SB Financial Group, Inc.
Q1 2021 Earnings Call Transcript

Published: 3 May 2021

[Operator:]

Good day, and welcome to the SB Financial Group First Quarter 2021 Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Sarah Mykus. Please go ahead.

[Sarah Mykus:]

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; Ernesto Gaytan, Chief Technology Innovation and Operations Officer; and Jon Gathman, Senior Lending Officer.

[Mark Klein:]

Thank you, Sarah and good morning, everyone. Welcome to our first quarter 2021 conference call and webcast. Let me start by pausing for a moment and recognizing all of our 250 staff members who contributed to delivering the largest quarterly earnings in our history. While the growth was bolstered by the servicing rights recapture, the adjusted net income was still extremely strong, reflecting higher mortgage gains accelerated PPP forgiveness and controlled expenses. Highlights for this quarter, which includes a $2.7 million pre-tax mortgage servicing rate recapture include net income of 7.1 million, up 6.4 million or a large 940% increase over the prior year quarter. And when we adjust for the non-GAAP impact in both '21 and '20, net income was 4.9 million, which was still up 2.5 million or 104%. Adjusted return on assets was 1.54%, up from the adjusted prior year quarter of just 0.92%. Pre-tax, pre-provision return on assets for the quarter was 3.01%. Net interest income of 9.6 million was up 12.6% from the prior year as the slight increase in interest income was supplemented by a large 48% reduction in interest expense. Loan balances from the linked quarter declined 25 million due to loan payoff and accelerated PPP forgiveness, but did grow 17 million from the prior year. Deposits continued their rise, up 71 million from the link quarter and up 256 million from the prior year. Expenses were up 1.5 million or 16% due to higher mortgage commissions and our targeted investments in technology. Revenue growth of 92% lead to positive operating leverage of 5.7 times. Mortgage origination volume increased 156 million, up over 54 million or 54% year-over-year. Asset quality metrics improved from both the prior year and link quarter and our level of 49 basis points of non-performing assets remain strong.

[Tony Cosentino:]

Thanks, Mark and good morning, everyone. Again, for the quarter, we had GAAP net income of 7.1 million or $0.97 per diluted share. Some of the highlights for the quarter include, total operating revenue up 91.9% from the prior year and up 38.1% when we adjust for the OMSR impact in both years. From the linked quarter, adjusted operating revenue was down slightly due to lower gains on mortgage sales. Loan sales delivered gains of 5.9 million from mortgage, small business and agricultural loans, up 3.8 million from the prior year. Margin revenue was up due to the $1 million decline in funding costs. The acceleration from PPP forgiveness offset the remainder of the decline in the interest income.

[Mark Klein:]

Thank you, Tony. Good report for sure there. We are proud to have delivered another great quarter, as we continue to build on the momentum we carried from our record earnings performance in 2020. We understand the challenges that lie ahead as PPP forgiveness goes away and mortgage volume potentially slows but rest assured, we remain committed to delivering on our expectations of high performance. I want to conclude with acknowledging the dividend announcement we made last week of $0.11 per share which equates to a 15% payout ratio and a dividend yield north of 2.4%. We continue to identify opportunities to not only enhance shareholder value and one that includes dividends but also are conscious and deliver return of capital to our shareholders. Now I'll turn the call back to Sarah for questions. Sarah?

[Operator:]

Our first question is from Brian Martin with Janney Montgomery. Please go ahead.

[Brian Martin:]

Hey, good morning, guys.

[Mark Klein:]

Hi, Brian.

[Tony Cosentino:]

Good Morning, Brain.

[Brian Martin:]

Thanks for the update. Just maybe a couple things you could touch on Mark. Maybe just on the mortgage and kind of the outlook and maybe Tony chimes in, but just It sounded like the uptick in rates wasn't a real headwind. But that the inventory could be one just how you're thinking about production for the remainder of the year. But just kind of an update on that and just where you think, Tony, I guess how we think about where the gain in the sale margin settles in. I heard your commentary about, maybe the peak where we're at here for the year, but just as things begin to normalize kind of how we should think about that.

[Mark Klein:]

Yeah, thanks, Brian. As you well know, we've been in this mortgage run for what going on 12, 13, 14 plus years, and we certainly are looking forward to very similar volume that we had in 2020, again absent, maybe a bit of a drawback from reduced inventory but that said, we do continue to have very robust pipelines in the construction arena, which has been good, and it continues to fill our pipeline. And as I mentioned, Brian, we also just created a PCG product that we think is going to shore up some of our traditional commercial balance sheet growth that is more prevalent in a more rising yield curve environment, versus a flat yield curve that we have now, which speaks to mortgage volume. So we're gaining some great traction and one that competes very effectively with the PNCs and the Fifth Thirds and a Huntingtons of the world. I know those highly coveted PCG households, so we're looking for similar volume. I believe our actual gain on sale might be tested a bit, because some of that volume is going to be put on our own books that will give us some good margin revenue over time and breakeven pretty quickly. Tony, comment?

