SB Financial Group, Inc.
Q4 2020 Earnings Call Transcript

Published: 29 Jan 2021

[Operator:]

Good day, and welcome to the SB Financial Group Fourth Quarter 2020 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; and Jon Gathman, Senior Lending Officer.

[Mark Klein:]

Thank you, Sarah and good morning, everyone. Welcome to our fourth and final conference call and webcast for 2020. At a high level, I'm pleased to report that in the midst of this pandemic, we found a way to deliver our strongest performance ever. For the quarter, we continued to see mortgage volume at the top end of our current capacity, welcomed the beginnings of processing PPP forgiveness and witnessed a greater flexibility by our entire staff to service clients in this new and different environment. Briefly highlights for the quarter, which included a $611,000 pre-tax mortgage servicing rates impairment; include net income $5.4 million up $2 million or 60% over the prior year quarter. When adjusted for the non-GAAP impairment item net income would have been $5.8 million or 87% increase. For the year GAAP net income of $14.9 million up $3 million or nearly 25%. Adjusted return on average assets was 1.89% up from the prior year quarter of 1.26%. Pre-tax pre-provision ROAA for the quarter was 2.41% up 74 basis points or 44% from the prior year. Net interest income of $9.3 million was up 7.6% from the prior year as our 5.5% reduction in interest income was more than offset by the 49% reduction in interest expense. This coupled with controlled non-interest expense delivered positive operating leverage of 5 times. Loan balances from the linked quarter declined $13 million, which reduced our year-over-year growth to $47 million or 5.7%. However, included in those balances were PPP initiative loans and those loans acquired from the Edon acquisition in June.

[Tony Cosentino:]

Thanks Mark. As Mark opened the call, we delivered $0.71 per share this quarter, up from $0.42 for the prior year quarter a 69% increase, leading to $1.96 in EPS for the full year of 2020. When we adjust 2020 full year EPS for the OMSR merger costs, which we have documented in our release were up 51% from 2019. Operating revenue was up 24.7% from the prior year and up 31.7% when we adjust for the impairment. Loan sales again were strong delivering gains of $7.3 million from mortgage small business and some agriculture loans, up $4 million from the prior year. Margin revenue up 7.6%, as we continue to offset interest income reductions with further reductions in our funding costs. Now, as we break down the fourth quarter income statement, starting with the margin. Net interest income was up from the prior year, but level to the linked quarter. Average loan yield for the quarter of 4.42%, decreased by 60 basis points in the prior year, and overall earning asset yield was down 114 basis points in the prior year. Loan yields and the earning asset yield were obviously impacted by the 1% PPP portfolio. And while as Mark mentioned, close to 50% of our Phase1 one PPP portfolio has applied for full forgiveness, we've really yet to receive the bulk of those payoffs from the SBA. As we get more detailed on the PPP Phase 1, we had $83 million in funded loans with total fees expected of $3.2 million. To date, we have realized $1.4 million of those fees and booked an additional $565,000 in interest income. If we exclude the initiative from margin, NIM would have risen by just one basis point for the entire year. On the funding side as expected, we again reduced the cost of our interest-bearing liabilities from the prior year. For the quarter, the rate on those liabilities was 0.64%, which is down from the prior year by 78 basis points and down from the linked quarter by 11 basis points. Net interest margin at 3.21% was down 49 basis points from the prior year as the impact of PPP, excess cash and Edon were headwinds to our margin. Interest expense costs are down by 49% from the prior year and down an additional 14% from the linked quarter. We are certainly nearing the bottom on interest expense reductions, however repricing on our loan and asset portfolio, we expect to continue on into 2021. Total non-interest income of $10.4 million was up $5.1 million or 94% from the prior year, reflecting the mortgage origination volume, which overcame the servicing rights impairment. As Mark indicated, our Title Agency had a very strong quarter, closing a large number of transactions and delivering revenue of $500,000, up 31% from the prior year. And our fourth quarter mortgage sales were 85% of our originated volume. We achieved a record level of sales volume for 2020 with our sale percentage exceeding 86% of the $694 million in volume. Yields also continued to be robust in the quarter which supplemented that sales volume.

