County Bancorp, Inc.
Q2 2020 Earnings Call Transcript

Published: 24 Jul 2020

[Operator:]

Good day, and welcome to the County Bancorp, Inc. June 30 2020, Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Tim Schneider, President of County Bancorp. Please go ahead sir.

[Timothy Schneider:]

Welcome everyone to our earnings call for the second quarter of 2020. As a reminder, we have our disclosure on the uses of forward-looking statements on Slide 2 of our presentation. Moving to Slide 3. We have made few changes with our Board of Directors. Andrew Steimle, who has been an independent director on both our Company and the Bank’s board since 2008 has been selected as the new Chairman of both boards. He is a business and real estate attorney practicing in Wisconsin and is a Founding Partner of Steimle Birschbach, LLC. He will be a great Chairman and I am looking forward to working with him more directly moving forward. We are also happy that William Censky, our Former Chairman will remain on the boards of both the company and the Bank. I am grateful for Bill’s leadership and strategic contributions over the past 23 years. His focus on excellence as well as his unwavering support for the Bank, its employees and our communities has been vital to our success. So I am very happy that he will remain a vital member of our Board moving forward. Lastly, we’d like to recognize that Board of Directors have been appointed Director Kathi Seifert as Chair of the nominating and governance committee and Director, Vicki Leinbach as Chair of the compensation committee. Kathi and Vicki has served our Board well over the last few years and we look forward to their expanded contribution. Now I’ll talk about the quarter one 2020 overview moving to Slide 4. There were several positive trends to our financials this quarter which resulted in a net income of $2.7 million or $0.40 per diluted share. Those included an increase in net interest income to $2.7 million, partially due to a shift in balances from interest-bearing deposits to investment securities, a decrease in loan loss provision to $1.1 million with overall credit quality holding up well; an increase in non-interest income to $3.4 million; $106 million in SBA’s PPP loans approved to support our loyal customers through the COVID-19 crisis; and finally client deposit growth of $101.9 million, which reflects our execution against our strategic initiatives. And I’ll talk a little bit about COVID-19 response and employee safety moving to Slide 5. I continue to be amazed that how our team has responded to the impacts of COVID-19. The health and well-being of our employees remains our top priority and we have made significant improvements in investments to be able to safely serve our clients and communities. During the quarter, we announced that together a game plan which will bring our employees back to the office in phases. We just brought back the first phase and we’ll monitor local infection rates and trends as we evaluate the timing of the next phases. We currently have approximately 80% of our workforce working from home with no drop in productivity. We have also instituted several safety measures including guidance on masks, protective barriers and continued education. Our team remains united around safety and again, I’ve been very proud of our collective efforts to work through these difficult times without missing a beat in the provision of excellent service to our customers and communities. Next Slide. Moving to Slide 6, we have opened up our locations to customers with an emphasis on safety first supported by numerous initiatives as you will see on this slide. Our team has loved to getting to see our customers in person again, but we’ll continue to prioritize safety as we move forward. I am also pleased to note that we have had $106 million in SBA PPP applications processed during the quarter, which will be a great benefit for our local customers and communities that have been impacted by the pandemic. In an effort to simplify the next steps of the process for our customers, we have recently partnered with a technology company to help support the required online forgiveness applications as well as continue to have ongoing PPP educational needs and for communication with the customers. Because of our speed to market, we were able to bring on 150 new customers through the PPP program. And now I will turn it over to John Fillingim, Chief Credit Officer for an update on credit. John?

[John Fillingim:]