[Tony Cosentino:]

Yeah. Thanks, Mark. Yeah, Brian, I think, specifically, as we look at yields, we've seen them kind of consistently come down every month through the first four months of the year on that what we're selling. Not big swings but a little bit each month, they've come down as pricing has become a little bit more competitive. We've certainly got more players in the market. And so as I said, I think Q1 is going to be the high watermark on gain on sale yields. I think we'll see a little bit more in construction in the private client that will potentially not only delay gains but put some on the balance sheet versus selling to the secondary market. And I think, as we look out the pipeline, as we sit here today and we did 156 million in Q1, I would think we're in the range of 170 to 180 in Q2 and we'll see how that goes in Q3. But I would suspect it's a similar type based upon pipelines that we see today. But again, it's all contingent upon inventory availability.

[Brian Martin:]

Gotcha. Okay. That's helpful. And maybe just, yeah, I guess, if you just jump over to the loan outlook and I guess that sounds maybe a little bit more tepid in the short run, just given all the stimulus money and some of the other factors you outlined, but just maybe this - putting a little bit more mortgage on the books and, I guess, how do we think about the loan outlook ex-PPP issued kind of look over the next couple quarters.

[Mark Klein:]

Yeah, Brian. This is Mark, Jon will give us certainly the details here, but safe to say that we've stuck to our knitting, if you will, on our general loan parameters, so the variable has been what has met our standards and they've been pretty good absent, again, the liquidity that the borrowers have found as a result of the stimulus and PPP. And competing with the government is no small task, given their liquidity, and as I mentioned, cap rates are very, very low, which has enticed some of the borrowers to make other arrangements on some of their investments. But that said, I think, Jon, we see a fair amount of interest and a fair amount of volume across our entire footprint.

[Jon Gathman:]

We do. I would echo Mark's comments. I think it's an interesting situation, we find ourselves in. As Mark said, the unprecedented liquidity and the government money that's available to borrowers has certainly driven down our line of credit balances and some financing need by companies that are flush with cash. That said, we're still in a situation of unprecedented, rather low interest rates and production levels have held in nicely. So while we haven't necessarily seen the growth that we would like, given some of the liquidity in line pay downs, and things like that, production levels remain relatively strong and, I think, we'll be optimistic in the second, third quarter that we'll see some of that evidence itself, again, with the headwinds of the additional liquidity as and as that continues to dry up, I think that's where we'll see additional loan volume.

[Brian Martin:]

Okay. Are you seeing much in the way of, I guess, the pay downs? It sounds like they picked up a bit this quarter relative to last quarter, but maybe they just - I know they've been high but just your outlook, I guess, is there any crystal ball on how those payoffs are - I mean, what you see in the that, maybe in the next quarter?

[Jon Gathman:]

I don't know that we've necessarily saw an acceleration of those, just additional liquidity. The second round certainly helped that and we'll see how that shakes out here, as people presumably use that money. That's the principles of PPP. But no, I don't know that I'd say it's accelerated, we just see a continuance of that trend. And until that money is exhausted, I don't see, for example, farmers and the ag community and some of those individuals drawing at the level they had in past years until that money is exhausted itself.

[Mark Klein:]

And Brian, just a comment. I think we've seen some ownership changes potentially in companies that have, obviously, some aging management teams and have decided to do something else, again, albeit with a historically low cap rate. So we're fighting that battle as well but when we lose one there, we pick up one somewhere else in the spirit of financing an equity changeover from new clients, as we pick up some of the PPP exposure that we have discovered in the last year or so.

[Brian Martin:]

Okay. And I guess, as far as just kind of the outlook, I mean, as far as - do you expect to see some net positive growth? And I guess just the other part of it was, the mortgage, kind of, what you're doing there on the product change, Mark, as far as what that contributes? I guess, is that a small contributor or is it - I guess I couldn't understand, just from your commentary how much of an impact that could have, if at all?

[Mark Klein:]

Well, we think, Brian, it could be a sizable impact. This year, we're looking for that 75 million plus or minus in growth, maybe 100 million. And given the, again, the flatness of the yield curve, we knew we needed to do something to potentially bolster our balance sheet and get some of that margin growth and that's when we came up with these lower risk, higher covenant households in the PCG arena. And we're looking for, again, I would say, the 40 to 50 million kind of a thing. We have to be a bit careful because I've challenged Tony to make sure we manage the margin appropriately, so we don't get too much of a liability sensitive balance sheet that we need to keep those in check and balance. And that's the goal and delivering half of that anticipated balance sheet growth, I think, is a fair number.

