SB Financial Group, Inc.
Q2 2020 Earnings Call Transcript

Published: 29 Jul 2020

[Operator:]

Good morning, and welcome to the SB Financial Group's second quarter 2020 conference call and webcast. I would like to inform you that this conference call is being recorded, and that all participants are in a listen-only mode. We will begin with remarks by management and then open the conference up to the investment community for questions and answers. I will now turn the conference over to [Sara Mykus] with SB Financial. Please go ahead.

[Unidentified Company Representative:]

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. This call may contain forward-looking statements regarding SB Financial's performance, anticipated plans, operational results and objectives. Forward-looking statements are based on management's expectations and are subject to a number of risks and uncertainties that could -- that could cause actual results to differ materially from those expressed or implied on our call today. We have identified a number of different factors within the forward-looking statements at the end of our earnings release, which you are encouraged to review. SB financial undertakes no obligation to update any forward-looking statements except as required by law, after the date of this call. In addition to the financial results presented in accordance with GAAP, this call will also contain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. I will now turn the call over to Mr. Klein.

[Mark Klein:]

Thank you, [Sara], and good morning, everyone. Great to have you all with us. Welcome to our second quarter 2020 conference call and webcast. Once again, our comments today, as with prior quarters, supplement our earnings release we filed yesterday. It certainly has been a challenge this past quarter for our company as we've navigated this pandemic. Even as we were able to close over $224 million in residential mortgage loans, processing $83 million in PPP loans that helped save nearly 9,000 local jobs, while successfully closing our first acquisition in over 12 years. By all measures, a great quarter. Ensuring that all of our customers could have their financial needs met in a safe and efficient manner require the dedication of each of our staff members, and I must say they've responded quite well. Highlights for this quarter, including a $1.1 million pretax mortgage servicing rights impairment and $1.2 million in merger-related costs include

[Tony Cosentino:]

Thanks, Mark, and good morning, everyone. For the quarter, we had GAAP net income of $3.7 million or $0.47 per diluted earnings per share. As noted by Mark, our earnings were impacted by a $1.1 million impairment on our mortgage servicing rights, and $1.2 million in Edon merger costs. Absent those items, net income would have been $5.5 million, up $2.3 million, which is a 73% increase. Highlights for the quarter include

[Mark Klein:]

Thank you, Tony. I want to conclude my remarks today with a clear call out of appreciation to all of our employees and clients that have endured a fairly challenging past 3 months. We have, for the most part, opened all of our offices currently, but certainly under different conditions in all of our varied markets. The efforts of our staff to aid small businesses and home buyers, as we mentioned, the new clients at Edon State bank in the quarter were both noticed and well appreciated. I'll now turn the call back over to Sarah for questions. Sara?

[Unidentified Company Representative:]

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

[Operator:]

[Operator Instructions] The first question is from Brian Martin of Janney Montgomery.

[Brian Martin:]

Nice quarter. Yes. So the -- Mark, I appreciate the disclosure -- the added color this quarter from you in your prepared remarks on the modifications. Just kind of curious with the positive migration you've seen so far, where do the total deferrals stand today, kind of, in July? And if you can just give a little color on where that is? Or maybe I just couldn't back into the numbers, you were giving the details there.

[Mark Klein:]

Yes. I know I threw a lot of numbers around there, Brian. We have a number of loans that are in deferral. As I mentioned, whether it's consumer, commercial or mortgage. Mortgage would all be Freddie Fannie loans, which, again, have begun to return to full P&I. Jon Gathman is with us here this morning. I know he's been deep into the forbearance world, particularly on commercial and the consumer. And as I mentioned, Freddie Fannie, we're following generally the spirit of the nationwide program offered through Freddie Fannie. But if I might, I'd like to ask Jon to give us a little bit of color on the forbearance positioning. Jon?

