County Bancorp, Inc.
Q2 2019 Earnings Call Transcript

Published: 18 Jul 2019

Operator:

Good day, and welcome to the County Bancorp Inc. July 18, 2019, Earnings Release Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.I would now like to turn the conference over to Tim Schneider, President. Please go ahead.
Tim Schneider:

Thank you, and thanks all for joining us today. Before we start, I'd like to direct you to slide 2 of our deck, which is our forward-looking statement disclosure.And I'd like to start with an ag credit updates. We saw an increase in classified assets this past quarter, as well as increases in loans rated special mention. The increase in special mention loans from the prior quarter is driven primarily by three ag relationships. We placed loans in special mention as a temporary grade. We monitor these credits monthly to see if their proposed changes in their business plans are successful, and we anticipate updating their loan grading by the end of Q4.Increase in substandard performing loans is driven by six ag relationships and one commercial relationship. The ag relationships downgraded are related to getting through our annual financial reviews of these relationships. The commercial relationship was a startup manufacturing business, which is having challenges on their sales cycle extending, which has created stress in their cash flows.We previously had this rated as a special mention in Q2. We also moved one commercial credit from substandard performing to OREO and charged off of a portion of our specific reserve that we had allocated in Q1. While we have seen some credit stress from a handful of commercial deals, overall, our commercial portfolio continues to perform well.From an agricultural perspective, we are about 80% of the way through our total dollars on the credit review process of our watch and lower classified credits. We continue to manage as aggressively as possible the reduction of classifieds, with a few liquidations of farm operations occurring this spring and a few more ongoing through fall and some solid activity on more of our ORE currently.Up to 80% of watch or worse credits reviewed, we were selective in reviewing the credits we felt were more sensitive to the recent low milk price cycle and the size of the relationship. We have seen continued improvement in milk prices on the Chicago Mercantile Exchange Class III futures market.The 12-month forward-looking average is $17.04 per hundredweight this quarter, up from $16 a hundredweight last quarter. Since we use a three-year average of cash flows when determining a loan's credit rating, the uptick in milk prices in 2019 and the drop off of the lower cash flows from 2016 should have some positive impact on the overall credit quality in 2020 when we go through the reviews.The Chicago Mercantile Exchange Class III 2019 milk prices actual through June and futures for the balance of the year are at $16.31 per hundredweight, and this is the best year-over-year price that we've seen since 2014, which as you recall was a record high milk price year.We also had a couple of commercial deals bubble up and have been downgraded, including one involving a deal related to the regional retailer that filed bankruptcy, which I alluded to earlier, and that did have a specific reserve in quarter one that was charged off that quarter.Now from a client deposit growth standpoint, we continue to be focused on client deposit growth and have been really pleased by our growth in such a competitive landscape. Client deposits are up $39.6 million or 5.2% since last quarter and up $96.3 million or 13.7% year-over-year.And now, I'll turn it over to Glen Stiteley.
Glen Stiteley:

Thanks, Tim. Couple of things. First off, on deposit pricing. We are closely watching the inversion of the yield curve that's occurring, and we're reflecting that in our deposit pricing strategies. We have begun to cutback on our rates across the board to more closely mirror wholesale funding rates. Our aggressive reduction in FHLB advances during 2019 will also allow us flexibility, in case we have to plug in liquidity holes by the end of the year.On the wholesale funding front, as we've talked about, we'll continue to focus on reducing our wholesale funding especially on the broker deposit side. And as we talked about earlier, we are targeting $120 million reduction in wholesale funding this year, focused mostly on brokered CDs. We saw a reduction of $51.7 million this quarter and $92.9 million year-to-date. In this challenging rate environment, we will continue to be aggressive in paying off wholesale as it comes due.In regards to Russell reconstitution, at the end of June, we were taken out of the Russell 2000 Index. So far in July, we have not seen an overall negative impact to trading volumes in comparison to the trading volumes during the first two weeks in July a year ago.I think that concludes our prepared remarks, and we'd be happy to open it up for questions.
Operator:

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Brendan Nosal with Sandler O'Neill and Partners. Please go ahead.
Brendan Nosal:

Hey good afternoon guys. How are you?
Tim Schneider:

Good Brendan. How are you?
Brendan Nosal:

Good, thanks. Just want to start off on the commercial book. I know that the one credit that drew loss content this quarter have been discussed previously and been reserved for. But it sounds like there are a couple of other commercial credits that you mentioned that you are kind of keeping a closer eye on. I mean is there something broader that's going on in the commercial book? Are these more or less a handful of isolated credits that probably wouldn't be very noteworthy if dairy weren't so pressured currently?
Tim Schneider:

They are really handful of isolated credits and definitely obviously, with our higher level of classified assets in the ag side is obviously raising the question, but there is nothing systemic that's occurring in the portfolio on the commercial side right now. Generally, it's very healthy.
Brendan Nosal:

Okay. Good. Thanks. And then, moving over to the review of the dairy books. So it sounds like you're about 80% of the way through the dollars here. I mean, I know it caused some migration. But have you found any big surprises where certain borrowers were much worth off and you would have assumed going in there. Have things pretty much played out as you would have expected?
Tim Schneider:

I think they played out as we expected maybe even a little bit better than we expected earlier in the year. And as we've talked before, our ag lenders, our ag bankers that are out in the farms quite often were obtaining interim financial statements. So, we're keeping a close eye on things. I don't think we had any real surprises at this point.
Brendan Nosal:

Okay. Good. And then one more from me before I step back. Just on the margin, I mean, obviously a lot of moving parts here. Loan balances have kept declining, which of course you give up some earning asset yield on, but you do keep shedding the wholesale funding and you are a bit liability sensitive. So, how do you see the NIM trajecting throughout the course of the year, especially if we get one or two rate cuts in the second half of the year here?
Glen Stiteley:

Hey, Brendan, this is Glen. Just let me speak first to the kind of current rate environment, and I can talk about the rate drops. So kind of inter quarter kind of May, June, we saw some creep up in loan yields, so we hope that's a positive sign that things are still repricing. So that kind of higher rate environment from a – kind of from the last year too as things refinanced. And on the deposit side, we've seen things kind of flatten out right now. So we're hoping that's positive on the margin side going forward based on the current rate environment, because I'm hoping it's competition, I talked about deposit price. I think it feels like folks are being more disciplined and kind of working on rushing back rates and thinking that's going to really help the deposit side.We're not really liability sensitive. We're asset sensitive, but it's very – we're not aggressively asset sensitive. So we are subject to near-term rate increases first and foremost on the liability side, but long term, we are asset sensitive. So if we see some rate cuts, I'm hoping that's going to have some – hopefully, have some more positive impact to us on the margin side in the short term so.
Brendan Nosal:

Got it. Okay. Thanks for taking my questions.
Glen Stiteley:

Yep.
Tim Schneider:

Thanks, Brendan.
Operator:

Our next question comes from Kevin Reevey with D.A. Davidson. Please go ahead.
Kevin Reevey:

Good afternoon, gentlemen. How are you?
Glen Stiteley:

Hi, Kevin.
Tim Schneider:

Great, Kevin. How are you?
Kevin Reevey:

Good. Thanks. So first question is on the reserving and net charge-off assumptions, how should we think about those two items as we're modeling out the next two quarters?
Glen Stiteley:

This is Glen, Kevin. So the charge-offs, especially, if we've got reserve specifics built in, it hasn't seemed to have as much impact yet, because they haven't – they've been fairly manageable. I think what's had more impact on the moving of our allowance is the loan gradings. We tend to put in some flat percentages for loans that are not impaired, but are in the special mention and substandard performing buckets. So the movement of loan grading seems to have had as much impact as charge-offs right now, again, not kind of we would. Hopefully, they are manageable on the charge-offs side. So if we keep them in, again, the $1 million to $2 million range, if we have any, it seems to not have as much impact.
Kevin Reevey:

And then – and given the outside charge-off that you had this quarter, how should we think about the charge-off side of that equation as we model out?
Glen Stiteley:

That's a good question. I don't know, if anything we've got specific reserves on is headed to charge-off in the immediate future. So I don't anticipate anything right now for the next couple quarters. So, I mean, obviously, something can bubble up, but we haven't seen anything yet that we think is going to in the charge-off.
Tim Schneider:

And we've articulated what occurred with that situation in the past. So I think we knew that was coming down the pike, and that seems to be sort of a one-off at this point. But as Glen said, we don't have anything that we're watching closely from that standpoint from a charge-off for the next couple of quarters.
Glen Stiteley:

Yeah. As we talked about the charge-off was from a regional retail bank kind of a larger shopping center bankruptcy that we took. We just decided to move in OREO this quarter.
Kevin Reevey:

Okay. And then lastly, you're participating out in loans. Can you give us some color? Is there kind of what your risk is as far as them being put back if there is a credit issue? And is there also any risk of a valuation, negative valuation adjustment on those loans?
Tim Schneider:

No. On both fronts, those are sales that the buyer ultimately has to take the risk. They can't put them back to us. And the only risk we have is that maturity that they could not agree to renew and it might force us to do some other things, but -- and then from a allowance standpoint or a valuation standpoint, there really isn't anything that there that would impact our valuation in the servicing side either.
Kevin Reevey:

All right. I'll step back and I'll go back in the queue. Thanks.
Tim Schneider:

Thanks, Kevin.
Operator:

Our next question comes from Terence McEvoy with Stephens. Please go ahead.
Terence McEvoy:

Good afternoon guys.
Tim Schneider:

Hi, Terry.
Glen Stiteley:

Hi, Terry.
Terence McEvoy:

Maybe just start with expenses. If I look at the quarterly expenses and remove the write-down of OREO, it's kind of a $7.2 million run rate. As you think about the second half of this year, what are your thoughts on expenses, again, kind of isolating OREO?
Glen Stiteley:

Yes. Sure, this is Glen. I think the run rate's pretty level. I mean, I don't anticipate any big changes in those kind of in the last two quarters of the year. So...
Tim Schneider:

It might be just slightly higher as we filled, I don't know, handful of positions that we've had opened for a while here just recently and I think there -- most of those people are starting in the next couple of weeks. So...
Glen Stiteley:

Yes. On a percentage basis, I don't see any big changes, but we may have a little bit of an uptick on the dollars but been not significant.
Terence McEvoy:

Okay. And then just as a follow-up, I went to the -- your website 30 minutes ago and lucky 13 CD product, the 2.35%, has that come at all? And I guess, I was looking your average time deposit rate of 2.26% versus the CD product, it seems like if that's the peak product out there, we're getting close to at the CD prices or CD rates at your bank kind of peaking out. Is my math correct? And do you see that 2.35% potentially at the top there?
Glen Stiteley:

Yes. We just introduced that it was a couple weeks ago. So we're going to cancel it, we'd be looking at -- if we need to start pulling back on everything as far as rates goes. So right now, we're pretty comfortable with that. We still want to attract good client relationships. I don't think that's overboard kind of where the market is right now. Like you said, we've really tried to ratch it back kind of the most kind of our RAC rates that you'll see hopefully, if you track and there you'll see we've cut back those quite a bit again to mirror the FHLB advance rates more or so.
Terence McEvoy:

Maybe one last question, if I could. Loan yields went up four -- I'm sorry, 5.14% to 5.26% quarter-over-quarter. Just talk about any impact loan yield -- loan fees had or TDRs or any call it, noise that impacted the rates?
Glen Stiteley:

I don't think we had anything material in the first quarter that would have taken that one down or anything that's used in this quarter, Terry. So we're obviously still dealing with the non-accrual situation as far as the overall level of loan yield. But I don't think there is anything unusual to back out.
Terence McEvoy:

Great. Thanks guys.
Tim Schneider:

Thanks, Terry.
Operator:

Our next question comes from Feddie Strickland with Janney. Please go ahead.
Feddie Strickland:

Hey, Tim and Glen. How are you guys doing?
Glen Stiteley:

Great.
Tim Schneider:

Hey, Feddie. How are you?
Feddie Strickland:

Good, good. I think most of mine have been answered, but just one quick question. How far are you guys through the balance sheet reduction? And how much more do you think you're going to have on the loan side there too?
Glen Stiteley:

Yes. We had some commercial payoffs that we didn't expect. We kind of targeted going down $40 million this year. So, we're obviously a little bit past that. I don't know that we're going to go much further than that right now because I think we really feel good about of overall liquidity. So, we're kind of in the mode now, we've kind of -- we'll try to maybe fill a little bit of that. We went over $40 million, but I don't know that we're going to aggressively grow from here on out for the next 18 months here.But things could change as we see better metrics on the milk prices and also the classifieds too so. I mean -- and it's also just really just governed by our ability to continue to generate client deposits too. So, we're really trying to watch -- manage our growth -- our ability to bringing good deposits. So…
Feddie Strickland:

Got it. thanks. So, relatively flat, I guess, then is kind of how we should be looking at total assets then.
Tim Schneider:

Yes, maybe little uptick between now and the end of 2020, but it wouldn't be -- I don't anticipate being material right now, especially, again, based on our ability to bring in the client deposit.
Feddie Strickland:

Got you. Thanks so much.
Tim Schneider:

Yes.
Operator:

[Operator Instructions] Our next question comes from Ross Haberman with RLH Investments. Please go ahead.
Ross Haberman:

How are you gentlemen. Just one or two quick questions. What is your total exposure from the loan book on retail today?
Tim Schneider:

Retail strip centers you're talking about, retail shopping centers, that's the thing.
Ross Haberman:

Yes, exactly.
Tim Schneider:

It's pretty minimal. I don't know the exact percentage, but it's insignificant relative to a concentration or anything. We've got a few, but not many.
Ross Haberman:

Okay. And then on the ag loans. Are most of them collateralized by land or would it be land and/or facilities, warehouses and so on and so forth?
Tim Schneider:

Everything. When we take an ag client in and it's almost without exception, we have their entire asset base as collateral, all the land, all their facilities, all their cattle, their equipment, their crops, their feed, it's all collateralized.
Ross Haberman:

Has there been any significant weakness in the land sales side? And if so, what have you seen there in the last year?
Tim Schneider:

No, they've -- land values have continued to remain strong out. Obviously, there is pockets that there may not be as much competition for land, but in the situations where the farmers have been liquidating their assets in the land, in particular, the values have been maintained.
Ross Haberman:

Okay. And then -- and just one last question regarding ag loans going forward. What's sort of your emphasis or your adjusted parameters in terms of making additional new loans today, particularly in dairy?
Tim Schneider:

Well, there are still producers out there that are -- have made money through this entire lower milk price cycle and we're being obviously very selective. There isn't much expansion occurring, but there've been a few deals that we book that are brand-new relationships.But to manage the overall exposure on our books, we're generally selling or participating the vast majority of those deals and those relationships where we can make a nice servicing spread, but there hasn't been a lot of organic growth occurring over the last 12 months or so. We're definitely managing that pretty tightly.
Ross Haberman:

And a final question. Do you think we peaked in terms of your not the non-performers but your...
Tim Schneider:

Classified assets?
Ross Haberman:

Your classified, yes, correct.
Tim Schneider:

Hard to say, I mean, with the futures price on milk right now and I alluded to in my comments earlier, even though that $16 or so average $16.31 for this year may be seems closer to that breakeven point. The reality is the early part of 2019 year had some quite low milk prices in January and February in that $13, $14 range.What we're seeing out the next six months is pretty much all over $17 and even approaching $18, a hundredweight for their base price. So we're feeling better about the operations out there and whether breakeven points are in the fact that at this stage if those milk prices hold that the majority of our operators will be able to make money.
Ross Haberman:

Okay, guys. Best of luck. Thank you.
Tim Schneider:

Okay. Thank you.
Operator:

Our next question is a follow-up from Kevin Reevey with D.A. Davidson. Please go ahead.
Kevin Reevey:

Just curious if you haven't updated stress analysis from an effectiveness that you shared with us when you had your earnings call last quarter. And if there have been any changes to that stress analysis?
Glen Stiteley:

No. Kevin, this is Glen. So we'll probably only do that once a year. And it doesn't pay off to do it more than that. The leveraging of our balance sheet and continued earnings is only going to help that what we call that cushion. So if you take, it's -- we hope it's going to -- continue to improve so.
Kevin Reevey:

And then lastly, if I -- did I understand you correctly, what's your -- what's the breakeven for milk pricing for your farmers on average? Is it around $16 or is it higher than that?
Tim Schneider:

No, I think that's kind of the range that if you average it all out there, we've said that's probably in the ballpark for breakeven. Obviously, every operation depending upon efficiency and management, they vary, but that's probably a reasonable and that's the base price that I was referencing earlier with the CME.The dairy farmers are receiving anywhere from $1 to $2 a hundredweight of additional bases on top of that for components. So if you add that on to the $17 milk price, we're looking at the balance of the year, a lot of them will be making $18, $19 a hundredweight. And we call it mailbox price, that's the final price they receive from the dairy plant.
Kevin Reevey:

Great, thank you. That’s helpful. Appreciate.
Operator:

The next question is a follow-up from Brendan Nosal with Sandler O'Neill and Partners. Please go ahead.
Brendan Nosal:

Hey, guys just a couple more from me here. First, can you just elaborate on the build in TDRs this quarter? Were these just credits you identified throughout the dairy review and not restructure? Or any color there would be great.
Tim Schneider:

Well, primarily, there were a couple of relationships that slid into there -- that slid into substandard and we did some restructuring with them. They're substandard performing mill. And I noticed in your note this morning that your NPA number was quite a bit more elevated.We've done these interest-only periods for these operators if we believe they have viability and could make it through the cycle, especially with some of the changes they're making in their business models. So unfortunately with the TDR definition, we've been trying to stay conservative on that.And unfortunately, some of those numbers have elevated, but again, the performing TDRs, we feel good about and that's maybe where you're referencing that number.
Glen Stiteley:

And Brendan, this is Glen, I mean so -- because of their TDRs, we had to go through the impairment process and those don't -- the two that you are -- the two that Tim mentioned aren't -- we haven't seen material impairments in those so.
Brendan Nosal:

Got it. Okay. And then last one for me. I mean, if milk prices kind of hold in this $16 to $17 range, let's say on average for the course of a year, how long will it take you to see a meaningful decline in either classified assets or in non-accruals?
Tim Schneider:

Well, I think if we get another -- if this milk prices withstand for the next 12 months, and we're at this point next year and are through 80% of our watch and worse review cycle, again, I think we'll see some meaningful movement in both those numbers.
Glen Stiteley:

By the end, but it's kind of year-over-year.
Tim Schneider:

6/30/2020.
Brendan Nosal:

Okay. But it sounds we've taken another review process, which happens once a year to really work through that noise, and again, assuming we have stable milk prices.
Tim Schneider:

Yeah. We generally haven't moved classifications in between years, and I think we've talked a little earlier about our score looks to the three-year milk price average and the benefit that's going to help us is that $16, which was kind of a low point for some of the milk prices here to last four years will fall off and 2019 as it appears should finish pretty strong and will add-on. So that should help our score on the classification side.
Brendan Nosal:

Perfect. Thanks for taking the follow-up.
Tim Schneider:

Yep.
Operator:

Our next question comes from David Honold with Patriot. Please go ahead.
David Honold:

Good afternoon guys.
Tim Schneider:

Good afternoon, David.
David Honold:

So just a follow-up on the balance sheet. Nice work sort of deleveraging during the quarter. How much more do you think you can do as it relates to reducing wholesale funding and selling off participations on the other side from here?
Glen Stiteley:

Yes, so, Dave, this is Glen. So right now, we're essentially just using cash to payoff anything that comes due. We've got decent chunks of maturities coming up here this quarter, but we should be able to take care of those with securities cash flow and deposits growth and principal payments on loans. So I think we're -- we should be okay there. So we shouldn't have to do anything drastic as far as participations other than normal participations that we will do anyway so.
David Honold:

Thank you.
Operator:

Concludes our question-and-answer session. I would now like to turn the conference back over to Tim Schneider for any closing remarks.
Tim Schneider:

We appreciate all of you jumping on the call today. We feel pretty good about the quarter overall. I think core earnings were pretty solid. Unfortunately, the classified assets elevated a little bit, but we anticipated some of that as we get through the -- got through the review cycle. We're also encouraged by the futures price on the CME right now that I think is helping and will help our dairy farmers moving forward, if this prices sustain.So, overall, we're feeling like we've got our arms wrapped around things, and hopefully, we'll be on this call 90 days from now and be reporting good news again. Thank you all for joining us.
Operator:

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

County Bancorp, Inc. Q2 2019 Earnings Call Transcript

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County Bancorp, Inc.
Q2 2019 Earnings Call Transcript