Earnings Call Transcript - CIVB Q1 2024

Operator, Operator

Ladies and gentlemen, before we begin, I would like to remind you that this conference call may contain forward-looking statements regarding the future performance and financial condition of Civista Bancshares Inc. These statements involve risks and uncertainties. Various factors could cause actual results to differ materially from any future results expressed or implied by these forward-looking statements. These factors are discussed in the company's SEC filings, available on their website. The company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement but not substitute the most directly comparable GAAP measures. The press release that contains financial and other quantitative information to be discussed today is also available on the company's website along with the reconciliation of GAAP to non-GAAP measures. This call will be recorded and made available on Civista Bancshares' website at www.civb.com. At the conclusion of Mr. Shaffer's remarks, he and the Civista management team will take any questions you may have. Now I will turn the call over to Mr. Shaffer. Please go ahead.

Dennis Shaffer, President and CEO

Good afternoon. This is Dennis Shaffer, President and CEO of Civista Bancshares, and I would like to thank you for joining us for our first quarter 2024 earnings call. I'm joined today by Rich Dutton, SVP of the company and Chief Operating Officer of Banc, and other members of our executive team. This morning, we reported net income for the first quarter of $6.4 million or $0.41 per diluted share, which represents a $6.5 million decline from our first quarter in 2023 and a $3.3 million decline from our linked quarter. While we are disappointed in our results, we knew there would be headwinds as we stepped away from the third-party processor of income tax refunds, and we did not have the benefit of a $1.5 million one-time bonus that we received from the renegotiation of our debit brand agreement. In addition, in late 2023, we implemented changes in the way we process overdrafts, which reduced service charge income. As a result of these three items, noninterest income was approximately $3.8 million less in this quarter than in the previous year. While we continue to reduce rates on our CD specials and select money market accounts, the migration from our noninterest-bearing and lower rate checking accounts into higher rate money market accounts and CDs continues to put pressure on our net interest margin. We also experienced an increase in our allowance for credit losses as our CECL model requires higher reserves based on our individually analyzed loan and lease portfolio and loan growth. During the third quarter of 2023, we announced that Civista would be stepping away from the third-party processor of tax refunds due to increased scrutiny from our regulators. Civista earned $1.9 million and $475,000, respectively, during the first and second quarters of 2023 related to this program. Like many in the industry, we have been analyzing the way we process overdraft accounts and the fees associated with those services. Late in December, we discontinued assessing a charge on represented overdrafts and reduced our NSF fees from $37 to $32. We are also enhancing how we communicate with our customers regarding the use of their deposit accounts. Our overdraft fees, which are included in service charges, declined $375,000 compared to our first quarter of 2023. We anticipate these changes will reduce service charge revenue by $1.2 million over the course of 2024. In anticipation of this lost revenue, we implemented a number of initiatives to reduce our reliance on wholesale and borrowed funding while seeking to increase revenue and reduce expenses. Although we have seen some immediate impact, most of the benefits from these initiatives will occur over the balance of the year. I am encouraged by the early results, and I'm optimistic that we are headed in the right direction. We anticipated pressure on our margin as we exited the tax program and the need to replace the significant interest-free funding balances it provided during the first and second quarters. However, it is difficult to model the impact of the depositors migrating from noninterest-bearing to interest-bearing accounts, which was evident during the quarter. During the quarter, our cost of funding increased by 35 basis points to 2.54%, while our yield on earning assets increased by 12 basis points to 5.64%. This resulted in our margin contracting by 22 basis points, coming in at 3.22% for the quarter. During the quarter, we continued our measured approach to decreasing rates on some of our higher-tier demand deposit accounts and CD specials. In spite of lowering these rates, our cost of deposits, excluding brokered deposits, increased by 21 basis points to 1.22% during the quarter. We have a number of initiatives in progress to reduce costs and our reliance on brokered and wholesale funding. The state of Ohio announced its Ohio Homebuyers Plus program to encourage Ohioans to save for home purchases by offering tax incentives to depositors and subsidizing participating banks. As part of the