[Jon Gathman:]

Yes. I would just add to that. We're just entering -- so we took the approach in all our forbearances, including the Freddie Fannie, it offered 3 months. So that 3 months just expired here in July. We're currently processing a potential second round. We're in the very early stages of that. The numbers are very small at the moment. Maybe half a dozen commercial loans, Freddie, Fannie, under that program. They're eligible for up to 12 months, but we're offering it at 3 months at a time, which is consistent with their guidance and permission on what we can do. But it's at the very early stages, and we are seeing, as I speak, some additional second round, but the numbers have been much smaller this go around. We also took the approach and consequently, because we took the approach of a more needs-based analysis in the second go around, which, again, we're currently processing. The first go around was more of a proactive. If you met certain thresholds and certain criteria we set, you obtain the forbearances. This is more needs based. So customers are depending on the type of loan, supplying us with financials and different records that we're assessing on a loan-by-loan basis.

[Mark Klein:]

Does that answer work, Brian?

[Brian Martin:]

Okay. Yes. And just kind of, Jon, where are the deferrals at today? I guess, as of July, I guess, is it any different than where they were at June 30, relative to kind of what you've seen come off? Or is it -- I guess, you're still working through that at this point?

[Jon Gathman:]

Well, in the first round, there were no additional forbearances in the month of July. So those first round numbers that Mark gave you were accurate as of today. The second round, we're right in the midst of. And again, I don't have the exact number, but totally 20, 30 maybe that are in process as we speak.

[Brian Martin:]

I got you. Okay. And the ones that are -- if they are requesting, is there any pattern, I guess, of the ones that would be requesting second deferrals or not really? It's too small a number, just not enough to detail as of yet.

[Jon Gathman:]

Yes, I think that's accurate. If there's any pattern emerging, it's certainly in the retail sector and the commercial real estate sector. We're starting to see some of those second forbearance requests come in. We had a few just this week. But again, it's very early and very small numbers.

[Mark Klein:]

And Brian -- just 1 follow up comment, Brian. As I mentioned, we've certainly seen a large increase in those DDA balances because, generally speaking, when you add forbearances in addition to PPP and the decline in discretionary spending on the business part, liquidity has improved dramatically, and we've noticed that in our balances.

[Jon Gathman:]

And I'm sorry, this is Jon again, I would just point out, I guess, the other sector, now that I think about it, would be maybe hotels. As you might imagine, we have a couple of those that have requested a second forbearance.

[Brian Martin:]

Okay.

[Tony Cosentino:]

And that number, Brian, has stayed consistent at that $35 million level that we disclosed at end of Q1. We've not had any additional or any downgrades of that portfolio.

[Brian Martin:]

Portfolio. Okay. Yes. Because remind me what the at-risk exposure is? I guess, if you guys kind of, in your mind, as you kind of segregate the pieces that are more at-risk today, where do those stand today?

[Jon Gathman:]

Yes, the at-risk number, which is a manually adjusted number. So we look at -- it's about 109 loans. We look at those loans in certain industries and then kind of pair it down from there. But the number that we internally analyzed to $71.2 million, 109 loans for 6.71% of our portfolio.

[Brian Martin:]

Okay. And the biggest components of that, Jon, are what, is it -- I guess, if you -- from a sector standpoint, and whether it'd hotels or restaurants?

[Jon Gathman:]

Yes. As Tony mentioned, it's hotels, which are presently just right around $33 million.

[Brian Martin:]

Okay. And any other sectors, I guess, you'd call out, whether it be restaurants or whatnot in there, the retail piece as you break them out?

[Tony Cosentino:]

Yes. We don't have in that number. We don't have our commercial real estate portfolio. We're starting to see some stress, as I mentioned, on retail and even office space. So that's not in that number. But inside that $71 million, not really anything additional to hotels. Our restaurant portfolio while is concerning, is small and primarily backed by SBA. So our exposure there is minimal. Our biggest exposure, there is 1 in net in that hotel sector just because of the pure volume and pure number of that.