[Mark Klein:]

Thank you, Tony. In summary, clearly delivering record net income was a tremendous accomplishment for us this year, but it's all about the other milestones and achievements this past year that we're certainly equally proud. We continue to embrace alternative communication channels to remain connected to our 30,000-plus households and still expand market share through the PPP program and close an M&A transaction with the Edon acquisition. Additionally, this year, we expanded the liquidity of our shareholder base dealt with significant forbearance requests that we've discussed for two quarters approved nearly 700 PPP applications and expanded our mortgage operation to provide record lending to over 3,100 homeowners across our entire footprint 2020. It was certainly unique in many ways and our team, literally stepped up to meet those challenges and delivered one of our strongest earnings in history. As we turn to page 20, 21 we certainly expect some challenges to subside yet others unknown will certainly emerge. That said, as our markets steadily open, we believe the pent-up demand and liquidity will welcome the partnership of a community bank like ours with a diverse product base delivered through our seven key business lines. Now I'll turn the call back over to Sarah for questions. Sarah?

[Sarah Mykus:]

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

[Operator:]

Thank you. Our first question comes from Brian Martin with Janney Montgomery. Please go ahead.

[Brian Martin:]

Hey, good morning, guys.

[Mark Klein:]

Good morning, Brian.

[Tony Cosentino:]

Hi, Brian. Welcome

[Brian Martin:]

Happy New Year. Well, the -- just maybe if you could start just on kind of maybe just the mortgage outlook. I appreciate the comments Mark on just maybe the -- getting a little bit -- adding some new geography in the Indiana markets. And just how we should be thinking about at least the kind of the production levels and then the pricing, which was obviously as Tony mentioned very robust this year? Just how we should think about that as we go into the first half of this year?

[Mark Klein:]

Yes. Thanks, Brian. As we all know mortgage has become increasingly important to our operation. As we've discussed before that success certainly has led to some good earnings per share and net income. And we look to continue to drive those levels to a comparable level as 2020 had and 2021. We know we're going to have to add some additional reasons and some additional MLOs to make all that happen, particularly if rates move on us. But we're expecting some stability in that arena. And we expect similar volume, but I know that our margins might not be as robust Brian as they were before. And I know Tony might have some perspective on our hedging process and how we think that's going to keep us to have a pretty robust $100 million to $150 million pipeline?

[Tony Cosentino:]

Yes. I think Brian, we had a fairly weak first quarter of 2020. We look to be 30-ish plus percent from that quarter here in 2021. I would think we're on a fairly good pace through the first half of the year and we'll see how things go relative to that on a volume basis. Yes on pricing, yields were certainly at a premium throughout 2020. Our expectation is that yields will constrict a bit in 2021. I think a lot of banks that have looked at margin pressure have reached out and started to increase their exposure to the mortgage business. We know the competitive nature of people coming after our employees and high producers. So I don't think they're just going to walk away from that. And I think there's going to be some potentially some stretch on price to maintain volume to manage that infrastructure which I think will constrict yields and pricing a bit in 2021.

[Brian Martin:]

Okay. But I mean, I guess given where they were if you look back to 2019 Tony versus even what you saw in the second half of this year, I mean, is it closer -- I guess is it higher in the first half of the year? And then I guess when does it kind of maybe go back to or does it ever go back to kind of the levels we saw on the 2019 on the premiums? I mean they were closer to the maybe sub-3% type of levels versus where we're at today at north of 5% or f-5%?

[Tony Cosentino:]

Yes. I mean we've historically been kind of the -- excluding 2020, we've been from the 2.3% to kind of the 2.8% range, fairly consistently going back 2016, 2017 to 2019. I would think we're probably trending towards that range. But the first half I think is still going to be above 4s based upon what I'm seeing right now. And we'll see how long that lasts. But I would think the first half of the year probably 4s and probably returns back to that at 2.75% to 3% range for the second half of 2021 would be my best guess as we see sit today.