Thank you, Tim, and good morning everyone. Moving to Slide 7, I’d like to provide an update to our COVID payment relief metrics. On the commercial side, we initially provided 90 days of payment relief to customers who requested it and were negatively affected by the pandemic. While the interagency guidelines issued in March of 2020 provide for longer term payment relief, the 90-day approach was taken given the uncertainty surrounding the potential impact and longevity of the business shutdowns. The initial request required the borrowers to serve by that their businesses have been impacted by the COVID crisis. During the last quarter, our commercial bankers have contacted their customers that requested payment relief to determine the degree of the impact due to COVID-19. At this time, we are highly encouraged to find that only five of the original 89 commercial customers have requested an additional 90 days of payment relief. We are also encouraged that Wisconsin’s unemployment rate is 8.5% as compared to the national rate of 11%. All requests for payment modifications beyond the original 90 days require the borrower to provide financial update and an action plan so that we can determine any necessary changes, the risk ratings and servicing plans. While there still remains uncertainty surrounding the long-term impact of COVID-19, we are encouraged by the minimum number of request for additional payment reliefs. Moving to Slide 8, I would like to highlight some of our key credit metrics. We continue to focus heavily on our high risk industries that include, hotels, restaurants and bars, multi-family including student housing, retail, office, and construction. Our adverse classified ratio increased 41.73% quarter-over-quarter, which is where we began the year. The increase was largely due to one commercial credit and four Ag credits migrating to sub-standard. On the positive side, we saw eight dairy relationships upgraded from watch to low satisfactory and three dairy relationships upgraded from special mention and substandard to watch. Additionally, we reduced our OREO exposure from the sale of two parcels of acquired property. We continue to have our bankers report on their high concern watch and substandard credits on quarterly basis to ensure proper monitoring and follow-on on these accounts. We’ve completed the annual reviews on 84% by dollar of our Ag, watch and worth rate of credits and do not anticipate any additional significant downgrades in that book at this time. Given the improved milk price environment, and the substantial amount of government assistance that’s been provided to our Ag producers, we are encouraged that the overall outlook for our dairy portfolio. And as previously mentioned, we continue to stay in close contact with our commercial customers to determine the ultimate impact of COVID-19 on their businesses. Moving to Slide 9, as of Q2 2020, we had $18.5 million in construction loans outstanding. $5.3 million of the $5.5 million in multi-family is related to a project that is complete and is awaiting conversion to permanent financing. This particular project is supported by a well-capitalized owner and have seen varied risk leasing activity. The limited service restaurant exposure is related to a franchise operator that’s supported by a SBA 504 loan and it represents minimal risk to the Bank. Moving to Slide 10, you can see that our C&I and owner occupied commercial real estate portfolio is well diversified based on the breakdown on the left of this slide. Additionally, the loans that are included in the high risk industries as detailed on the right-side of the slide carries satisfactory LTVs and risk ratings and continue to be closely monitored by our banking teams. Moving to Slide 11, you’ll see the breakdown of our investor commercial real estate by industry, as well as those industries we have identified as higher risk. As you’ll see, we do have limited exposure to retail, hotels and assisted living operations. However, it’s important to note that we have comfortable levels of LTVs and risk ratings on these credits. At this time, I’d like to turn it over to Dave Coggins our Chief Banking Officer to give an update on the overall Ag environment. Dave?

[Dave Coggins:]

Thanks, John. Moving to Slide 12, the second quarter provided substantial volatility for our dairy customers. When shutdown orders started in March, it created a dramatic, but temporary oversupply problem. Food service hotels essentially shutdown and much of the dairy consumption is done through that sector. Some dairy plants started requiring their farmers to cutback that production or dump knock if they couldn’t. Class III futures plummeted and any customer who wasn’t protected with milk marketing positions were facing some strong headwinds. Fortunately, this situation was short lived as prices went from $12.74 for Class III in April to $21.4 in June. Our current outlook for the balance of 2020 looks solid with forecasted average futures, the combination of actual for the first six months and futures for the last six months was $17.46. This puts most of our customers in a pretty good place for 2020 with substantially above breakeven prices in most cases. Some of the drivers of this significant improvement include, the ramp up to the economy opening up created significant demand to stock restaurants. An important consideration is that limited service and quick service restaurants have recovered nicely and they drive a lot of cheese sales places like McDonald’s, Dominos and some of the limited service type establishments have driven much of that improvement. Retail dairy consumption has been very solid. Exports for May were much better than expected. Cheese and nonfat dry milk continue to be the export stars and China is now buying more dairy as a result of their commitment to the trade agreement that have been developed between our two countries. Some calling of the dairy hurt in cutbacks in melting frequency have had an impact as farmers were trying to deal with some of the limits that their dairy plants were putting on them. And the U.S. government has been buying a lot of dairy products through some of their programs which has been supported. And finally, the global milk production continues to expand but at a much slower rate and that’s something that has also have an impact. A few other factors looking forward regarding things that are affecting the industry and our dairy customers, the forecast do suggest that a price high is near. That’s been predicted and we expect that that’s going to happen this quarter because the next two months still have really high price forecasts on them. Many producers have utilized risk management tool to predict - protect their margins and that’s been, there are many tools available to them at very affordable prices. Feed price is an important component of every farm’s expenses have softened due primarily to ethanol and energy price collapses and export disruptions. Expectations are for China to continue to be a more active buyer and energy prices do drive a lot of cost on the expense portion of the farm income statement and that’s continuing to have a positive impact on input cost. As you drive around, Wisconsin cropping conditions are generally very good and should result in a strong supply of feed this fall. The SBA PPP program has assisted many of our dairy customers and something called a producer price differential, which is a factor when Class III prices get higher than Class I. There are some rules in the federal milk marketing order that create a negative basis for some plants. And that’s a temporary problem right now, but that’s expected to be short lived. Finally, CFAP or the Coronavirus Food Assistance Program that the government developed guided USDA has provided a big boost for most producers. And now I’d like to turn it over to Glen Stiteley, our Chief Financial Officer for an update on the rest of our financial performance. Glen?