program, the state will deposit up to $100 million in low-cost funds at the current rate of 86 basis points into participating banks. We also have historically maintained the cash balances of our wealth management clients and other financial institutions. However, we are currently taking steps that will allow us to hold the cash deposits of our wealth management clients at the bank. We anticipate the rates to approximate Fed funds less 20 to 25 basis points. Based on the current cash positions, we anticipate moving $75 million of these funds into the bank by the end of the third quarter. Our loan and lease portfolios grew at an annualized rate of 5% for the quarter, indicative of the continued strength of our markets and organization. Although this growth is slower, we have focused on holding rates at higher levels. We anticipate continuing to grow at a mid-single-digit pace for the balance of 2024. While our overall credit remains solid, as I previously mentioned, we experienced an increase in our allowance for credit losses due to our CECL model requiring higher reserves based on our annually analyzed loan and lease portfolio. This was primarily attributable to a hospitality credit and a cellular tower credit that have both been classified for several quarters. Both borrowers continue to cooperate. However, new information became available during the quarter, necessitating an adjustment of the collateral values and an increase in our reserve. Earlier, we announced a quarterly dividend of $0.16 per share, representing a 4.16% yield and a dividend payout ratio of 42.1%. Our efficiency ratio for the quarter was 73.8% compared to 64.3% for the linked quarter. However, if we were to back out the depreciation expense related to our operating leases from our leasing group, our efficiency ratio would have been 70% for the quarter and 60% for the linked quarter. During the quarter, noninterest income declined by $319,000 or 3.6% in comparison to the linked quarter and $2.6 million or 23.2% in comparison to the prior year first quarter. The primary drivers of the decrease from our linked quarter were declines in service charges due to the aforementioned changes to how we are processing overdrafts, and a $418,000 decline in swap fee income. These declines were offset by increases in other noninterest income, which included increases of $182,000 in fees related to leases and $280,000 in income from our captive insurance subsidiary. The primary drivers for the decline from the prior year's first quarter were $1.9 million in tax refund processing fees earned in the prior year and a nonrecurring $1.5 million signing bonus recognized in the first quarter of 2023 related to a new debit brand agreement. These declines were partially offset by increases in other noninterest income items, including a $584,000 increase in fees related to leases and a $453,000 increase in income from our captive insurance subsidiary. Noninterest expense for the quarter was $27.7 million, representing a $2.3 million or 9% increase from our linked quarter. This increase is primarily attributable to increases in compensation-related expenses, including salaries, which were up $139,000, payroll taxes, which increased by $434,000 as the beginning of the year full payroll tax load resumed, and an increase in health insurance expense of $346,000. You will recall that Civista is self-insured for our employee health insurance. As has been our practice, we begin each year by accruing our health insurance expense at the rate computed by our actuaries. Thankfully, just as has been the case in previous years, we were able to reduce that accrual in the third and fourth quarters of the prior year. Additionally, the combination of truing up our marketing accrual in the previous quarter and the resumption of our monthly marketing accruals in the current quarter accounted for $669,000 of the increase. Compared to the prior year's first quarter, noninterest expense increased $257,000 or 1%. This increase is attributable to our normal annual merit increases, which take place in April, and software expenses related to our digital banking platform that were mostly offset by declines in depreciation related to operating leases and professional fees paid to the consultant who assisted us with our debit card brand renewal last year. Turning to our focus on the balance sheet, for the quarter total loans and leases grew by $36.4 million, representing an annualized growth rate of 5%. While we experienced increases in nearly every loan category, our most significant increases were in non-owner-occupied CRE loans, residential real estate loans, and real estate construction loans. The loans we are originating for our portfolio are virtually all adjustable-rate loans, and our leases all have maturities of five years or less. New and renewed commercial loans were originated at an average rate of 7.92% during the quarter. Loans secured by office buildings make up about 5.1% of our total loan portfolio. As we have stated previously, these loans are primarily secured by single or two-story offices located outside of central business districts. Along with year-to-date loan production, our pipelines