[Brian Martin:]

Yes. Okay. No that's helpful. And just remind me Mark, the markets you intend to add staff in this year or I guess build out, you mentioned Northeast Indiana, is this -- is there - what are the expectations to be adding folks this year?

[Mark Klein:]

Well, clearly, as we've gone on record Brian that Columbus model that we've built certainly we think we can replicate. We've had a slower start than we anticipated in Indianapolis, but we finally caught stride of $50 million in this market. And we know the Northeast Indiana is rich with lots of lakes and lots of nice expensive properties up around those lakes and we're committed to getting in the Northeast Indiana. We thought we had a strategy to lift the team out and build a team, but we're going to have to retool a little bit here. We've had a little of an aberration so to speak of who is going to lead that team. But we're committed to the market and we like the eastern side of Indiana and lower Michigan. And we're going to continue to push it along and find MLOs as well as the support team to make that $600 million to $700 million happen.

[Brian Martin:]

Got you. Okay. Perfect. That's helpful. And then maybe just a little bit of thought on the loan growth outlook. I mean, given the liquidity in the market just kind of how you're -- what the pipelines look like today? Or just kind of what your customers are? How you're expecting things to kind of unfold this year?

[Mark Klein:]

Yes sure. We've been a custom brand as we've said a number of times. And as you've witnessed, we like that median level growth. We don't like to get out over our skis on loan growth. We like to be a median player in that world, want to be a top decile player in asset quality as a result of that. But generally speaking, we know that in these times with real high sensitivity of the clients with regard to interest rates and no GDP or low GDP that we've got to be very competitive. And so, through Jon's leadership, we've developed some fairly aggressive programs to hit some of our target markets with some very competitive interest rates, albeit with a little bit of duration risk. But our goal is to get back to that middle to upper range single-digit growth in the lending arena. And Jon, I know our pipelines have been fairly robust of recent.

[Jon Gathman:]

Yes, I think that's a fair assessment. As Mark said, we've developed some programs. We've really begun thinking Brian as we enter 2021, as you said the pie is not getting any bigger with limited GDP growth and liquidity in the market. So, we’ve really focused on client acquisition from frankly other competitors. PPP has been a nice boost for us. We did a nice job running that program and obtained some good prospects through there in the first round and anticipate doing that in the second round, in addition to the programs Mark mentioned. The pipeline, I would say, returned to a more robust level in the fourth quarter and we're seeing that again here in the first quarter up significantly from the second and third quarter, probably like most banks. But we're very optimistic just talking with some of the lenders about some of the things that we're working on that's primarily coming from client acquisition of other financial institution business, but trying to make sure we get our share of any economic growth that's out there as well.

[Brian Martin:]

Okay. And I mean, it's a headwind the production and the pipelines are good. Just are the payoffs continuing to be a little bit elevated? And is that any trend you're seeing there as far as those slowing?

[Jon Gathman:]

I do see it slowing. I think I said that last quarter. We continue to see -- we saw in December, a borrower sell some properties to a REIT. And I think in the first quarter, particularly here in January and early into February, we're going to see just a couple more. But really, the pipeline of those, because they request us pay so far in advance, we kind of know today that we expect that to slow here for the remainder of the first quarter and throughout 2021, as many of those companies have already taken advantage of those opportunities to sell real estate or their operation or whatever. So no, I expect that to slow considerably here later in the first quarter and the remainder of 2021.

[Brian Martin:]

Got you, okay. That's helpful. And how about -- maybe just for Tony or somebody else, I guess, just on the margin outlook and just I guess how you're kind of thinking about that given the levels of liquidity and getting the loan growth to kind of deploy that? Or I guess would you look at doing some type of -- something with the proceeds if the loan growth isn't materializing? And just kind of how to think about that?