[Brian Martin:]

Okay. So no other big numbers just broken out. On the $71 million total, the $33 million is hotels and no other big -- a lot of other small components in there, nothing other substantial portfolios that you'd call out?

[Tony Cosentino:]

Yes, I don't think so. Again, we have nursing facilities in there for $6.6 million. And then another one, just looking through the list, religious organizations, churches, $3.8 million. And so far, those portfolios have performed as we expect.

[Brian Martin:]

Okay. Perfect. I appreciate all the details. In the -- maybe just touching on the mortgage market. It was just a great quarter. Just kind of your outlook on mortgage, just in general, into the third quarter and just kind of the second half of the year? And maybe just 1 for Tony on the gain on sale margin, obviously, picked up quite a bit, I guess, just kind of the mix and whatnot. But if you could give any thoughts on just how you're thinking about that as you step into the back half of the year, it would be helpful.

[Mark Klein:]

Yes. Sure. As you know, we've been committed to the business line for, jeez, going on 12, 13 years now. And Columbus is just doing a great job. They'll probably do 50-plus percent of all that volume. We continue to add staff marginally, not necessarily, Brian, on the front end production as much as the middle of the value chain, which would be underwriters and the processors and closures, but also on the back end for the quality piece, because we know we have to be pretty pristine when it comes to the quality of that portfolio. But no, we're very -- we have been bullish and are bullish on the business line. We like it, Tony and Matt Booms have done an outstanding job in hedging all of that volume. At one time, we were comfortable with about $20 million in volume and fixed rate mortgages. And then because of the risk, we didn't want to go any deeper. And the hedging process has allowed us to go deeper and broader with that pipeline, and of course, balances the risk out nicely. And so we've got that set up nicely. Our Encompass platform is literally ubiquitous and is available for all of our producers, regardless of whether they're working on-site or from home to process all of these mortgages, and they've done -- and Ernesto and company have all just done an outstanding job. And to move on to our $1 billion in annual production goal. We just recently informed our Board, we're adding some additional management responsibilities to the business line, defining it a little better from the top. David Homoelle is going to be adding some managerial depth and taking on more responsibility to approve mortgages on our books as well as exceptions. So we're getting a little more definition and a little more identification of that business line and how it is. We're going to run it and take it to the next level, which is $1 billion a year in mortgage originations. But with a flat yield curve and no increases in sight on the intermediate and long end, we like the business line, and it has certainly shored up our operations. And till the yield curve steepens, we're in. And we like it, and we continue to develop deeper relationships in all markets. And it's nice now to have Brian Indy now contributing in delivering their $50 million that we envisioned when we went through Indianapolis originally. So we like it, and we're bullish on it, and we intend to continue to expand it. As far as gains, I know Tony can speak to those and...

[Tony Cosentino:]

Yes, sure, Brian. We went into the quarter kind of anticipating $150 million type quarter in terms of volume, and that's what it was looking like as we were getting there to the quarter. We weren't sure what was going to happen with the pandemic. I think early on, it started to really accelerate. And pricing became very profitable as the yield curve kind of move down, the bifurcation of pricing between purchase and refinance. And I think the general market was fine with maintaining a little extra yield because we weren't sure what was going to happen in the future on defaults, et cetera. So that, for the most part, added to the ability to really expand the spread on each 1 we sold. I think hedging, we did some nice things there, and we were in place to do some nice things to take care of our pipeline and our portfolio, which allowed, really, our yields to be really spectacular relative to anything we've seen for some time. So the combination of 225 -- $224 million of volume and yields probably 140% higher than we traditionally have led to the quarter that we had.

[Brian Martin:]

Yes. And I guess in thinking going forward, Tony, I mean, those yields that you're, I guess, anticipating, let's say, in the back half of the year or just into next year, do you expect that to trend a little bit lower in the near term or kind of hold that and then trend down into '21? But just more big picture?