are fairly strong, with undrawn construction lines amounting to $244 million at March 31. We anticipate loan growth to continue to be in the mid-single-digit range for the balance of 2024. On the funding side, total deposits were mostly flat, declining by just $4.3 million or negative 0.1% since the beginning of the year. However, if we exclude non-core tax program and broker deposits, our deposit balances declined by $29 million or 1% year-to-date. As I mentioned earlier, we have a number of initiatives focused on gathering core funding. Our deposit base is fairly granular, with our average deposit account, excluding CDs, approximately $25,000. Noninterest-bearing demand accounts remain a focus. Excluding tax-related and brokered deposits, noninterest-bearing deposits made up 29.5% of our total deposits as of March 31. With respect to FDIC insured deposits, excluding Civista's own accounts and those related to the tax program, 13.1% or $392.3 million of our deposits were in excess of the FDIC limit at quarter-end. Our cash and unpledged securities at March 31 were $452 million, which more than covered these uninsured deposits. Other than the $369.5 million of public funds with municipalities across our footprint, we had no deposit concentration at March 31. At quarter-end, our loan-to-deposit ratio was 98.3%. Our commercial lenders, treasury management officers, and private bankers continue to have success requesting additional deposits and compensating balances from our commercial customers, and we will maintain discipline in how we price our deposits. We believe our low-cost deposit franchise is one of Civista's most valuable characteristics, significantly contributing to our strong net interest margin and overall profitability. The interest rate environment continues to exert pressure on our loan portfolios. At March 31, all of our securities were classified as available for sale and had $62.5 million of unrealized losses associated with them, which represented an increase of unrealized losses of $7.9 million since December 31, 2023. Over the past few quarters, we have reduced our security portfolio by using its cash flow to strengthen our balance sheet. At March 31, our security portfolio was $608.3 million, constituting 15.7% of our balance sheet. We ended the quarter with our Tier 1 leverage ratio at 8.62%, deemed well-capitalized for regulatory purposes. Our tangible common equity ratio was 6.26% at March 31, down slightly from 6.36% at December 31, 2023. Civista's earnings continue to create capital, and our overall goal remains to maintain adequate capital to support organic loan growth and potential acquisitions. Although we did not repurchase any shares during the quarter, we continue to believe our stock is valued well. While our capital levels remain strong, we recognize our tangible common equity ratios may spring loans. Our previous guidance remains that we would aim to rebuild our TCE ratio back to between 7% and 7.5%. To that end, we will continue to focus on earnings and balance any repurchases in the payment of dividends with building capital to support growth. As we stated in an earlier 8-K filing, the Board reauthorized a new stock repurchase program of $13.5 million during its April meeting. Despite the uncertainties associated with the economy and expense pressures on borrower space, our credit quality remains strong, and our credit metrics remain stable. As I mentioned earlier, we did make a $2 million provision during the quarter, primarily attributable to higher reserves required by our model based on individually analyzed loans and leases, driven by troubled credits: a $3.3 million hospitality credit, which we expect to resolve via the sale of properties, backed by a substantial guarantor, and a $4 million cellular tower credit, which we expect to resolve in the next six months. I would note that neither of these credit issues relate to underwriting weakness. The hotel faced an issue with its fire suppression system during the pandemic that prevented it from operating for 17 months and continues to limit operations. The cellular tower business suffered an internal fraud incident where an employee caused significant damage to the company for personal gain. Our ratio of allowance for credit losses improved from 1.3% at December 31, 2023, to 1.34% at March 31. In addition, our allowance for credit losses to nonperforming credits increased from 245.67% at December 31, 2023, to 247.06% at March 31. In summary, while our margin compression was greater than anticipated, our margin remains strong, and we are taking steps to generate more lower-cost funding. Our loan growth during the quarter should continue at a mid-single-digit pace for the balance of 2024. While we experienced some isolated credit issues, we have seen no systemic deterioration in our credit quality. Overall, Civista continues to generate solid earnings and is focused on creating shareholder value. Thank you for your attention this afternoon and your investment. Now we will be happy to address any questions that you may have.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Your first question is from Brendan Nosal from Hovde Group.