[Tony Cosentino:]

Yes, I think that's well put. And liquidity has certainly been significant this year and our alternatives for that liquidity, has been somewhat limited. I think we expect to do a decent level of PPP here in Phase 2. I think we've got some loan pipelines that we feel fairly good about. I think we've got kind of a window here that we're going to see what that looks like to utilize that liquidity. And then, if that doesn't come together as we expect then I think we're -- we'll go into whatever investment market that we need to try to supplement margin a little bit. We've been extremely aggressive on the funding cost side. We've moved a lot of people out of high-cost deposits. We're going to continue to do that. But zero is fast approaching. So we understand we're limited on how much we can reduce cost, and we've got to do more on the asset side of the balance sheet.

[Mark Klein:]

And Brian, just one comment. We know that the landscape out there is very competitive, which is why we've developed these low-rate buckets of money with the intent that margin might decrease, but we're always having that conversation that if the margin is going down, we know we have to incrementally add organic growth to replace that margin all in the spirit of increasing total revenue. So, ROA might go down, but net income and EPS and ROE should increase as a result of our approach to a client that is more sensitive to the low rate environment.

[Brian Martin:]

Yes, got you. And Tony, just high level on kind of your thought on the margin. If you -- if this loan growth takes a little bit of time to kind of come together, in kind of absent the PPP some acceleration there. I mean the level you're at this quarter directionally, how do we think about -- I mean I guess is it kind of flattish here? I guess, it sounded like from your prepared remarks, there were some -- like you said there's not much room on the liability side, but there's still continued -- it sounds like there's still some continued pressure on the asset side. So I mean as a margin percentage goes versus the margin dollars, the percentage should drift lower absent forgiveness here? Or is that not the case?

[Tony Cosentino:]

I think, generally, our indication is we're going to be in kind of our fourth quarter range moving forward, absent the moves and shakes of PPP. I think our core is going to be in kind of just 3.20% to 3.30% range for most of 2021. Mortgage volume is always a big factor in that because of the fees that we deliver, how much liquidity is going to go away. Is the consumer going to start to spend some of that money and that's going to improve just by its very nature because we really don't have anything to do with that liquidity right now. And so there's a number of factors I think there. So I would think we're kind of at the bottom end, but we'll see how this first quarter goes.

[Brian Martin:]

Got you. Okay. And just the size of the balance sheet with the PPP forgiveness, I mean, I guess there's -- I guess the forgiveness will just increase your liquidity further is that your expectation right now as this process begins?

[Tony Cosentino:]

Yes, absolutely. I mean, we've taken I don't know $10 million or so that we've received to pay down of our original $83 million. I would expect those balances will be sub-$40 million by the time we report here at Q1, absent what we do in Phase 2. Thus far, Jon, we've done I don't know 16 million or 17 million of applications on the second part. So our expectation is going to be somewhere between 50% to potentially 75% of the volume we did in the first phase because of the different requirements. So absent PPP I do think the cash and liquidity will trend down. And our hope is that we're going to put that in a lot of the loan categories. We may look at not necessarily securitizing, but keeping a bit more of our production on our books whether that be SBA or maybe some form of our residential real estate that we've traditionally sold. Because I think in the current environment that -- using that liquidity is going to be a smarter play maybe a little depressing on earnings in the short-term, but long-term a better play.

[Mark Klein:]

And Brian, that said just a follow-up comment. As Tony indicated and as Jon indicated, we've received 50% of our round one applications for forgiveness. We've only received 25% of the money. And so as we field the round two requests, five days into it we have 144 requests and on an average amount of $118,000. So we're kind of back in. And with the government's commitment for a minimum of $2500 per loan we're in and we continue to expand not only with our clients, but with prospects. And we'll have some good numbers in subsequent quarters here on the additional business we've received from at least round one of those 260 prospects that we brought in. So we're using it as a lever and we're turning lemons into lemonade on that thing.

