Earnings Call Transcript - CIVB Q1 2023

Operator, Operator

Good day, and welcome to the Civista Bancshares First Quarter 2023 Earnings Conference Call. 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. that involve risks and uncertainties. Various factors could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. These factors are discussed in the Company’s SEC filings, which are available on the Company’s 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 replace the most directly comparable GAAP measures. The press release, also available on the Company’s website, contains the financial and other quantitative information to be discussed today as well as a reconciliation of the GAAP to non-GAAP measures. This call will be recorded and made available on Civista Bancshares website. At the conclusion of Mr. Shaffer’s remarks today, he and the Civista management team will take any questions that you may have. Now I will turn the call over to Mr. Shaffer. Please go ahead, sir.

Dennis Shaffer, President and CEO

Good afternoon. This is Dennis Shaffer, President and CEO of Civista Bancshares. Thank you for joining us for our first quarter 2023 earnings call. I'm accompanied by Rich Dutton, SVP and Chief Operating Officer of the bank; Chuck Parcher, SVP and Chief Lending Officer of the bank; and other members of our executive team. I want to begin by addressing our deposits, liquidity, credit, and capital positions given the recent banking industry events. Firstly, we have noticed very little unusual movement in our deposits. Our team has proactively engaged with customers to educate them on Civista's strengths and differences from recently failed banks. Additionally, our employees have successfully provided customers with options to maximize FDIC insurance coverage. Excluding Civista’s own accounts and those related to our tax program, 14% or $397.4 million of our deposits were uninsured by the FDIC as of March 31. Our cash and unpledged securities were $434.8 million at the end of the quarter, which fully covered our uninsured deposits. Aside from $156.7 million from public funds across our footprint, we had no significant deposit concentration. Total deposits, excluding our tax deposits and brokered CDs, fell by $55.8 million or 2.1% compared to December 31, 2022, which aligns with industry trends since many retail and commercial customers are utilizing the stimulus funds received during the pandemic. Notably, about $20 million of this movement was directed into higher-yielding treasury funds in our wealth management division. Mid-quarter, we enhanced our promotional rates on higher balance money market accounts and CDs to retain more deposits. Retaining the operating accounts of our business customers remains a priority. At March 31, 33% of our deposits were noninterest-bearing demand accounts, with 76.6% being commercial business accounts. We firmly believe our deposit franchise is one of Civista’s most valuable assets, significantly contributing to our leading net interest margin and profitability. Secondly, we consistently monitor our liquidity position and maintain strong on-balance sheet liquidity with easy access to off-balance sheet funding. As of March 31, we had $434.8 million in cash and unpledged securities, along with nearly $1.3 billion readily available from the Federal Reserve, the Federal Home Loan Bank, and other sources. Although we are enrolled in the Federal Reserve Bank’s Term Funding Program, we do not plan to utilize this funding source, which is not included in our $1.3 billion of off-balance sheet funding. Thirdly, despite economic uncertainties, our credit quality remains robust. Our credit metrics are stable compared to year-end, with no systemic deterioration in our customers’ financial health. We recorded a $620,000 provision during the quarter, reflecting growth in our loan and lease portfolio rather than economic stress. We implemented CECL on July 1, 2023, leading to a $4.3 million increase in our credit loss allowance and a $3.4 million rise in reserves for unfunded commitments. Following generally accepted accounting principles, these adjustments were made to our equity and did not affect earnings. The CECL adoption improved our allowance for loan losses to loans ratio from 1.12% at December 31, 2022 to 1.33% at March 31, while our allowance for loan losses to nonperforming loans rose from 261.45% to 346.82%. Lastly, we are generating capital through earnings, maintaining strong capital ratios that are above the well-capitalized threshold. Regarding our first quarter detail, we reported net income of $12.9 million or $0.82 per diluted share. Net loans and leases grew by $35.4 million or an annualized rate of 5.2%, including $16.2 million from equipment loans and leases from our new leasing company, Vision Financial. Our funding costs increased by 44 basis points this quarter, but we maintained a margin of 4.11% as asset yields kept pace. Our Comunibanc transaction is advancing well toward full integration, allowing us to focus on integrating Vision Financial. We are optimistic about increased volume as the first quarter is typically slower in the leasing industry. Our return on average assets was 1.47% compared to 1.41% for the previous quarter, while our return on average equity was 15.32% compared to 16.09%. On performance, net interest income remained strong and was $9.7 million or 42.2% higher than the same quarter last year, driven by organic loan growth in 2022 and acquisitions that enhanced our results in the rising interest rate environment. Our net interest margin stood at 4.11% for the quarter, slightly down from 4.14% but showing significant growth compared to one year ago. The yield on earning assets improved significantly, reflecting new loans at higher rates and the repricing of existing loans. Our funding costs for the quarter were at 1.44%, up by 44 basis points from last quarter and 89 basis points from last year. We observed an acceleration in our deposit beta as we offered higher rates for larger deposits. Service charge revenue fell by $297,000 from the previous quarter but increased by $194,000 year over year, influenced by the timing of certain tax program services. Mortgage banking faced challenges due to rising interest rates and limited housing inventory, with gains on the sale of mortgage loans declining significantly. Interchange fees increased due to a growing number of debit card customers from our Comunibanc acquisition. Lease revenue decreased slightly from the last quarter, as lease activity typically peaks later in the year. Other noninterest income rose due to a new partnership with MasterCard, contributing a signing bonus and increased transaction revenue. Noninterest expenses rose $7.4 million year-over-year, mainly due to annual compensation increases and the addition of Comunibanc and Vision Financial. Our efficiency ratio improved to 62.4% compared to previous quarters. Regarding our balance sheet, total loans rose by $33.4 million, and we are seeing strong demand across loan types despite a decline in mortgage production. Total deposits increased by $223.5 million, driven by our tax processing program and brokered deposits, even as personal and business checking deposits declined. We strategically filled an order for brokered CDs to manage our overnight borrowing capacity amid recent uncertainties. Despite pressures from a higher interest rate environment affecting bond portfolios, we finished the quarter with our Tier 1 leverage ratio at 8.63%, meeting regulatory capital standards. Our tangible common equity ratio strengthened to 6.14%. Our strong earnings contributed positively, despite a $6.1 million impact from CECL. Civista is focused on generating capital and maintaining adequate levels to support growth and potential acquisitions while continuing to pay dividends and manage share repurchases. In conclusion, we are pleased with our strong earnings, consistent loan growth, and stable credit quality despite economic challenges. The first quarter’s conditions present us with opportunities to attract new lending and deposit clients and strengthen our relationships as we move forward. Thank you for your attention this afternoon. We are now ready to answer any questions you may have.

