Earnings Call: Q2 2021

Jul 27, 2021

Good morning, and welcome to the SB Financial Second Quarter 2021 Conference Call and Webcast. I would like to inform you that this conference call is being recorded and that all participants are in a listen only mode. We will begin with remarks by management and then open up the conference to the investment community for questions and answers. I will now turn the conference over to Sarah Nikas with SB Financial. Please go ahead, Sarah. Thank you. Good morning, everyone. I would like to remind you that this conference call is being broadcast live over the Internet and will be archived and available on our website at ir. Yourstatebank.com. Joining me today are Mark Klein, Chairman, President and CEO Tony Cosentino, Chief Financial Officer and John Gaffman, Senior Lending Officer. This call may contain forward looking statements regarding SB Financial's performance, anticipated plans, operational results and objectives. Forward looking statements are based on management's expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied on our call today. We have identified a number of different factors within the forward looking statements at the end of our earnings release, which you are encouraged to review. SB Financial undertakes no obligation to update any forward looking statement, except as required by law, after the date of this call. In addition to the financial results presented in accordance with GAAP, this call will also contain certain non GAAP financial measures. A reconciliation of GAAP to non GAAP measures is included in our earnings release. I will now turn the call over to Mr. Cline. Thank you, Sarah, and good morning, everyone. Welcome to our Q2 2021 conference call and webcast. Briefly, reviewing some highlights for the quarter, which included a small mortgage servicing rates impairment of roughly 100,000 dollars would include net income of $3,800,000 up $100,000 or 3 percent over the prior year quarter. On a year to date basis, when adjusted for the non GAAP impact in 2021 and 2020, net income was 8,800,000 up $860,000 or nearly 11%. Return on average assets, 1.13 percent, pre tax pre provision ROA for the quarter 1.39%. Net income, net interest income of $9,200,000 was up 3 0.2% from the prior year as a slight decrease in interest income was supplemented by a nearly 42% reduction in interest expense. Loan balances from the linked quarter rose $2,400,000 and when we adjust for PPP balances, we're up $21,900,000 or 11 percent on an annualized basis. Compared to the prior year, net of PPP, loans were essentially flat. Deposits declined from the linked quarter by $29,000,000 but were up over 100 $1,000,000 from the prior year. Expenses were down $600,000 or 5 percent over the prior year quarter due to lower mortgage commissions and merger costs in the prior year. Mortgage origination volume for the quarter was 100 and $65,000,000 down over $58,000,000 or 26 percent year over year. Asset quality metrics remained strong both from a prior year and the linked quarter and our level of 46 basis points of non performing assets remains strong. We achieved a significant milestone in the quarter as all clients that were on COVID related forbearances have now returned to full paying status. Tangible book value is now up to $17.26 per share. And finally, we had a successful subordinated debt raised debt closed. The $20,000,000 in debt capital certainly prepares us quite well for potential growth opportunities. We continue to believe that our laser focus on those 5 key strategic initiatives that we've discussed for a number of will continue to lead to top quartile peer group performance. Revenue diversity and growth, of course, more scale in a larger footprint, certainly more services in those households with our client base, which leads to more scope, Delivering technology and excellence in our operations and communications with our clients is a key and of course the foundation of all high performing banks asset quality. First revenue diversity a bit. This quarter mortgage volume and loan sale gains were down from the prior year, 26% on volume and 48% on gains. For the last 12 months, we delivered nearly $700,000,000 in total mortgage origination volume. Columbus region delivered 61%, Northwest Ohio approximately a third and 6% from Northeast and Central Indiana. Our volume continues to be bolstered by our newer PCG fixed rate 15 year fixed then to a 1 year variable product that we underwrite and book in house. Closed to date in this new Q1 2021 product is $33,000,000 and the pipeline of another $24,000,000 Our metropolitan market of Columbus accounted for 64% of this PCG activity, which would include the volume and of course the pipeline. Non interest income decreased to $6,500,000 from the prior year quarter of $8,600,000 but is up over $6,600,000 for the year primarily due to a year to date variance of over $6,000,000 in servicing rights impairment. The current quarter includes a mortgage servicing impairment, as I mentioned, of $100,000 compared to an impairment of $1,100,000 last year. Non interest income to total revenue remained strong at 42% and 2% of our average Peak Title, our affiliate, continues to take market share with another strong quarter. This business line is a great complement