[Tony Cosentino:]

Yes. I think knock on wood, I think the yield picture is going to stay where it is, probably for the rest of 2020 because I think pricing and the yield curve is going to stay right where it is. So we're not going to have as much volatility. Our hedge is going to perform a little bit better. And as Mark has said before, we really have to applaud our MLOs who deliver to us great clients that we know are going to close. So we were able to hedge at a much higher percentage and which enables us to improve yields on the back end. So really, it's kind of worked from front end to back end. And I think as we look at volume, we would expect probably $180 million to $200 million Q3, if things continue the way they are. And we'll see what happens in Q4 as seasonality comes into play. But we feel very good about $600 million for the year.

[Jon Gathman:]

And Brian, just 1 comment. We all know it's all about pull-through, and that's exactly what Tony just talked about, which is the quality of MLOs we have that when we take an application, that we have a high probability, it's going to make it to the other end. And when you get into 80% and 90%, you can obviously make a good forecast on what it is we can do on the hedging side. So kudos to Tony and Matt and all that group for not only accepting all that volume, but improving the margins on the way out. So it's all good.

[Brian Martin:]

Yes. No, I appreciate it. And how about just stepping over to the margin for just a minute, guys. Just the -- I guess, it sounds as though the cash levels, liquidities will drop a little bit. If you get the loan growth, those sound positive as well as making a little bit more progress on reducing the funding cost. So just how are you thinking about directionally the margin? And then, I guess, Tony, it's just the impact this quarter of PPP on the margin, how much was that impact in Q2? And then -- and just as you look at the margin ex-PPP kind of going forward, just with those couple of things I mentioned or you guys mentioned on the call, how are you thinking about that core piece?

[Tony Cosentino:]

Sure. I think as we've talked about, Brian, we came into the quarter with a pretty robust pipeline, which made the Edon acquisition just perfect for us because it provided extraordinarily low funding cost for us to fund that pipeline. Obviously, with everything going on in the marketplace, pipeline kind of went into a stall pattern and the bond markets went away. So we didn't have a ready use really of that cash to deploy it. We think loan pipelines are coming back and will come back. I think Jon nods his head that it's starting to improve a little bit. And I think we'll see some maneuver here in Q3 as cash starts to move a little bit out of the bank and do some things. PPP, we'll see what happens on the next phase of that. And specifically, for PPP, we took $300,000 on the fee side on amortization in Q2. And our interest income for the 3 months on the portfolio was about $160,000, so just a shade under $500,000 between the 2, which leaves us $2.7 million of unrealized fees. Going forward, we've talked about the utilization of that, obviously, keeping in mind higher provision levels for the second half of the year, which is kind of our intention right now because we think mortgage is going to be able to provide significant income levels for us for the second half of the year, and we won't need to rely on the PPP funds for tangible book value growth necessarily.

[Brian Martin:]

Okay. No, that's helpful. So the total fees on the PPP, I was going to get to that anyhow, Tony, was about $3 million in total is what you expect on the -- from the PPP?

[Tony Cosentino:]

Yes. $3.1 million. Yes.

[Brian Martin:]

Okay. Perfect. All right. And then just the forgiveness that you guys are expecting, is there -- I guess, I mean, what -- given the low size of the loans, it would seem as though the expectation would be a pretty high level of forgiveness. Is that fair and just kind of how you're thinking timing-wise? Is it fourth quarter, first quarter kind of event? Is that where you're at today? Or is it different than that?

[Jon Gathman:]

Right now, we're expecting that to be a fourth quarter event. There's a lot of talk, as you know, Brian, about de minimis forgiveness levels anywhere from $150,000 to $1 million, which would encompass. I think at the lower end 86% of our volume, at the higher end 97% of our volume in terms of numbers of loans. So yes, we expect that to be right now that forgiveness, the payments, the SBA covering the interest due will end here in the fourth quarter. So we anticipate, one way or the other, the SBA will come out with some guidance in the fourth quarter. I know that's coming out fast and furious as we speak. They've just introduced last week their forgiveness pipe -- or system.