[Brian Martin:]

Gotcha. Okay, that's helpful. Maybe just one or couple - one or two other things just on the margin. Maybe, I don't know, if Tony just gives a little thought on that. I guess, kind of looking outside of PPP and just what's the strategy on the excess liquidity here, I guess, if loan growth isn't super robust, I guess, or contrary, I guess, if you are seeing this new product pick up and meet it, but how should we think about deploying that liquidity and then just the margin impact here in the next couple quarters?

[Tony Cosentino:]

Yeah, I think, Brian, and obviously, net of PPP, for the quarter, our margin is below 3%, which we had certainly have not seen that kind of level in really ever and it's a constraint. Our level of loans and total assets is 64% of our balance sheet. We've traditionally been high 70s to low 80s. So, we understand the challenge of getting that liquidity re-deployed in the loan side. We're looking at a number of opportunities. We think we'll get back in the bond market a little bit more strenuously. We've already increased that probably 15 million from where we were late fourth quarter. So we think there's some opportunities there but again, you're not going to make a big change in that margin on the asset side, it really is about getting loan volume up and accelerating, and that's what we're focused on.

[Brian Martin:]

Okay. And how about just the - Tony, the cost of deposits, kind of where that trends? It sounds like there's still - you had some good improvement this quarter. I guess, is there still runway on that side?

[Tony Cosentino:]

Yeah, I think that's a great question. I mean, we've the level of cost of deposits on a year-over-year basis. I don't think you can see that acceleration in the linked quarter going forward, but we are going to continue to reduce funding costs, at least for the remainder of this year based upon where we are. The clients are very, very happy. Well, not, I wouldn't say happy, but they're comfortable when their CDs roll over to putting that money in the money market and in a checking account and waiting to see when things happen. And it's all about when that turns is when that real challenge will come. So I do anticipate further reduction in liability costs, but not certainly at the pace that we've seen in the last, call it, two to three quarters.

[Brian Martin:]

Okay. And as far as getting - I guess, getting this liquidity and stuff deployed, I guess your expectation you can get a decent amount of that done in the coming quarter or is it - I guess it can be pretty methodical how you put that to work for, looking at kind of the loan demand that's out there?

[Mark Klein:]

Brian, this is Mark. We obviously need and want that organic growth that we certainly seek. But we're also not going to rule out potential M&A, which can give us more of that scale that we're looking for but generally speaking, we still have high expectations, but we're not going to lower the standards. It's going to take more work, the variable here is more work, not lowering standards.

[Brian Martin:]

Gotcha. Okay And to your point Mark, just that the M&A outlook today, I guess it has picked up for the industry, I guess, have you noticed kind of a pickup in dialogue or I guess, is there anything more interesting happening on that front with your conversations?

[Mark Klein:]

Well, we still continue to pursue not only balance sheet accretion kind of opportunities, but also geographical footprint. We continue to have great conversations with a number of individuals. And my job is to make sure that on behalf of our board and our stockholders that were out there having those right conversations and we think that this compressed environment, absent our 50% fee-based machine that we have going, we think those potentials will rise sooner than later. No guarantees but we're having the right conversation with the right people in the right place.

[Brian Martin:]

Okay, perfect. And I guess the assumption is that the buyback, I guess, expectations are you'll continue on that front.

[Tony Cosentino:]

Yes, we have some left on our existing allocation. And we've obviously talked extensively at the board level about our next steps. And I think that's the appropriate use of our internally generated capital as we sit here today.

[Brian Martin:]

Okay. And Tony, you mentioned, I didn't get all of it but on PPP side, what remains and then just how you're thinking about most - it sounds as though most of that was coming back this year. And just big picture, how do we think about the forgiveness and the timing of that? You just could maybe run back through that?

[Tony Cosentino:]

Sure. So as we're looking at phase one, we originally booked 3.2 million of fees at the onset. We've taken about 2.6 million of those; 1.4 million in 2020, and 1.2 million in the first quarter here in 2021. So 600,000, remaining there and I would suspect the bulk of that will happen in Q2. We have a few large clients that may not get done, but for the bulk of that will get done. Phase two, as we looked at it, through the end of March, we had about 1.2 million of fees that we booked and based upon our projections, we think that number will get to 1.8 to 2 million potentially. And I would suspect, most, if not all of that forgiveness will happen in 2021 and probably Q3 and Q4, based upon what we're seeing from our clients.

[Brian Martin:]

Okay. Is that a function of just being smaller? I think you talked about the smaller size? It sounds like some of the larger credits are taking longer, but just is that what you're attributed to or is it just the customer base you guys have?

[Tony Cosentino:]

I think that it's an interesting dynamic. We have some significantly large clients, we didn't do a whole lot of them in phase one that have yet to get their forgiveness. They've indicated they're going to. It's just a matter of getting that paperwork in and getting that done. I just attribute it to being a larger company and having more things to do, but I think that'll get taken care of here in the short term. But in the second phase, absolutely, it's predominantly small Schedule C filers and pretty much a one page, just check the box and you get forgiven, so I think that'll just get done very quickly.