to our residential lending strategy as they will be clearly the impetus to leverage technology to deliver a fully integrated electronic closing soon. We continue to seek out growth opportunities for this fee based division across our entire footprint. Our wealth management team achieved a significant milestone this quarter. Total assets under management now at over $600,000,000 represents $106,000,000 increase in assets under management or 21.4 percent improvement over the prior year while providing $950,000 revenue for the quarter, a 23% increase over the prior year. With regard to scale, loan growth certainly showed improvement in the quarter compared to the pandemic headwinds that nearly all banks encountered, including ours in the last 15 months. From the linked quarter, loan balances were up by $2,300,000 And when we adjust for the rapidly declining PPP balances, linked quarter growth was nearly $22,000,000 dollars PPP activities are winding down for our calling officers as they have witnessed a shift in the conversations with their clients to include expansion and opportunity from that of liquidity and safety. We join our clients' optimism and feel the economy will continue to grow as demand expands, supply chains improve and interest rates remain accommodated. Our pipelines reflect this optimism as we currently have over 2 16 loan requests for over $155,000,000 Our recent expansion into Edgerton, Ohio market that we've discussed somewhat in the past, our 5th office in Williams County has been well received. After just 3 months, we have over 100 transactional deposit accounts for over $1,500,000 and loan balance is now $4,500,000 with another $4,000,000 in the pipeline. We're pleased with our de novo expansion. Our overall deposit base declined from the linked quarter as both our retail and business clients began to open up their lives and businesses to reflect the change in pandemic status. We still have significant liquidity, which was supplemented by the debt raise that we closed in the quarter as I mentioned earlier. Although we did not have an imminent need, we felt that the pricing and opportunity to build a stronger balance sheet was critical for our long term growth initiatives. 3rd, more scope. We ended the quarter with $35,000,000 in PPP loans outstanding with $7,000,000 remaining from the $84,000,000 we originated in the first phase and $28,000,000 from the recently initiated Phase 2. We now have just 30 of our original 692 Phase 1 loans that have not yet applied for forgiveness, not only 9 of our 451 Round 2 loans have been forgiven. This quarter, we expanded our number of households and we continue to have great potential to expand our balance sheet further as our services per household in this current footprint remain well below 3 due in part to our rapid rise in single service mortgage households. We fully intend to onboard these new households with multiple touches. Additional operational excellence remains the 4th theme. We encountered headwinds on our mortgage business line during this quarter. Refinance activity was down $65,000,000 from the prior year or 45% and the reduced inventory available for sale continued to constrain most of our market production. The level of purchase and construction volume this quarter at 51% of our total volume was the highest percentage we've achieved since well before the pandemic. Expense levels for the quarter that Tony will touch more in greater detail were down from the prior year, although mainly as a result of a significant one time merger cost that we realized Q2 of last year. We're continuing on the path of reinvestment in technology that we mentioned in prior quarters to improve our client experience and interaction. We're well aware of the need to improve our digital platform and allow our clients to reach us through multiple channels. We've also moved aggressively in a number of our rural markets to capture market share from the regional banks stepping away from their traditional end market role using their digital platform as an end market substitute where clearly we continue to use the digital dimension as a complement to our client centric brand. 5th and final asset quality. At quarter end, as I indicated opening remarks, we had 0 loans in COVID forbearance, which obviously could portend a different approach to reserve levels as we begin to see growth in our own portfolio now. Coverage of our non performing loans, which is a metric that I continue to believe is a key measurement for a healthy banking environment, now eclipsed the 300% mark at the end of the quarter, even with an overall delinquency at an all time low of 0.41%. We continue to believe that our disciplined approach to lending during the good times has helped our client base withstand the unknown effects of the imminent downturn. Our profitability in the past 4 quarters has also enabled us to continue to build a healthy reserve level now to 1.56 percent of total loans for a year over year increase of 41% just in case we witness a slowing economy. Now I'd like to turn it over to Tony Constantino, our CFO, for some detailed remarks on our performance. Tony? Thanks, Mark, and good morning again, everyone. Again, for the quarter, we had GAAP net income, as Mark indicated, of $3,800,000 or $0.52 per diluted