Operator, Operator

Today’s first question comes from Terry McEvoy with Stephens. Please go ahead.

Terry McEvoy, Analyst

Could you discuss when the tax refund deposits will leave the balance sheet? I believe you mentioned it is moving off at an accelerated pace this year, but I want to ensure I accurately capture your expectations on this.

Rich Dutton, SVP and COO

Yes, this is Rich. Similar to previous years, the balances might be slightly lower. It's mainly a phenomenon for the first and second quarters. Last December, we had $70 million in tax deposits in the bank. Not all of it exits, but the surplus funds have been lingering as they have in past years. I hope that provides some insight.

Terry McEvoy, Analyst

Okay. Thanks, Rich. And then the Vision, the VFG, is that a good run rate for revenue? And then the equipment depreciation was a $2 million increase. Maybe is that a good run rate as well, or will that be volatile and kind of up and down as the year progresses?

Rich Dutton, SVP and COO

I would think that the depreciation of it would be a pretty good run rate. And again, it has to do with how the operating leases we originate keep, but it will grow slowly over the course of the year. And what was the first...

Dennis Shaffer, President and CEO

The revenue run rate will be a little bit higher. Their volume should pick up as the year increases. So, I think that run rate will be higher, particularly the fourth quarter is usually a strong quarter in the leasing industry.

Terry McEvoy, Analyst

Could you discuss your loan portfolio, particularly the commercial real estate portion, and address any concerns that investors may have regarding it in your markets?

Paul Stark, SVP

This is Paul Stark. We have quite a bit of real estate, but it’s pretty diversified by type and across our market. Overall, I think the biggest areas that people point to are the office space and construction. And we’ve done a deep dive on our portfolio. We feel pretty good about where we’re at. We haven’t seen any systemic deterioration, really haven’t seen any concerns come at any event. Clearly, there’s a little more stress because of increased input costs and interest reserves. But they’re all strong. They all should get finished without any troubles.

Chuck Parcher, SVP and Chief Lending Officer

Yes. Terry, this is Chuck. I mean our metrics around our commercial real estate I don’t think it’s ever been stronger. You read a lot of stuff in the national news about the problems of commercial real estate. But I’ll tell you in the Midwest, especially in the 3 Cs, we’re not seeing really any deterioration in any of our portfolio. 3 Cs are Cleveland, Columbus and Cincinnati.