[Brian Martin:]

Right. Got you. Okay. And then maybe just last one or two here. Just the reserve levels are kind of as high as they've been here, given the ability to kind of put some aside for COVID. But with credit quality kind of holding up and I guess maybe just -- it sounds as though the outlook continues to be pretty strong on credit. The deferral trends were positive. How do we think about maybe I guess, the post-COVID economy reopening type of reserve? I mean, is there -- should that trend a bit lower as you get more visibility? Is that fair?

[Tony Cosentino:]

Yes. I think Brian, well, first of all, a lot of the money we've put in reserve has really been a function of PPP revenue. So we made this strategic decision to set a lot of that money aside for a what-if scenario. As you said our asset quality has really hung in there nicely and a fair amount of that is a function of liquidity that the government has pumped in, whether it's PPP or stimulus. And you can see that in our forbearance numbers. But yes, we have I think accounted five credits that we've adversely rated due to COVID issues at various levels early in the process, special mention and a little substandard. But we're just keeping a close eye on them. But we feel pretty good about many of them, if not all of them. And I think it's self-ingratiating to say, but our strict underwriting standards and having good secondary and tertiary sources of repayment have really led us to a good place here that many of those borrowers were prepared particularly when we talk about hotels, some pretty good borrowers, pretty good guarantors backing those things that have enabled them to weather the storm, so to speak. And with a little bit of luck and a return to normalcy, if there is such a thing in the second or third quarter of this year, a lot of our borrowers are starting to see light at the end of the tunnel. And have weather the storm, so to speak. And we're starting to see some returns to some -- pre-COVID levels. For example, in our hotels, we're starting to see, some ADRs returned to levels back near, breakeven if not a little bit better even in the middle of COVID. So with some return, we're optimistic that we're going to be over-reserved in -- later in the year.

[Brian Martin:]

Okay. And that one -- I guess, the thought would be if, all that plays out, your hope would be to grow into that reserve with loan growth as opposed to seeing a negative provision for instance or reserves? I mean that's the, -- at least the way to think about it today? It could change certainly but...

[Tony Cosentino:]

Yes. That's our preferred method and thought process, because obviously that yields some positive things in terms of growth and income.

[Mark Klein:]

And Brian, just, last parting comment on the loan growth is, the variable is how hard we need to work. It's not that we make the same number of calls and find credits that don't have the metrics we want. We've conveyed that to our staff. We've got to work twice as hard to get the same volume that we've done in prior years, absent this COVID thing. So, the variables the number of calls and how we get it quality remains constant.

[Brian Martin:]

Got you, okay. And then, just the last one or two, the -- I guess from a capital deployment standpoint, the buyback is still intact. And I guess just kind of your expectations on that? And just what -- from a M&A perspective, I guess, how have the -- I guess, how is activity in that area right now? I mean, I guess, has there been more dialogue, given the conditions in the market? Or it's been pretty steady?

[Tony Cosentino:]

I want to talk a little bit about capital. And then, Mark can fill it in on the M&A side. I think, yeah, we've been I think fairly aggressive in the buyback. We probably spent -- of our $15 million in earnings we spent about $10 million of it between dividend and buyback. And in 2020, we certainly would have preferred to grow $150 million on the loan side, but that wasn't there. So I think that was the best use of our earned capital. I think we continue to think we've got plenty of liquidity and plenty of capital to, manage the type of M&A transactions that we think are appropriate for us at this time. And I think we're going to continue along the lines of the buyback and where we are. And we'll see how that goes. So...

[Brian Martin:]

And compare to that…

[Mark Klein:]

Just to follow-up…

[Brian Martin:]

Oh, go ahead, Mark.

[Mark Klein:]

Well, just to, follow-up Brian. With regard to the M&A I might as well, get that on the table here. We continue to poke around the entire landscape of absent organic growth we think that organic growth is where we deliver immense amount of value. But M&A is certainly on the platform. We continue to talk to some opportunities. We have the bench. We have the managerial bench. We've got products. And we've got the business line. We're just working to make sure that we control what we can which would be quarterly earnings. And hopefully that will give us a stronger currency someday.