share. Some of the highlights in the quarter. Operating revenue was down $1,800,000 or 10.3 percent as mortgage gains on the lower activity was off nearly $3,900,000 or 48%. We were, however, able to offset that large mortgage variance with higher wealth and deposit fees, which were both up 23%. Loan sales delivered gains of $4,300,000 from mortgage, small business and agriculture. Margin revenue was up 3.2% due to the continued decline in funding costs, which were lower by over 700,000 dollars The acceleration from PPP forgiveness offset a portion of the core decline in interest income. Now we want to break down further the 2nd quarter income statement, starting with margin. Average loan yield for the quarter of 4.61 percent decreased by 7 basis points from the prior year, but was down just 1 basis point from the linked quarter. Overall, earning asset yields were down 70 basis points from the prior year due to the change in mix of the balance sheet down 31 basis points from the linked quarter. Loan yields were impacted by the fees from the PPP portfolio, which were $651,000 compared to $1,200,000 from the linked quarter. We still have $1,600,000 in unamortized fees of the original $4,900,000 from both phases of the PPP initiative. We continue to expect the large majority of these fees will be realized within this fiscal year. On the funding side, we again reduced the cost of our interest bearing liabilities from the prior year. For the quarter, the rate on our interest bearing liabilities was 44 basis points, which is down from the prior year by 44 and down from the linked quarter by 6 basis points. Net interest margin at 2.94 percent was down 38 basis points from the prior year, but remained flat to the linked quarter due to the negative impact of excess cash and restraints on our ability to increase loan growth. Total interest expense costs were down by 42% from the prior year and down again 7% from the linked quarter. When we exclude the impact of PPP fees from both years, the second quarter margin would decline 14 additional basis points to 2.80 percent. And on a year to date basis, our GAAP margin of 3.07% would be reduced for the PPP impact by 21 basis points to 2.86%. Total non interest income was down $2,100,000 or 24 percent from the prior year, reflecting lower mortgage origination volume and the $1,100,000 negative swing in servicing rights. As I discussed last quarter, gain on sale yields had reached the high end in the Q1 and we will not see those levels nor the levels we realized in 2020 again. Gain on sale yield for mortgage sales this quarter was 3.6%, which is a strong historical level, but well off the high 4% range that we took to the bottom line in 2020. Coupled with the lower level of sales due to the private client strategy we have discussed has made annual comparisons of our mortgage operation challenging. Our servicing portfolio does continue to grow and is now at $1,320,000,000 and provided revenue for the quarter of 830,000 value of our mortgage servicing rights declined slightly this quarter with a calculated fair value of 84 basis points. This fair value was up 19 basis points from the prior year, but down 2 basis points from the linked quarter. We now have a servicing rights balance of $10,700,000 and remaining temporary impairment of $2,300,000 We are hopeful that a continued slight rise in the rate curve and a slowdown in prepayment speeds will allow us to recapture this remaining balance yet this year. As Mark indicated, total operating expenses this quarter were down $600,000 or 5% compared to the prior year and were flat to the linked quarter. Prior year quarter included $1,200,000 in costs related to the Eden merger. And when we adjust the prior year for these merger expenses, operating costs would be up $655,000 or 6.3%. Now as we turn to look at the balance sheet. Loan outstandings at June 30, 2021 stood at $850,500,000 which was 65% of the total assets of the company. As we have discussed, deposit levels continue to be above our expectations and have certainly impacted total asset growth. Absent what has been some loan growth, we have reallocated cash balances to supplement our investment portfolio. And that portfolio of $217,000,000 is now up $108,000,000 or nearly 100% from the prior year. Looking at our capital position, we finished the quarter at $144,000,000 up $6,100,000 or 4.4 percent from June 30, 2020. And our equity to asset ratio stands at 11% or 11.3% when we exclude the remaining PPP balances. On a per share basis, tangible book value was up $2.25 per share from the prior year or 15%. And the buyback that we had announced continued at a brisk pace in the quarter with 215,000 shares repurchased at an average price slightly above tangible book value. With our market price of $107 of tangible book, our shares are still well undervalued in our opinion and repurchasing aggressively at these prices is an effective strategy. The reduction in non performing loans to 51 basis points reflects not only improved quality in our loan portfolio, but also the movement of a large credit into OREO. We are in the process of marketing this property and hopeful as the economy reopens, we will realize the full appraised value. As we said, we decided to forego any additional provision for the quarter as