[Brian Martin:]

Quickly. Gotcha. Okay. And how about just on the expenses? I guess that kind of a good story there, I guess. How should we think about expenses, given your outlook on mortgage? I know, there's typos, it sounds like you made some changes to the compensation we saw in the back-office side? Does that have a notable impact or is it just - is this kind of the base level we're at today? Kind of a good way to think about it, especially if maybe production or volume in the second two quarters of the year or maybe it's something similar or a little bit more?

[Mark Klein:]

Brian, this is Mark. We certainly enjoy the mortgage business line. We'll take that trade every day of the volume and the less than 50% efficiency ratio that brings to the table. But as Tony mentioned earlier, I think, in his remarks, the competitive landscape is tough. And we have a number of open positions that we're working to fill, but the positive part about that is that it certainly constrained some of our expenses, but we would expect those to increase marginally as we fill up the ship, so to speak, and find the talent that we're looking for, albeit at an environment that seems to be a bit elusive to us.

[Tony Cosentino:]

Yeah, I think that's a good point, Brian. I think Q1 was a little bit of a - some headwinds in our favor, because of some of the open spots. We think we're going to fill a number of those. But it is a much more competitive landscape and the expectation is higher compensation and higher compensation packages that will constrain expenses. But I think on a general basis, our revenue growth continues to outpace what we anticipate on expense growth for the remainder of 2021.

[Mark Klein:]

And, Brian, a final comment, and because of that, we continue to seek ways and establish goals and initiatives to make sure that we're driving the client's willingness to pay a little higher all the time, because that's where that marginal revenue is going to come from. So we look to continue to expand the margins, albeit with a staff that has done a great job on a number of business fronts, and our expectations remain high on all fronts.

[Brian Martin:]

Gotcha. And just on the - back to liquidity for just one thing, have been deposits begun to slow or are you still seeing that, let's say, that surge, but just one the - have you started to see some leveling off on the deposit side?

[Tony Cosentino:]

We saw it in the in the second quarter of 2020, we had a very large increase when the first phase of PPP came into effect. During the summer, it kind of moderated and what we've seen really since, I'll call it, November to today, has been the retail customer has really, really taken all of their stimulus money and just put it in the bank and that's what all the money is, and it has shown no sign of slowing down.

[Mark Klein:]

And Brian, the other wildcard is we did have some pretty strong success and are calling of new prospects on PPP loans that we've begun to develop into a larger relationship. And people sense that ability of a community bank to get the job done, and to fund and to fuel their liquidity needs. And we're finding traction in that. We lay off some of that liquidity to stimulus but certainly some of it has also been by the acquisition of potential new clients through that PPP program, and it's almost an unintended consequences of the PPP program.

[Brian Martin:]

Gotcha. Okay. That's pretty much it. Just maybe last one, guys, just on the credit quality, it looks really, really strong. You built the reserve a little bit more. Maybe just how to think about the reserve, it's obviously at a very high level, especially given that the quality of the portfolio and how it's holding up. So, just how we think about that. And then was there any change - I guess my assumption is maybe improvement on the criticizing classified levels this quarter, right. So just to reserve in those and that's it for me.

[Mark Klein:]

Yeah, Brian, just one comment. Like I say, be careful, yes, for you may get it. I've asked Tony forever to build that reserve when you're making money. And this pandemic has allowed us to put an asterisk to Jon and that the allowance for loan and lease loss has enabled us to look forward now and make pretty sizable contributions to our reserve for future profitability stability and I think it'll benefit us in the coming quarters. Jon, additional comments?

[Jon Gathman:]

No, I think that's a fair statement. You'll - again, as Tony alluded to, in his remarks, I think we've built the reserve for the unknown. We're going to be looking at that here, as the skies clear and crystallize over the next couple quarters. Our criticized and classified quarter-over-quarter were slightly up, not a huge increase. But as we saw a couple credits and we got some urine financials due to the pandemic, we're keeping a close eye, but I feel pretty strongly that many of them are in good stead and we're going to be looking at them here later in the year. Potentially they continue to improve and some run rates for some of those companies have been nice here through the first quarter. So we're looking closely at those but yes, it's all about the unknown and with any luck, again, the skies clear, we'll take some of that back.

[Brian Martin:]

Gotcha. Okay. Perfect. That's all I had, guys. Thank you for taking the questions.

[Tony Cosentino:]

Thanks, Brian.

[Mark Klein:]

Thanks, Brian. Have a good day. Operator Showing no further questions. 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 for joining us this morning. We look forward to reporting on our second quarter 2021 results here in July and look forward to chatting with you then. Thanks again for joining us and goodbye. Take care.

[Operator:]

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