SB Financial Group, Inc.
Q2 2021 Earnings Call Transcript

Published: 27 Jul 2021

[Operator:]

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. 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 Mekus with SB Financial. Please go ahead, Sarah.

[Sarah Mekus:]

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 Jon Gathman, Senior Lending Officer.

[Mark Klein:]

Thank you, Sarah and good morning everyone. Welcome to our second quarter 2021 conference call and webcast. Briefly reviewing some highlights for the quarter, which included a small mortgage servicing rights impairment of roughly $100,000, would include net income of $3.8 million, up $100,000 or 3% over the prior year quarter. On a year-to-date basis, when adjusted for the non-GAAP impact in ‘21 and ‘20, net income was $8.8 million, up $860,000 or nearly 11%. Return on average assets, 1.13%; pre-tax pre-provision ROA for the quarter 1.39%; net income – net interest income of $9.2 million was up 3.2% from the prior year. The slight decrease in interest income was supplemented by a nearly 42% reduction in interest expense. Loan balances from the linked quarter rose $2.4 million and when we adjust for PPP balances were up $21.9 million, or 11% on an annualized basis. Compared to the prior year, net of PPP, loans were essentially flat. Deposits declined from the linked quarter by $29 million, but were up over $100 million from the prior year. Expenses were down $600,000 or 5% over the prior year quarter due to lower mortgage commissions and merger costs in the prior year. Mortgage origination volume for the quarter was $165 million, down over $58 million or 26% year-over-year. Asset quality metrics remain strong both in the 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 raise that closed. The $20 million in debt capital certainly prepares us quite well for potential growth opportunities.

[Tony Cosentino:]

Thanks Mark. Good morning again, everyone. Again, for the quarter, we had GAAP net income, as Mark indicated, of $3.8 million or $0.52 per diluted share. Some of the highlights in the quarter, operating revenue was down $1.8 million or 10.3% as mortgage gains on the lower activity was off nearly $3.9 million 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 $4.3 million, mortgage, small business and agriculture. Margin revenue was up 3.2% due to the decline – continued decline in funding costs, which were lower by over $700,000. The acceleration from PPP forgiveness offset a portion of the core decline in interest income. Now we want to break down further the second quarter income statement, starting with margin. Average loan yield for the quarter of 4.61%, decreased by 7 basis points from the prior year. It was down just 1 basis point from the linked quarter. Overall, earning asset yields were down 70 basis points to the prior year due to the change in mix of the balance sheet and 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 $1.2 million from the linked quarter. We still have $1.6 million in unamortized fees of the original $4.9 million from both phases of the PPP initiative. We continue to expect the large majority of these fees will be realized within this fiscal year.

[Mark Klein:]

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 a 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 it costs us deliberate return of capital to our shareholders in the form of stock buybacks, as Tony mentioned. I will now turn the call back to Sarah for questions from our audience.

[Sarah Mekus:]

Thank you, Mark. Now we are ready for our first question. And while we are waiting for additional questions, I would like to remind you that today’s call will be accessible on our website at ir.yourstatebank.com.

[Operator:]

And our first question today comes from Selena Xia with Janney Montgomery Scott. Please go ahead.

[Selena Xia:]

Hi, good morning.

[Mark Klein:]

Good morning.

[Selena Xia:]

I am asking questions for Brian Martin. So, the first one is what’s your outlook of mortgage production and its gain on sale margin?

[Mark Klein:]

Mortgage production for this year is certainly going to be below the prior year. Again, we discussed the trailing 12 months here at that $700 million pace. Tony can give us some additional color. But I would think that we would hopefully come into that $500 million to $550 million number this year given the pace that we are on, absent any aberrations in the 10-year treasury yield. Yields are still very accommodative to our borrowers. As we have 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 have had a very robust refinancing opportunity to last 1 year or 2 years. 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?

[Tony Cosentino:]

Yes. I think, Mark, that’s good color there. If you look at our mortgage business, we’ve done about $321 million thus far this year versus $325 million for the first half of 2020. 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 third 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, Selina, 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 first quarter of 2022. And then it will start to stabilize. So we will probably end up at a stabilized range of probably 2.85 to 2.75 somewhere in the first quarter of 2022 and stay in that range going forward

[Selena Xia:]

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 property the loan growth in your pipeline going forward?

[Jon Gathman:]

This is Jon. I think you’re right. I think the second quarter began a nice trend for us. As we look at the third quarter, we’re very optimistic. There is still a lot of cash out there providing headwinds that the government has supplied borrowers. But with a 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 are looking to do. So if we can get a combination of some of those, I feel really good about our prospects in the third quarter. If you look at our loan growth, commercial real estate all through the pandemic, continue 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&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 1.5 years, 2 years.

[Selena Xia:]

Okay, sounds great. So would you expect the net interest margin to increase, as you mentioned, the interest rate has been pretty low.

[Tony Cosentino:]

Yes. I think as we look at NIM going forward, I think Q3, we will start to see a much larger acceleration of our Phase 2 PPP fees. I think that’s going to provide a boost. We had a big first quarter of PPP fees down fairly significantly here in Q2. Q3, it will get back up. We have $1.5 million remaining on the Phase 2 PPP fees, and I would suspect Jon will take a big portion of those there. As Jon said, we got a fairly large total pipeline, and I would think we’re going to fund $30-plus million 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’ve moved rates down fairly aggressively. But we will see how that potentially may turn going forward.

[Mark Klein:]

I think, Selina, this is Mark. And I think it’s safe to say, and Jon can confirm this, but literally, the conversations with our C&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 is going to be more opportunities. And I think we’re seeing that in our pipeline as we speak today.

[Selena Xia:]

Okay, thanks. So as you mentioned liquidity, so do you expect the deposit inflow to slow down as so many products have remained in the balance?

[Mark Klein:]

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 is 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 Jon mentioned, the real wild card here the optimism that might emerge from the market and whether anyone is 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 world might be changing just a little bit as we change the mix in our balance sheet.

[Tony Cosentino:]

Yes. I think we saw a $30 million decline in total deposits this quarter, really the first decline we’ve had in, gosh, five, six quarters. I would suspect we will probably see a similar decline here in Q3, and then it will 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.

[Selena Xia:]

Okay. I see. So are you going to use up all these excess liquidity in the loan production? Or what’s your outlook for this?

[Mark Klein:]

I am sorry I didn’t get the question there. Could you repeat the question?

[Selena Xia:]

Sure. So are you using up most of the excess liquidity on loan production or what’s your plan for that?

[Mark Klein:]

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 in a total of $20,000 losses and loan losses to date. 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 million growth plus or minus and you lever that 3x 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 order our benefit. And we will move that liquidity over to the asset side of the balance sheet – in loans with higher-yielding loans, albeit with an asset-sensitive balance sheet, increasing with, we think, potential market increases in rates – someday.

[Selena Xia:]

Okay, got it. Thanks for the color. So the last question is about the reserves. So for this quarter, there is no provision despite the loan growth. So what’s your outlook of reserve ratio going forward?

[Tony Cosentino:]

Yes. This is Tony. As we look at this quarter, net of PPP, our allowance at the 163 versus 122 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 will 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.

[Selena Xia:]

Okay. I really appreciate that. Thanks.

[Tony Cosentino:]

Thank you.

[Mark Klein:]

Thank you.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Klein for any closing remarks.

[Mark Klein:]

Yes. Once again, thanks, everyone, for joining. I’m 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 third quarter. Thanks again, and have a great week. Take care.

[Operator:]

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