Brendan Nosal, Analyst

Maybe just to start off here. I think you folks have historically had the CFO position vacant for quite a long time. So just maybe talk through the decision to formally fill that CFO position you're announcing earlier today? And why now is the right time?

Dennis Shaffer, President and CEO

Well, I think Todd Michel has filled that role for us for the last 30 years, and he's done a great job at that, but Todd is approaching retirement age. He'll be retiring in the next couple of years. We wanted to have sufficient time for Todd to share his institutional knowledge, and we think the timing is right now given his plans for the future.

Brendan Nosal, Analyst

Maybe one more for me. Moving to the expense base. Costs were up sequentially, but they still came in quite a bit better than I was expecting. I think on the last earnings call, you folks pinpointed like $28.7 million of expenses per quarter for the final three quarters of the year. Just curious to hear your updated thoughts on the expense base and how you expect that to trend going forward.

Richard Dutton, Chief Operating Officer

Brendan, this is Rich. We guided last quarter, I think, during the call of $28.4 million per quarter. I would say that's a good number for the rest of the year. The big difference between the first quarter and the rest of the year is that our merit increases go into effect on April 1 annually, and that's really the only significant additional cash expenditure we have slated in our budget between now and the end of the year.

Dennis Shaffer, President and CEO

Yes, we really focused on expense control near the end of last year and going into this year, considering the lost revenues that we would face. So I think it's positive that we're guiding to that amount because we’re starting to see some of the expense control initiatives that we put into place.

Operator, Operator

Your next question is from Justin Crowley from Piper Sandler.

Justin Crowley, Analyst

I wanted to hit on the net interest margin for the quarter. Given some of the dynamics you discussed in the prepared remarks, can you unpack a little more just what you're seeing as far as lingering upward pressure on the funding side? Where do you see us when asset repricing allows for margin stabilization in a flat rate environment?

Richard Dutton, Chief Operating Officer

Justin, this is Rich again. I can't remember if you were on the call last time or not, but I don’t have a great track record of predicting what our market will do. But even with the contraction in our margin, it's still respectable. I think the initiatives that Dennis discussed, such as the Ohio Homebuyers program, give us confidence that we'll be able to bring in $100 million of low-cost funding related to that. The opportunity to move some cash balances that our wealth management group currently holds off-balance sheet onto our balance sheet are two opportunities to reduce funding costs. The bigger wild card is the migration from noninterest-bearing deposits into higher-yielding products like money market accounts or CDs. That aspect continues to be hard to model, and I’m unsure where it will land. Our models suggest that absent significant changes in interest rates, we might see further contraction by a few basis points.

Dennis Shaffer, President and CEO

The key difference, Justin, is that we are starting to see some positives. We managed to reprice some brokered deposits at the end of March, and we saw some improvement there. Our CD specials haven't moved, so those rates were set high last year and will adjust downward at their next repricing in the next quarter or so. There are some positive signs, but ultimately, it depends on our loan growth because we'll need funding for that.

Justin Crowley, Analyst

That's helpful. Additionally, what are you able to quantify regarding brokered funding that's maturing throughout the year? What does that repricing look like as we look forward?

Dennis Shaffer, President and CEO

So that’s all in the fourth quarter. The remainder of our brokered funding will reprice later in the year. We had a significant maturity of $151 million on March 20, so we didn’t capture much benefit from that in the first quarter. The next two segments of brokered funding will mature in the fourth quarter.

Richard Dutton, Chief Operating Officer

That's right. We've got about $500 million that has remained relatively constant in brokered CDs. As Dennis noted, about $200 million will come due or mature in November of this year, while the rest extends into 2025.