[Mark Klein:]

Portal.

[Jon Gathman:]

Online system, which is Portal, yes, thank you, which is different than the regular 7a Portal. So yes, we fully expect a lot of that to happen here in the fourth quarter of this year.

[Brian Martin:]

Okay. Perfect. That's helpful. And Tony, just that impact of the -- I guess, you gave the dollars around -- so I can back into the basis point impact of PPP in the quarter. But maybe just onto the -- just the reserve building. You mentioned that, Tony, with the mortgage revenue and the PPP, I guess, the expectation is today that given the uncertainty in the economy that we should anticipate some level of further reserve building as you get into the second half of the year that's consistent?

[Tony Cosentino:]

Yes. I think we've set aside $1.9 million through 6 months and we've had $650,000 of charge-offs with basically no loan growth. So that's kind of where we get to our $1.2 million that we've set aside for COVID. I would think as we look at the second half of the year, our expectations are that provision levels are probably in line with the first half of the year. And we'll see what happens. I mean, as we've seen, Brian, and I'm -- most everybody has talked about, we really don't have exposure to credit card or consumer-type lending of a big number. So we haven't seen charge-offs related to COVID impacts as we sit here today. Now we're not naive enough to think that we're not going to see some of that, but we haven't seen it on the consumer side, and it's really about where we are on the commercial side, as Jon has talked about and where that weakness is. So we're going to have further reserve building of, call it, $1.5 million to $2 million, maybe in the second half of the year, but we think we'll have a solid $2.5 million to $3 million of additional PPP fees to fund that. And mortgage revenue and income will deliver where we need to be on the net income side.

[Brian Martin:]

Got you. Okay. No, that's helpful, Tony. And how about just the loan growth, it sounds like it's slowly picking back up. So I guess, from that standpoint, the pipelines are building today. So you'd expect some net growth in the second half of the year, kind of excluding what goes down with PPP? That's the...

[Jon Gathman:]

I think it's a fair thing to say as we -- Mark and Tony have alluded to, pipelines are building, and we're starting to see some return to normalcy in terms of borrowers. We're going to come under pressure of a couple of large clients selling. So that net-net will provide some pressure in the other direction because I don't think -- I think some of those customers have decided there's just not a lot better price or time to do so, and don't want to see out what COVID is going to do to their operations, although they're very strong customers. But those aren't customers we're necessarily losing to competition, they're just a couple of businesses sold. But yes, the pipelines on the other side have built nicely, and we have some nice things coming here, we believe, in the third quarter, and look forward to one offsetting perhaps the other.

[Mark Klein:]

Yes, and Brian, 1 comment from where I sit, we know we're going to have to work harder to find the quality of the deals that we found before, particularly in this environment. But I think it's a testament, generally to the quality of the clients that we have because many of those clients that we have, fortunately, have great liquidity and good balance sheets and are still expanding and doing things. And so we're happy to participate with them. And again, I think it's a function of our median level growth the last 5 or 7 years. We just -- we could have grown a lot faster, but $75 million a year was a nice number, and that's 1 area that we don't mind being a median performer at. I'm hopeful that our underwriting will pay dividends here as we fight our way through this next couple of quarters.

[Brian Martin:]

Yes. And I guess the -- given the talk about credit, Mark, I mean, you guys have done a great job. I guess the -- from the exposure standpoint, it's pretty minimal at that $70 million level. I mean, where today outside of that, are you guys seeing stress? And has there been any change in risk ratings or kind of the criticized and classified levels as you kind of reviewed some of these credits, now that we're into this period, I guess, new economic times, I guess, because like second quarter, criticized and classified, are they pretty comparable? And then just kind of that exposure outside of the $71 million, where there's still maybe some concern or areas you guys are focused on?