Dennis Shaffer, President and CEO

Terry, I want to emphasize that there is no concentration in our portfolio; it is very well diversified. For example, our office portfolio accounts for just over 4% to 5.9%, and we are not involved in downtown high-rise office projects. We feel positive about that. Additionally, we do not have any large box retailers in our retail segment, which also gives us confidence. Overall, we believe our portfolio is well diversified with no concentrations, and we conduct extensive monitoring of it, receiving positive feedback from our regulatory agencies regarding our portfolio oversight.

Operator, Operator

Thank you. And our next question today comes from Tim Switzer at KBW. Please go ahead.

Tim Switzer, Analyst

I’m on for Mike Perito. Thanks for taking my questions. First off, can you give us what the purchase accounting impact was to NII and if that’s a good run rate going forward for the rest of the year?

Rich Dutton, SVP and COO

I think it was 6 basis points. First of all, I’m talking.

Tim Switzer, Analyst

Okay.

Dennis Shaffer, President and CEO

Yes. That would be a good run rate wherever it was.

Tim Switzer, Analyst

Okay. And on the talk about deposit rates, you think the beta is going to not increase by as much as it did this quarter. Can you help us think about the NIM trajectory over the rest of the year, maybe the magnitude of compression or if it can stabilize? What are your expectations there?

Rich Dutton, SVP and COO

Well, this is Rich. This is the first quarter that has contracted in this cycle for us. As Dennis mentioned, we saw some aggressive mid-quarter shifts in the deposit rates. We expect another 25 basis-point move in the next week or so. We're at 90% loan to deposit, which relates closely to how much the loan portfolio grows. If you're asking for our thoughts, we anticipate a slight contraction in basis points, but not excessively.

Dennis Shaffer, President and CEO

We became more aggressive due to bank failures, realizing that we needed to do everything possible to retain deposits. During that period, we felt a bit more urgency. We believe that if we don’t receive many ratings, the next rate increase could actually be advantageous for us. We don't see a need for significant action on the deposit side. Additionally, we think there's potential to widen our lending spreads, which could improve our net interest margin. Historically, larger banks tend to reduce their activities during crises, and we see this as an opportunity for us. Some banks might scale back due to the inverted yield curve and high short-term borrowing rates, which could limit their ability to make sufficient spreads. This situation presents us with a chance to increase some of our loan spreads, benefiting our overall performance as well.

Tim Switzer, Analyst

Okay. Yes. That’s helpful. And you made the comment that you still believe your stock has tremendous value. You didn’t repurchase any shares this quarter. Was a lot of that because of the activity we saw in March being a little bit cautious? And are you able to give us any kind of like parameters of expectations going forward?

Dennis Shaffer, President and CEO

Yes, absolutely. We are coming off two acquisitions in consecutive quarters, which required some capital investment. We feel it's best to let things settle down a bit for now and continue to evaluate our situation. Given the recent events in March and the concerns surrounding liquidity and capital, we were uncertain about how well our approach would be received in the marketplace.

Tim Switzer, Analyst

Yes. I think that was probably pretty reasonable, I think. And my last question then, last quarter, you guys seemed a little open to, but any more plans there, willingness to purchase possibly your other leasing businesses or other fee businesses or bank M&A overall?

Dennis Shaffer, President and CEO

Yes, we remain interested in that. We would like to increase our size, as it would make us more efficient as a company. Given the current values of banks, it becomes quite challenging. However, we will continue to engage with potential partners and will not stop pursuing our strategy of bank acquisitions. With many fees currently under pressure, including overdrafts, we are open to exploring additional leasing or other fee-based businesses.

Operator, Operator

Thank you. And our next question today comes from Manuel Navas with D.A. Davidson. Please go ahead.

Manuel Navas, Analyst

I just wanted to catch up on a couple of things that you touched on. So you have a good amount of construction that’s still going to be drawn down. Do you have an idea of the timing of those drawdowns? And also kind of what are those yields going to be?

Chuck Parcher, SVP and Chief Lending Officer

I don’t have that chart right in front of me, but I would say that most of it will be drawn down in this calendar year. Some projects will carry over into next year, particularly the new ones we approved in the last quarter. The rates are likely in line with what we’ve experienced, around the mid-6 range for the already approved projects that will be drawn down, possibly a bit higher for some of the floating-rate construction. Overall, I’d say it’s in the mid-6s.

Dennis Shaffer, President and CEO

Manuel, we didn’t originate that over the course of the year. So some of that will eventually go to the permanent market because we do a lot of construction and mini-perm type work. A lot of that goes to a nonrecourse lender as well. So it’s not like all of that will hit our balance sheet. But it’s all been accounted for over the course of last year and will continue through this year. However, it does help our balances until that eventually transitions to the permanent market.