[Brian Martin:]

Right. Yeah. And I guess, just as far as going back to the buyback Tony, the remaining authorization out there, what you haven't completed yet. Can you remind me of what that was?

[Tony Cosentino:]

Yeah. We originally approved $500,000. And we've got $210,000 roughly left on that. And I would think as we go through that, we're doing I don't know between $20,000 to $35,000 a month, based upon volume and availability. And when that runs out likely mid of 2021, I think we'll look at that again. And see what the opportunities lie going forward.

[Brian Martin:]

Got you. Okay. Perfect. And then, look the expenses were a bright spot this quarter with -- along with some of the other items you guys have called out. But just, your thought -- I mean, given we're in an environment we're in. And I guess is your -- I guess kind of just expectations on expenses, as you think about 2021?

[Mark Klein:]

Just at a high level Brian, we know that margins are going to continue to compress. And we certainly don't want to allow the mortgage -- the robust mortgage business line overshadow prudent operations in the other arena. So we're continuing to look at all of the travel arrangements and meetings and offices and can we run them with drive-ins, do we need as many people. We're continuing to look at operating new in different ways and a new world order. So we've got a keen eye on those because we know the job to be done is going to get more difficult. That said a broader balance sheet albeit with thinner margins is where we're headed with the competitiveness in the landscape to find more scale. And we think we can continue to push profits higher by margin spending, but a bigger balance sheet.

[Brian Martin:]

Got you. Okay. And then just the classified and criticized level, you talked a little bit about them earlier. Was there any notable change this quarter? It didn't sound like there was a whole lot of movement one way or the other on those areas, but...

[Mark Klein:]

Well, we're maintaining a solid criticized and classified level. We did have some movement like I said in about -- well, five credits total but four in the quarter. And again, many of those are just some preemptive kind of watch, sort of, things special mention and one or two substandard. But just keeping a close eye on a couple of credits. All those credits are performing and doing very well. We haven't had any delinquency or increases there. Just again just more to keep an eye and see how the 2020 financial shape up and how they hit the ground running here in the first and second quarter of 2021.

[Jon Gathman:]

And our expectation Brian is we've got six or seven commercial credits on forbearance as we sit here today. We really expect all but one of them will come off in Q1 based upon their current expectations and where we are. So at worst-case scenario as we sit here today we potentially have one still on forbearance on the commercial a hotel at the end of Q1. So we think it's going to continue to improve.

[Brian Martin:]

Okay. Perfect. And Tony that's part about the expenses, I guess, at high level if your expectation is that the mortgage volume is -- your hope is that it's similar to what it was this year, albeit with a little bit different pricing. Would the expectation be that expenses from, kind of, the -- as you say the second half run rate, I mean, kind of all in with Edon. This type of level we saw in the second half of the year is how we should think about going into next year? I think this quarter is what $10.5 million or call it $10 million to $11 million. Is that -- $11 million-ish is that kind of the run rate to think about as we go into next year given all the variables?

[Tony Cosentino:]

Yes. I think in general, I would have one caveat there. I mean, we've certainly put forward in our calls and our conversations that we're making some investment in technology in 2021 which will come onboard a new commercial loan origination system in the nCino platform. We're moving CIP to Salesforce for all of our sales teams. So we have some higher level of kind of year one as we transition, which will be in 2021 on some technology spend that will in my mind inflate expense a bit. And I can get more color out on that. But generally yes, mortgage is going to be the variable on how expenses are going to flow quarter-by-quarter.

[Brian Martin:]

Okay. You know, that’s helpful. Tony, I appreciate that. So okay, well, thanks for taking the questions, guys. I appreciate it. Nice quarter and nice year.

[Tony Cosentino:]

Thanks, Brian.

[Jon Gathman:]

Take care, Brian.

[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:]

Once again, thanks everyone for joining us. We're pleased with the year. We're looking forward to 2021, albeit, the challenges that we know we're going to face, but we'll look forward to joining up with you again in April as we report on our first quarter of 2021. Thanks again and goodbye. Take care.

[Operator:]

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