[Glen Stiteley:]

Thanks, Dave. Moving to Slide 13, we recently raised $22.4 million in the sub debt at a fixed rate of 7% callable after five years. Even though our capital ratios are very strong, we decided to raise this additional capital with an abundance of caution with an outset of returning too offensive capital. Based on our current capital levels and credit quality metrics, we plan on continuing with our common stock repurchase plan that we announced in January this year. While continuing to be prudent and balancing our risk profile against our desire to be opportunistic with this program, we purchased 122,606 shares at a weighted average price of $20.62 in the quarter. We currently have no plans for a change in our dividend paid per share and as always management of the Board will adjust our capital plans as we know more about the credit impacts from COVID-19. Turning to Slide 14, you will see the breakout of how our allowance is made up for this quarter. We see it’s in with our COVID-19 qualitative factor which totaled $1.9 million this quarter and as you’ll see, we also added $1.7 million of specific reserves relating to one commercial relationship. Turning to Slide 15, we had strong client deposit growth during the quarter of $119 million, which included an estimated $58 million in growth from customers who took PPP loans. Similar to last quarter, we continued to lengthen wholesale funding maturities where we can to mitigate our liquidity risks and take advantage of the overall lower interest rate environment. Turning to Slide 16, loan yields are being impacted by the Fed rate cuts in the first quarter, as well as SBA PPP loans, which was about 12 basis points impact to margin. We have aggressively cut deposit rates but haven’t seen [Indiscernible] We will begin to invest our excess cash during the third quarter, so that we should have a positive impact to our net interest margin going forward into 2020. We did incurred a penalty on calling some higher rate brokered CDs which we refinanced to lower interest rates. Turning to Slide 17, loans sold and serviced increased $10.3 million during the quarter along with a 4 basis point improvement in loans servicing spreads. Our loan servicing rights origination income increased due to the originations this quarter as well as an increase in servicing spreads. Turning to Slide 18, we had improvement in non-interest expense in this quarter due to some of the noise in the first quarter related to our goodwill impairment and an OREO write-down that happened in the first quarter. We continue to see lower cost especially with employees traveling work for clients, as well as education opportunities. Salaries and benefits decreased in Q2 due to the deferred cost impact from the SBA PPP loans. Turning to Slide 19, wanted to give a little bit of color on what we think is going to happens in the third and fourth quarter and into 2021 related to the PPP loans. As of the end of the quarter, we had a $106 million of loans on our books at a yield of 1%, which are largely funded with our – with Federal reserve funding at 35 basis points. We had deferred a fee income of $3.8 million and deferred loan cost of $1.3 million. As we are looking forward, we expect about 20% of loan balances being forgiven at a monthly basis in September through December of 2020 with the remaining 20% being forgiven throughout 2021. Deferred fees and cost will amortize to loan income and we are giving a little bit of color on this Slide as what we think those amounts could be based on the 20% forgiveness assumptions. Average balances for the quarter on the PPP loans in the second quarter were $68 million and the interest income and fees related to this were $79,000 to help with modeling. So to conclude, I would reiterate some of Tim’s comments earlier, we are extremely proud of this organization. Our people and the role we play in supporting our local customers and communities, our team knows to the challenge this quarter and navigated but truly new to them, their dedication to safety and service drove strong performance, but most importantly, help support our customers in these difficult times. We look forward to attacking the third quarter with the same passion. And now I’d like to open it up to questions.

[Operator:]

[Operator Instructions] Today’s first question comes from Jeff Rulis with D.A. Davidson. Please go ahead.

[Jeff Rulis:]

Thanks. Good morning. Certainly appreciate the detail on the slide deck. So, thanks for that. On the deferral side, the five that requested extensions did I follow that right that out of the 89, there was only five or are there extensions beyond that number or that was it?

[John Fillingim:]

Yes. This is John Fillingim. No, there have only been five customers of those original 89 that have come back. Lot of those are initial 90 days either maturities in the June or first part of July. And we’ve reached out again to all those customers and at this point, those are the only ones – at this point to allow for an additional 90 days payment relief.

[Jeff Rulis:]

So that deferral number of $200 million at the end of the quarter, has that come in and/or declined then?

[John Fillingim:]

It has, yes.