Manuel Navas, Analyst

It's a bit of a downside to the loan growth guidance. That's how to think about it. Is that incorrect or...

Chuck Parcher, SVP and Chief Lending Officer

No, I think that’s correct. I think as a company, I think like everybody else, we’re not seeing the same acceleration of large payoffs from people selling products just because the rates are up a little bit. We’re not seeing as much changeover. I looked at that just before we came in, our large payoffs were $10 million or less this first quarter than they were first quarter of last year. So, we’re seeing a little stickiness of that. But I have to tell you the large projects that do go to the perm market and for the people to get off the guarantees, they’re still going to go and they’re still planning on going.

Manuel Navas, Analyst

You were able to transfer some funds to sweep accounts, specifically on the deposit side. I believe those are associated with wealth management sweep accounts, approximately around $20 million. How much do you currently have in those accounts?

Rich Dutton, SVP and COO

So, Manuel, those are about sweep accounts, right? That’s why that actually left the bank and went into our wealth management department.

Dennis Shaffer, President and CEO

Those were potential depositors looking for higher yields, primarily purchasing one-year treasuries. This option was available to them. When we chose not to offer a higher rate, instead of allowing that money to leave the bank, we directed them to our wealth department, which is set up to buy one-year treasuries for them at a slightly better yield. We believe that when those investments mature, we will have a greater opportunity to bring those funds back into the bank.

Manuel Navas, Analyst

Thank you for clarifying. That makes perfect sense. You mentioned some pressure on net interest margin this coming quarter. If we experience one more rate hike and then pause, how does net interest margin look for the rest of the year during the pause?

Rich Dutton, SVP and COO

Yes. I think, pretty stable. It really just depends on how fast our loan portfolio grows and how we have to fund it. And our lenders are great and bringing deposits along with those loans. I mean we’ve kind of had a history of about doing transactions, we do relationships. And so, we expect when we make a loan to get the deposits they go with. But in the 90s for loan-to-deposit ratio, certainly funding and how much we have to fund and how inverted the yield curve stays, that will put pressure on the margin for sure.

Operator, Operator

Today's next question comes from Ben Gerlinger with Hovde Group. Please go ahead.

Ben Gerlinger, Analyst

I would like to follow up on a question that Terry asked, just phrased differently. Regarding leasing and overall fee income, I understand that the fourth quarter is typically the peak, while the first quarter tends to be the lowest, with a gradual increase throughout the year. For instance, we saw total fees of about $10 million in the fourth quarter and around $9.5 million in the first quarter if we exclude the one-time items. Is it reasonable to estimate around $40 million, or do you believe that the increase might be more significant now that it’s integrated and you have the potential for additional clients?

Dennis Shaffer, President and CEO

You mean $40 million a quarter of product?

Ben Gerlinger, Analyst

No, sorry. For the full year.

Dennis Shaffer, President and CEO

Yes, that’s probably close.

Chuck Parcher, SVP and Chief Lending Officer

I think you'll notice a slight increase in mortgages and a small rise in leasing gain on sale. Some of the leasing gains may be somewhat lower than usual because we had some originations in the fourth quarter that were sold in the first quarter, and rates moved against us slightly. Therefore, the gains on sale aren't as high as we would typically expect. I foresee improvement in this area as we manage it better. Although our inventory is limited in most markets, spring is a selling season, which should lead to more first mortgages. Overall, I believe things are generally on track.

Dennis Shaffer, President and CEO

We have the tax program money included as well, so we will need to calculate that and follow up with everyone with a better number. We expect to receive some of the tax money in the second quarter, and that will also factor into our overall equation.

Rich Dutton, SVP and COO

Historically, what you’ve seen is that different to what you’ll see going forward, again with the exception of maybe the mortgage piece. But we’d be kidding if we told you we were all leasing experts yet. We’re still new at, and we’re still kind of trying to get our arms around that part of it. So yes, it’s going to grow. It’s just a matter of how fast it grows and how much of it we sell.

Ben Gerlinger, Analyst

Yes, that's good and helpful information. I understand that seeing a full year and the pattern within it has certainly been a learning experience for all of us. When considering the expenses related to this, do you see a comparison with salaries, or has it already been accounted for throughout the year?

Rich Dutton, SVP and COO

Most of the high-salary positions are primarily commission-based. This is beneficial because when they succeed, we also succeed.