Justin Crowley, Analyst

Shifting gears, can you provide any high-level commentary on the environment for M&A, which has remained fairly quiet recently? What are your capital priorities over the medium to long term?

Richard Dutton, Chief Operating Officer

There's a lot of dialogue happening around M&A. I just think it's a challenging environment for buyers and sellers due to the loan marks. It's essential to understand how both buyer and seller loan books are repricing and what effects higher rates will have. So for us, we’re focused on building our capital base right now because we believe this environment isn’t conducive to M&A.

Operator, Operator

Your next question is from Terence McEvoy from Stephens. Please ask your question.

Terence McEvoy, Analyst

Could you talk about loan pipelines? Are you confident in maintaining that mid-single-digit growth rate for the remainder of the year? Will that growth continue to come from multifamily in metro Ohio markets and other categories mentioned earlier?

Charles Parcher, Executive

Yes, Terence, this is Chuck. Pipelines are looking pretty good right now. Compared to last year, our pipeline is higher than it was at this time. However, our pull-through rates are not as strong as in the past because we are being careful about margin and holding rates above 8% for most real estate deals. There is strong demand, particularly in the multifamily sector, and we're seeing good growth not just in Columbus but also in Cincinnati and Cleveland. We're feeling optimistic about the five major metro markets. The overall demand is still strong, even though cash flow management often requires more equity in these projects, developers are willing to invest more to make it work.

Terence McEvoy, Analyst

As a follow-up, can you provide insight into noninterest-bearing funds from the tax refund processing programs? With last quarter at $19.5 million, should we model out approximately $20 million per quarter going forward, or was the first quarter somewhat outsized?

Charles Parcher, Executive

No, that's probably fair. At the end of March, we had about $31 million left in the program. We're somewhat at the mercy of the tax processing partner. They could move that money out, but if they hold onto it longer, it's free money for us. The current expectation is that those funds will likely be gone sometime in the second quarter.

Terence McEvoy, Analyst

Just one last quick point. The $1.2 million of overdraft service charge revenue lost this year, is that fully reflected in the first-quarter run rate, or might there be additional declines throughout the year?

Charles Parcher, Executive

I would say that our first quarter is typically our highest NSF quarter post-holidays. If we had $375,000 less of NSF income in the first quarter, it'll likely be something less than that moving forward. Overall, the $1.2 million projection for the year remains accurate.

Operator, Operator

Your next question is from Tim Switzer from KBW.

Timothy Switzer, Analyst

I had a follow-up regarding your loan commentary. It seems you raised your guidance expectation from low single digits to mid-single digits. I remember mentioning the competitive environment becoming more intense last quarter; have you experienced any moderation in that aspect, and is that what drove the upside to guidance?

Charles Parcher, Executive

I think I've always stated we were projecting mid-single digits, in the 5% to 6% range. We have indeed seen a little bit of relief, but not by much. There is a high level of competition out there. Previously, we talked about competitors bidding treasury plus, making it slightly more challenging for us considering the inverted yield curve. But rates have improved a little in the first quarter and into the second quarter, bringing treasury-plus closer to what we offer. However, I believe our guidance has remained consistent regardless of what happened in the first quarter results.

Dennis Shaffer, President and CEO

To add, the biggest impediment to our loan growth is our ability to fund that growth, and we're disciplined about pricing. Competition challenges us, but lack of funding can hinder our balance sheet growth.

Timothy Switzer, Analyst

Can you remind us what percentage of your loans are floating rate and how you expect loan yields to trend in a potentially decreasing rate environment? What would the overall impact on the NIM be if we experienced one or two basis point cuts towards the year-end?

Charles Parcher, Executive

We believe that a rate cut would benefit us. We have been funding some of that with our overnight borrowings, which have increased $30 million from December 31 to $331 million. We would see advantages from that, especially as more loans are repriced. A significant portion of our portfolio, around 75%, is linked to treasuries, so as short-term rates rise, we would benefit as those loans roll over.

