's not in the deal math here, but is there any way to size how big those revenue synergies could be?

We haven't really tried to run the math on that at this point, Brady, it's -- the best way to describe it is we're -- in order to fully take advantage of it, there's some investment that's going to be needed to scale the insurance business, for example. But they did -- and all between the insurance title company and the wealth business, it's roughly $5.5 million in revenue. But we have -- particularly on the insurance side, it's probably going to lean much harder into commercial insurance. We have 78,000 businesses at Seacoast in our customer profile. So the penetration of that, even if it was a small number, is going to lead to material results. And so there's a lot of upside, but I don't have sort of a quantification I can provide for you today.

Okay. And then, Chuck, you guys have been so successful in acquiring all these small Florida banks. How many more banks are out there in the state of Florida that would be a target that you guys would be interested in kind of like Drummond? Like is that 5 banks? Is it a dozen? What's the opportunity that's left in Florida for you guys?

A little over 10.

Okay.

In that ballpark.

10 to 12 finally covers about it, right?. Okay. And then finally from me, just back on the Durbin question. So $9.2 million pretax annually. I think that was the number back when you guys were like closer to $9 billion in assets and now you're $13 billion. Like does that -- I'm guessing that $9.2 billion has grown from back then just given the recent M&A. Like what's that number including everything, even including Drummond in there? What would that impact be with you guys as a $13 billion in asset bank?

Yes. I think it's fair to say that, that number grows as the franchise grows. I think the $9.2 million included not only Interchange and Durbin Direct, but also the additional costs associated with some of the regulatory changes that take effect outside of the interchange. So I don't have a specific number, but you're right to think that, that number would have increased.

Our next question is from Michael Young with Truist Securities.

Wanted to maybe just ask for a little more detail on sort of the cost save assumptions, 40% is pretty healthy for market extension deal. It didn't look like the branches were all that clustered together, but maybe there's some opportunity there with your data analytics to kind of prove that. Could you just walk through kind of how you're getting to the 40% cost save number?

Michael, yes, there will be opportunities for consolidation. We'll finalize those decisions here in the next couple of months. So the overall plant cost saves of 40%, the way that breaks down, the majority of the cost of maybe 40% of the total relates to the consolidation of back office functions and locations. And then after that, savings in data and transaction processing, the integration of various systems, that represents another about 25% of the overall cost out we have planned. The remaining -- that would be 35% is really achieved through the consolidation of other operational expenses, things like legal and audit fees. We'll have most of the cost outs achieved by the first quarter of '23. I have 85% by the first quarter of '23, with 100% by the second quarter of '23.

Okay. That's helpful. And maybe just looking at kind of the relative yields of both books, both the loans and the deposits, they have pretty high yield on the loan side. So I don't know if a lot of that more related to the consumer paper that Chuck just talked about or if that's more the C&D book, but it would be helpful to kind of understand where those higher loan yields are coming from. And then on the flip side, just on the non-time interest-bearing deposits, not sure what's in there, but is there anything that's particularly rate-sensitive where you guys might shrink the size of the book as you bring the bank over?

Yes, just talking about loan yields. There's a little bit of it is, in fact they have the consumer paper that's higher yielding. The other fact is it's a real franchise. They've gotten paid for the lending they've done in the markets for a long time, and that's the quality of the service and quality of the history of the bank. And so it's a good-yielding portfolio. The C&D book is primarily construction loans to individuals to build homes, it's all residential. And a lot of that's built under a program they have with a secondary market that will buy that paper at the end of construction. So it's actually kind of a flow-through type situation. We're able to move out and being sold for premium at close. It's a pretty nice product, something we probably will bring on to the Seacoast franchise. Now on the deposit side, it's just all transaction accounts, Michael. I don't see any of it really running off. There is no high yield. There's -- it is just purely -- that's the beauty of this bank, it is a deposit portfolio built on transactions. It is -- they have always focused on building the funding base, and they've done an incredible job over multiple decades, and that's what we're buying here.

Okay. Helpful color. And then last one for me is just, obviously, 4 deals being completed this year. I know 2 are already done and on the books, but a decent pace of M&A here over the past kind of 6, 12 months. So do you have to kind of -- or do you need to sort of take a bit of a pause, a bit of a breather? Or is it still full steam ahead, seeing opportunities and want to capitalize on the near term?

Well, the first 2, after this coming weekend will be fully converted and closed and consolidated. So those are behind us. Apollo, we expect to do early in Q4 and then this one later this year and maybe a conversion right at the first of the year. I would say we need to get through our approval. On Apollo, which we expect in about 45 days, once we get through that, we'll be ready to start thinking about what's next.

[Operator Instructions] Our next question is from Steve Moss with B. Riley Securities.

Most of my questions have been asked here. I guess just one follow-up. I'm not sure if you specified, but just -- is the entire consumer portfolio, the fintech loans? Or is it just a portion? I'm just wondering any color around what the FICO scores are within that portfolio and maybe the underlying yield if you have.

It's just a portion and the FICOs are north of 750 for the most part. It's right around 750, probably on average. So that's about what that portfolio looks like.

Okay. And is it probably like about 8%, 9% yield, kind of the way to think about it?

Yes, that's about right, Michael. I mean, Steve, sorry.

No problem. All right. Well, thank you very much, and congratulations on the transaction.

Awesome, Steve. Thank you.

And Mr. Shaffer, there are no questions at this time. You may continue with your presentation or closing remarks.

Okay. Thank you all for joining us. It's an exciting transaction. We're glad to be able to talk to you about today, and that will conclude our comments. Thank you, operator.

You're very welcome, sir. And this does conclude the conference call for today. We thank you all for your participation and kindly ask that you please disconnect your lines. Have a great day, everyone.