Chuck Parcher, SVP and Chief Lending Officer

And we’ll answer too, Ben, just on the swap piece, too, we’ve had a little bit more interest in swaps, over the last probably 6 weeks or so. It will be interesting to see if that continues going forward or not. Obviously, we try to push that longer term rate lock piece and swap side…

Rich Dutton, SVP and COO

A few people have taken advantage of that right now and compared to one to be shorter on the interest rate cycle.

Ben Gerlinger, Analyst

Got you. And then lastly, what would be a good tax rate for full year? It’s moved around a little bit year-over-year.

Dennis Shaffer, President and CEO

For the quarter 16.4%.

Rich Dutton, SVP and COO

And I would say 16.5% is probably a good number. We’ve got a fair amount of tax preference revenue, and we try to manage that down. That would be fair.

Operator, Operator

Thank you. And our next question today comes from Dan Cardenas with Janney Montgomery Scott. Please go ahead.

Dan Cardenas, Analyst

I guess, just as I look at operating expenses for you guys here, is the first quarter number kind of a good run rate to build off of, or is there some room maybe to moving all those numbers in a little bit?

Rich Dutton, SVP and COO

Well, like Dennis said during the call, we have a $400,000 fee for a consultant that helps us with the MasterCard program. And the payroll tax and the 401(k) contributions are always big in the first quarter, too. And some of that gets balanced out with the raises that we go into effect on April 1st or the first part of April. So going forward, if you guys penciled in about $27 million a quarter for the next three quarters, that would be pretty close to what our budget is going to be.

Dan Cardenas, Analyst

Okay. All right. That’s helpful. Thank you. And then how should I think about deposit balances as you approach the end of the year? Do you think you can kind of sustain them? And if you do, is that going to be through broker deposit growth, or how are you looking more at organic deposit growth? I guess a couple of questions there.

Dennis Shaffer, President and CEO

Yes. I think we can sustain deposits. We’ve gotten a little bit more aggressive. Again, I do think this is going to be an opportunity for us. So, we’re going to demand a little bit more. We always have been pretty good at gathering deposits. When we do a loan, we’re going to go back to a lot of those borrowers, existing borrowers, whether they’re having new loan requests or not, and we’re going to say, look, we’re hearing that certain banks are pulling back in their lending efforts and things like that. We’re still in the game, but to be in the game, we need deposits and we’re asking them to move more deposits to us. So, we’re really going to play off the relationships that we have to try to drive a little bit more business there. So, we think definitely we can sustain. We know deposits are kind of at a premium now, and we’re going to really work those relationships.

Dan Cardenas, Analyst

All right. I imagine the competition for deposits is quite intense right now. Is it more from the smaller banks in your market, the bigger banks, or everyone?

Dennis Shaffer, President and CEO

Yes, it's really everyone. We see various banks offering specific promotions, and each has a slightly different strategy. We have chosen to keep our approach focused and I believe we will maintain that. It is quite competitive, which is necessary as we aim to grow our lending activities. Therefore, we are going to leverage our existing relationships to attract more affordable funding, avoiding the more volatile sources.

Operator, Operator

And our next question today is a follow-up from Manuel Navas. Please go ahead.

Manuel Navas, Analyst

I wanted to ask about the loan loss reserve increase due to the CECL addition, which is currently at 1.33%. What can we anticipate moving forward regarding provisions? It did increase a bit in the fourth quarter of last year. Is that the right level, or is it lower than what you had previously?

Paul Stark, SVP

This is Paul Stark. We are relatively new to the CECL methodology. If you examine the risk profile, it remains strong, and we do not anticipate any changes to that. The model's adjustments will need to be balanced after the experience of the first quarter. However, I do not foresee it being significantly higher than where we ended the year.

Rich Dutton, SVP and COO

I mean, I don’t know that we provided for any losses for a number of quarters. I mean, it’s all been growth.

Dennis Shaffer, President and CEO

It’s all been growth. We at 1 point had like 8 straight quarters of recoveries.

Chuck Parcher, SVP and Chief Lending Officer

Even though the small loss we took this quarter was really related to an acquisition as opposed to any type of normalized deterioration. So we expect that profile to continue to be strong.

Dennis Shaffer, President and CEO

Yes. So that provision is likely to remain approximately at its current level.

Operator, Operator

Ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back over to Mr. Shaffer for closing remarks.

Dennis Shaffer, President and CEO

Thank you. In closing, I do want to thank everyone for joining and those that participated on today’s call. Again, we are pleased with our first quarter results. Our strong core deposit franchise, our proven disciplined approach to pricing deposits, our solid credit history, I think all positions us very well for future success. I look forward to talking to all of you again here in a few months to share our second quarter results. So, thank you for your time today.

Operator, Operator

Thank you, sir. This concludes today’s conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.