we feel significant increase in our reserve that we achieved in 2020 and in the Q1 of 2021 now puts us at the appropriate level. Classified loans are down over 21% and net charge offs for the quarter were minimal at $20,000 Now I'm going to turn the call back over to Mark. Thank you, Tony. I want to conclude my remarks by acknowledging our recent dividend announcement we made last week of $0.11 per share, which is 21% payout ratio and a dividend yield of approximately 2.4%. We continue to identify opportunities to enhance shareholder value and certainly one that includes dividends and a conscious deliberate return of capital to our shareholders in the form of stock buybacks, as Tony mentioned. And I'll turn the call back to Sarah for questions from our audience. Thank you, Mark. Now we're ready for our first question. And while we're waiting for additional questions, I would like to remind you that today's call will be accessible on our website at ir. Yourstatebank.com. And our first question today comes from Selina Jai with Janney Montgomery Scott. Please go ahead. Hey, good morning. Good morning. I'm asking questions for Brad Martin. So the first one is, what's your outlook of mortgage production and its gain on sale margin? Mortgage production for this year is certainly going to be low the prior year. Again, we discussed the trailing 12 months here at the $700,000,000 pace. Tony can give us some additional color, but I would think that we would hopefully come into that $500,000,000 to $550,000,000 number this year given the pace that we're on. Absent any aberrations in the 10 year treasury yield. Yields are still very accommodative to our borrowers. As we've mentioned in prior quarters and certainly this quarter, the inventory levels have remained quite constrained, which is going to have an effect on our volume. And of course, we've had a very robust refinancing opportunity the last year or 2, and that has begun to slow a bit. And further, and finally, as we mentioned, the 15.1% that we've begun to underwrite on a private client basis for our higher end clientele and some of our urban markets have certainly shored up the balance, which again will not come to us in the form of loan sale gains, but rather in loan balance growth. So we're optimistic that we've begun to play literally on both sides of that equation. But I would say we ultimately this year will probably be off maybe 20% from that which we realized the prior year. Tony, any additional comment? Yes. I think, Mark, that's good color there. If you look at our mortgage business, we've done about $321,000,000 thus far this year versus $325,000,000 for the first half of twenty twenty. Interestingly, we've done about 9.5% less actual mortgage units. So our dollar item per ticket has gone up to about $236,000 average loan size. I would suspect our 3rd quarter mortgage volume will be down, call it, 10% to 12% from the second quarter of 2021. And I would think that that $5.25 to $5.75 type range for the full year as we look at 2021 is a pretty accurate number as we sit here today looking at our pipeline. On the yield side, you also asked about Selena. I think we're going to continue to see gain on sale yields probably decline about 15 basis points over the prior quarter. I would guess through the Q1 of 2022 and then it will start to stabilize. So we'll probably end up at a stabilized range of probably $285,000,000 to $275,000,000 somewhere in the Q1 of 2022 and stay in that range going forward. Thanks for the color. So next question is about the loan growth. So this quarter has been really nice. So what's your outlook for probably the loan growth in your pipeline going forward? This is John. I think you're right. I think the Q2 began a nice trend for us. As we look at the Q3, we're very optimistic. There's still a lot of cash out there providing headwinds that the government has supplied borrowers. But with the combination of low interest rates and an improving economy and hopefully a little bit of an improving supply chain, a lot of our clients are looking to borrow. They just can't get the materials they need to build or do a machine or whatever they're looking to do. So if we can get a combination of some of those, I feel really good about our prospects in the Q3. If you look at our loan growth, commercial real estate all through the pandemic continued to grow and continue to grow and had a very nice second quarter and we would expect that trend to continue. We get some improvement back in the C and I through the supply chain and maybe people using up cash or paying down something else or better yet buying an investment, I think we're in good shape. And as Tony mentioned in the web call, pipeline is as strong now as it's been in probably year and a half, 2 years. Okay. Sounds great. So, do you expect the net interest margin to increase? As you mentioned, the interest rate is, I think, pretty low? Yes. I think as we look at NIM going forward, I think Q3 will start to see a much larger acceleration of Phase 2 PPP fees. I think that's going to provide a boost. We had a big Q1 of PPP fees down fairly significantly here in Q2. Q3, it will get back up. We have 1,500,000 remaining on the Phase 2 PPP fees, and I would suspect John will take a big portion of those there. As John said, we