Richard Dutton, Chief Operating Officer

To provide some numbers, a little over 25% of our book is floating rate. At the beginning of the year, we identified about $140 million that would be repriced in 2024, of which only $15 million repriced in the first quarter. As Dennis noted, we do feel optimistic about some repricing benefiting us in the second half of the year from those $140 million, with $93 million poised to adjust in that period.

Operator, Operator

Your next question is from Manuel Navas from D.A. Davidson.

Manuel Navas, Analyst

I think many of my questions have been answered, but could you help quantify the potential size of the wealth management opportunity you mentioned regarding $75 million in the third quarter? Will there be more after that, or is that the only amount?

Richard Dutton, Chief Operating Officer

This is Rich. It's just a transaction. Those deposits are sitting in our wealth management department now. Once we get the mechanics sorted out, we will move that over to the bank. This won't be super cheap funding, but it will certainly cost less than what we currently borrow.

Dennis Shaffer, President and CEO

While we mentioned those two initiatives, there are numerous other actions underway to increase our deposit base. We are actively looking at outreach to public funds in areas where we have branches, including schools, libraries, municipalities, and county funds. We're being proactive and looking to strengthen our funding pipeline. We have also developed reports targeting customers with little or no loan or deposit relationships, with several initiatives aimed at enhancing our funding overall.

Charles Parcher, Executive

I wouldn't describe the impact as immediate. It would unfold over the next year.

Operator, Operator

Your next question is from Daniel Cardenas from Janney Montgomery Scott.

Daniel Cardenas, Analyst

I have a couple of questions regarding fee income. I appreciate all the details provided, and it sounds like you're working to address some of the holes that have emerged. But can you help set a benchmark for what a good run rate looks like going forward?

Richard Dutton, Chief Operating Officer

So if we are at about $8.5 million for the quarter, I think the wildcard right now for us is our mortgage banking performance. We are entering a good season for that. Chuck can elaborate further on that. Additionally, fee income related to leasing could vary, depending on the timing of equipment sales and such, but let me turn that over to Chuck.

Charles Parcher, Executive

Well, Dan, our first-quarter production in mortgages didn’t reflect as well due to about $10 million more in production compared to the first quarter last year. Our pipeline is robust, but we are still somewhat limited in Ohio regarding inventory. While we’re seeing preapprovals, many people are hesitant to buy homes. We are focusing our efforts on increasing salable production while maintaining quality. Consumer demand appears more resilient as they become accustomed to higher rates, even though they may find the transition from a 3% to a 7% rate challenging.

Dennis Shaffer, President and CEO

In spring and summer months, we expect volume to increase. We also created a syndication desk in our leasing company to help maximize gains on sale. Their focus will be building relationships to improve our pricing strategy, giving us an opportunity for enhanced gains.

Richard Dutton, Chief Operating Officer

Additionally, while we saw the NSF fees decline by $375,000, our service charges fell by $300,000 as well. The overall approach is to recover as much lost revenue as possible in various ways.

Dennis Shaffer, President and CEO

In March, we benefited from only one month of our service charge adjustments, which we implemented across the board. We are actively working to offset any lost revenue.

Daniel Cardenas, Analyst

So, it sounds like you can remain stable in Q2 and then gradually build from there modestly. Regarding the tax rate, how should we think about it?

Richard Dutton, Chief Operating Officer

Our effective tax rate came in lower than expected at just under 12% this quarter. We have typically projected a rate of 15% to 16%. I’m not sure which tax preference items drove this drop, but it’s among the lowest we've observed.

Operator, Operator

There are no further questions at this time. I will now hand the call back to Dennis Shaffer for closing remarks.

Dennis Shaffer, President and CEO

In closing, I just want to thank everyone for joining and participating in the call today. While we are not pleased with our first quarter performance, we are confident in our strong core deposit franchise and our disciplined approach to managing the company, positioning us well for future success. I look forward to talking to you all again in a few months to share our second quarter results. Thank you for your time today.

Operator, Operator

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may now disconnect.