[Jon Gathman:]

Criticized and classified in the second quarter, we did see our classifieds increase, but that was a non-COVID related situation with a large borrower. We're working through here going forward, we have not downgraded anything related to -- specifically related to COVID. But we will be looking at that as these forbearances roll off in the third and fourth quarter, and we'll be taking a harder look at some of those. But that said, the government, as you know, Brian, flooded the economy with so much money. Many of those borrowers have continued to make payments and met kind of contractual obligations and/or under forbearance. So we're working through all of that as we speak. But yes, we intend to reassess those. Your 1 question, I think I alluded to earlier, is there anything outside of that at-risk industry list that we've put together, again, manually adjusted? I remain concerned about two, in particular, sections of our commercial real estate portfolio, retail, which we don't have a huge exposure to. But also office, a lot of articles about changes in the workforce dynamic and how that will affect office space and potentially affect prices. But again, we haven't seen any softening in that per se at the moment nor have we downgraded anything specifically related to that COVID or coronavirus.

[Brian Martin:]

Got you. Okay. And Tony, you mentioned the capital, obviously, being very strong still. Just the -- your sense on kind of your appetite to continue to repurchase shares. Is that -- I guess, do you anticipate to still be active or opportunistic on that front?

[Tony Cosentino:]

Yes. I think both of those words are perfect for us. We continue to believe our stock trading at a little bit above tangible book value is an incredible value, and really, in terms of execution, the best use of our capital. Obviously, we keep in mind that we're acquisitive, and we feel like we've got some opportunities that are going to be presenting ourselves -- to ourselves and that we're in discussions with. So I'd say we're balancing both of those out.

[Brian Martin:]

Okay. I mean, is there -- go ahead, Mark.

[Mark Klein:]

Brian, just 1 follow-up question for Tony. I know Tony and I have discussed this at great length. But in the last 5 years, I think we've pulled into the bottom line about $50 million. And we have made somewhat of a conscious effort to attempt to drive some of that back out to our investors in the form of buybacks and dividends. And I think, Tony, is probably half of that has gone back out in terms of those 2 general programs.

[Tony Cosentino:]

Yes. About $20 million between dividends and buybacks. So about 40%, 45% of that $50 million. So we really have raised equity capital for the future and supplementing what was when Mark and I first got here, a fairly weak tangible capital scenario that we have improved dramatically since that time.

[Mark Klein:]

So an increasing tangible book value along the way. So...

[Brian Martin:]

Yes. And to your point, Tony, on M&A, are there -- I guess, or Mark, just opportunities today, I guess, or is it on hold for a bit of time until you assess your own portfolio? Or I guess, just kind of how would you characterize the opportunities you're seeing from an M&A perspective today?

[Mark Klein:]

Well, Brian, we've talked at great length. We think there's opportunities out there abound now after we've had 3 months of this COVID-19 discussion. We've worked hard to get our tangible book value up, we've worked hard to improve our capital position and we've worked hard to grow the old fashion way, which is 1 client at the time on our organic growth. But as I mentioned, when -- now we can jump into the M&A market, and accelerate organic growth with some prudent M&A where we don't overpay, we know where we can be, and we want to be in the 3 or 3.5-year payback arena. But if we got a stronger currency, we can certainly do a lot more and be a lot more. But we do know that there's the opportunistic kind of opportunities out there, and we have to be a bit aggressive, if you will, to identify those opportunities because we do feel we have a model that works and one that's decentralized, and that can provide a little more inertia outside of organic growth. So they're out there, and we're going to continue to pursue opportunities to improve our reach and improve our performance by gathering some more scale.

[Operator:]

[Operator Instructions] There are no other questions at this time. This concludes the question-and-answer session. I would like to turn the conference back over to Mark Klein for closing remarks.

[Mark Klein:]

Yes. Thank you. Once again, thanks, everyone, for joining us. We're trying to take care of all of our communities and remain safe as we attempt to improve performance, and we look forward to the next quarter and maybe an improved pandemic environment as well as GDP and financial markets as we report our third quarter earnings to you in October. So thanks again for joining us, and have a great weekend, quarter. Thank you.

[Operator:]

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