[Jeff Rulis:]

Okay. Got it. And then, on the Ag deferrals, on the six months timeline, so, maybe a while before we see actual activity, but any early indication approached by any of those folks that maybe requested to go back on payment status.

[Timothy Schneider:]

Yes. This is Tim Schneider, I’ll respond to that question. Dave alluded to the very low milk price environment through those couple of months that we saw in April and May and we basically were proactive in providing that six month deferral given some of the regulatory guidance just to give them breathing room. It’s a very expensive – expense heavy time of the year to putting the crops in the ground. At that point, we didn’t really see prices rising like they have. So I would anticipate after this initial six month period, we would not have many additional borrowers that are going to ask for a further extension. Yet the futures market for milk as we’ve said today holds.

[John Fillingim:]

This is John Fillingim, I would just add to that, in addition to the deferrals, I mean, since then, there has been PPP funds, there has been several programs from the government that have allowed our dairy customers to be able to build – rebuild some working capital and some liquidity. And so, again, as we mentioned during the time, that’s a – we are really pretty encouraged about where our dairy book is right now with this support, with the milk price where they are. So, we don’t anticipate any additional need on that side of the book if it’s on.

[Jeff Rulis:]

Got it. That’s good detail. On the margin side, Glen, I think you mentioned, you said the PPP was a 12 basis point headwind to margin this quarter?

[Glen Stiteley:]

Yes. Correct.

[Jeff Rulis:]

Okay. And I guess, if we kind of look forward, you had a lot of kind of moving pieces in there, calls and CDs and as you look to put cash into investments and perm up that margin, any kind of outlook type commentary on what to expect from here?

[Glen Stiteley:]

Yes, Jeff. Just like you said, there is so many moving parts to our margin right now. It’s getting really challenging to kind of forecast and predict it. So, we are trying to have that especially with the PPP and kind of detail we gave you that maybe help with that. But it’s – I am challenged to kind of predict what our margin is going to do this next quarter. So, hoping investments and cash is going to help take away some of the impacts. There is still going to be some headwinds, because the rate cuts haven’t fully impacted everybody. We try to aggressively cut our deposit rates. We are continuing to look at recent cuts on those deposit rates. But it’s just going to be – you know, it’s going to be somewhat challenging to predict the margins. We should have some uptick as loans are forgiven though, because that will pull back into interest income. So, but it’s – unfortunately, it’s going to be kind of a bumpy margin ride, the rest of the year.

[Jeff Rulis:]

Right. On a core side, is it safe to assume that, less volatility than we saw in – the jump off going on rates Q1 to Q2 was large, but maybe we sort of settle in a little bit, at least magnitude of change might mitigate a bit. Is that fair?

[Glen Stiteley:]

Yes. Well, if you check the PPP index, yes, it’s – once you introduce that

[Jeff Rulis:]

That PPP?

[Glen Stiteley:]

Yes, it’s going to be – it’s going to jump, so.

[Jeff Rulis:]

Fair enough. All right. I’ll step back. Thanks.

[Operator:]

Today’s next question comes from Brendan Nosal with Piper Sandler. Please go ahead.

[Brendan Nosal:]

Hey, good morning everybody. How are you?

[Timothy Schneider:]

Good morning, Brendan. Good. How are you?

[Brendan Nosal:]

Good. Thanks. Just want to follow-up on deferrals. So I know the number at quarter end was $200 million, but kind of basing your commentary, you are telling the number is a lot lower today. Do you have kind of what the balance of current long on deferral is? Just because it’s such a closely watched number and it sounds like it’s a lot better than kind of what was in the release.

[Timothy Schneider:]

We don’t have that number at our fingertips, Brendan, but we can definitely follow-up with you on that and others on this call.

[Brendan Nosal:]

Okay. Great. And then, I just want to move on to kind of the allowance today. I guess, you are speaking about the need for further reserve builds. I guess, on the one hand, you have one of the higher reserves of anything in your size today and then of course on the other hand, back-end levels are more elevated for you guys. So, just what is your sense as you look out over the next few quarters for the need for further reserving terms?

[Timothy Schneider:]

Glen, do you want to start that one? Maybe I’ll chime in there with you.

[Glen Stiteley:]

Yes, that’s the million dollar question and that’s – it’s just really tough to tell, Brendan right now. I mean, we are kind of preparing for the worst. As I think everybody was in the first quarter reloaded up. We were looking, should we load up again in the second quarter, but we just don’t have anything that’s pointing to this. We need to keep loading up. So, we are just going to continue to watch the deferrals very closely, continue to watch the classified asset levels. Let’s kind of level off for now and I think we are encouraged by, I think, John kind of pointed a couple things, just on a macroeconomic perspective, unemployment has been lower in Wisconsin and Wisconsin tends out be kind of a hot bubble state I mean, during the crisis. Losses were lower than probably nationwide. And this is obviously a little bit different kind of animal that we are trying to get about today. But we haven’t seen the metrics that say, we got to continue to load in. So, as of right now, we are not planning on big load with the provision in the rest of the year. But that could change obviously pretty quickly as some of those metrics start going into a different direction.