got a fairly large total pipeline, and I would think we're going to fund 30 plus $1,000,000 of that in the next 60 days, which is a pretty strong level of funding growth for us in a 60 day period. So I think that's going to be additive to margin. And we continue to be very aggressive on the funding side, and we've seen that clients have been not okay, but not moving large amounts of deposits out even as we move rates down fairly aggressively, but we'll see how that potentially may turn going forward. I think Celine, this is Mark. And I think it's safe to say and John can confirm this, but literally the conversations with our C and I clients as well as maybe some CRE clients have changed from again safety and restraint to optimism and potentially leverage because once that liquidity gets levered 2, 3, 4 plus times, there's going to be more opportunities and I think we're seeing that in our pipeline as we speak today. Thanks. So as you mentioned liquidity, so do you expect the deposits inflow to slow down as so many deposits have remained in the balance? Just a high level comment, Tony can kind of clean this up. But again, we've taken another bite out of another rural market. And so we think there's a lot of opportunities not only just from a household growth, but a little more scope in every household. But we continue to see a lot of larger regionals assume that they can attract clients in rural markets with again the digital platform as a substitute and we're using that as a lever to get into household as a complement. And we think they will continue, but as John mentioned, the real wildcard here is the optimism that might emerge from the market and whether anyone's going to continue to want to constrain that loss of liquidity or whether they want to go to the other end of the spectrum and leverage that liquidity. I think that's a big key. But generally speaking, we've been mildly aggressive on the CD side, maybe just mildly extending the maturities a bit just in case rates do go the other way in the midst of impending inflationary fears. So we've tried to hedge that a bit. But clearly on the asset side, we remain asset sensitive, but that we might be changing just a little bit as we change the mix in our balance sheet. Comments? Yes. I think we saw a $30,000,000 decline in total deposits this quarter, really the first decline we've had in, gosh, 5, 6 quarters. I would suspect we'll probably see a similar decline here in Q3, And then it'll start to stabilize a bit. I just think the consumer is going to spend a little bit of the money that they have in their DDA accounts and we've seen some of our businesses start to spend a little bit of their liquidity and I think that's going to be reflective of our balance sheet as well. Okay. I see. So are you going to use up all the fees excess liquidity in the loan production? Or what's your outlook for this? I'm sorry, I didn't get the question there. Could you repeat the question? Sure. So are you using up the most of the excess liquidity on loan production or what's your plan for that? Well, right now, as Tony mentioned, the investment signs up dramatically, not where we would like it. But we're pretty disciplined, as I mentioned, and that's one of the reasons we have the asset quality and a total of $20,000 losses and loan losses today. So we really like our asset quality positioning and we're pretty stingy with who we loan our money to. So that liquidity is eventually going to be deployed prudently. And again, if you just take a $100,000,000 growth plus or minus and you lever that 3 times by our clients, which is mild leverage in our estimation, that could yield a growth of 25% in our balance sheet. So as our clients remain optimistic and begin to deploy that liquidity to other opportunities, we think that's going to in order our benefit and we will move that liquidity over to the asset side of the balance sheet. And loans with higher yielding loans, albeit with an asset sensitive balance sheet increasing with, we think, potential market increases in rates someday. Okay, got it. Thanks for the color. So the last question is about the reserve. So for this quarter, there is no provision despite the loan growth. So what's your outlook of reserve ratio going forward? Yes. This is Tony. As we look at this quarter net of PPP, our allowance at $163,000,000 versus $122,000,000 a year ago, up 34%. Given our COVID deferrals and lack of actual losses, I think we're, as Mark said in the call, well prepared for any downside. I think we'll be prudent as we go forward with our loan growth and how we manage our allowance levels relative to loan growth. But I wouldn't think we'd be dramatically different from our current stance about where we are from a percentage standpoint, somewhere in that 1.4 to 1.5 type range. Okay. I really appreciate that. Thanks. Thank you. Thank you. This concludes our question and answer session. I would like to turn the conference back over to Mark Klein for any closing remarks. Yes. Once again, thanks everyone for joining. Excited about what the next quarter is going to bring. We have a lot of optimism and we're looking forward to reporting on those results in October for Q3. Thanks again and have a great week. Take care. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.