[Brendan Nosal:]

Yes. Got it. I understand. And then, last one maybe before I step back, just a technique type question here. The prepayment penalty on the brokered CD, does that flow through non-interest expense or did it flow through our net interest income this quarter?

[Glen Stiteley:]

Net interest income. So, interest expense.

[Brendan Nosal:]

Thanks for taking the questions.

[Operator:]

[Operator Instructions] Today’s next question comes from Terry McEvoy with Stephens. Please go ahead.

[Terry McEvoy:]

Good morning.

[Timothy Schneider:]

Good morning, Terry.

[Terry McEvoy:]

And thanks for all the work that went into the presentation. I appreciate it. Just starting with dairy, obviously, nice to see milk price is higher in the quarter. My question is, can farmers, your farmers lock in at these prices or do anything to protect themselves on the downside should prices move in the other direction?

[Timothy Schneider:]

Dave, I’ll let you respond to that. You are the expert.

[Dave Coggins:]

Yes. Terry, there certainly are a number of tools, as we maybe talked about in previous calls, one is, just go into the board and hedging. Many milk plants have offered forward contract type programs and then in addition, there is a couple of programs that offered by USDA once called the Dairy Revenue Protection Program, which was sort of a margin type insurance product and the other is livestock gross margin insurance which is also an insurance product, but it protects – it allows farmers to protect the margin, not just the price. And all those tools are available, the key to it is, they work with advisors including our own insurance division of the Bank to make sure that they’ve got strategy because it is unlike corn, and beans and things like that, you can’t just lock in a year’s production in one contract. You have to lock in each month and the futures market is moving month-by-month. So, there is lot of strategies involved, but yes, they can – for those that didn’t do that for April and May, those are the two months that really hurt producers. But, going forward, most of them are in pretty good shape and have been able to do take position. Most of them – the predominant tools has been the Dairy Revenue Protection, a newer tool that’s been offered by the USDA.

[Terry McEvoy:]

Thank you there. And Glen, a question on expenses, the $1.3 million of deferred cost that reduced salaries and benefits, what are your thoughts on the third quarter as it relates to that line? And maybe operating expenses overall, specific to the third quarter?

[Glen Stiteley:]

Yes. Terry. So, I mean, the noise from that, should be as drastic. It will – we have originations – deferred cost originations that come out of salary and expense every quarter. It’s just drafted this quarter, because of the PPP loans. So, obviously, I don’t anticipate that kind of large number coming out in Q3. Generally, we’ve been trying really hard to manage cost as best we can. Again, we – people are traveling less. We don’t have as many people in the branches. So, overall, our cost should be pretty maintainable, I think going into the next couple quarters here. So, again, back off that impact from the deferred cost, I think that’s a pretty good number.

[Terry McEvoy:]

Thanks. And then, just one last one here. I mean, you mentioned Culver’s, right on Slide 10 here, 11 plus million dollars of loans. How is their business? And does the Culver’s out by the Walmart in your city, is that – or the lines in the drive-through extending into the parking lot and the activity in volume pretty strong there?

[Timothy Schneider:]

This was relative to the limited service restaurants. Is that what I heard you say?

[Terry McEvoy:]

Correct. Yes. Slide 10. The Culver’s restaurants.

[Timothy Schneider:]

Yes. Yes. There is a Culver’s that’s half a mile here from the Bank in the outlet of a Walmart. And those lines are continuously busy and we’ve heard the same from Culver’s corporate which we have a good relationship with throughout their footprint in Culver’s. So, they’ve responded very well to the COVID environment. And I think we continue to hear that with the drive-through service through COVID-19. They were doing 65% to 75% of their normal sales through the drive-through. So - it’s, they’ve responded quite well. Thanks.

[Terry McEvoy:]

Thanks, everyone.

[Operator:]

Thank you, ladies and gentlemen. This concludes the question and answer session. I would like to turn it back over the management team for any final remarks.

[Timothy Schneider:]

Yes. Thank you everyone for joining us today. I think we had a relatively solid quarter given the COVID environment. And we appreciate your support and if you have any further follow-up questions, I ask you to call, feel free to reach out to any of us. Thank you again.

[Operator:]

Thank you, sir. This concludes today’s conference call. You may now disconnect your lines and have a wonderful day.