Earnings Call Transcript - CIVB Q1 2021

Operator, Operator

Good afternoon everyone and welcome to the Civista Bancshares Incorporated Q1 2021 Earnings Conference Call. All participants will be in a listen-only mode. Please note, today’s event is being recorded. At this time, I would now like to turn the conference over to Dennis Shaffer, President and CEO. 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 2021 earnings call. I'm joined today by Rich Dutton, SVP of the company and Chief Operating Officer of the Bank; Chuck Parcher, SVP of the company and Chief Lending Officer of the Bank; and other members of our executive team. Before we begin, I would like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of Civista Bancshares, Inc. that involves risks and uncertainties. Various factors could cause actual results to be materially different from any 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 substitute the most directly comparable GAAP measures. The press release available on our website contains the financial and other quantitative information to be discussed today, as well as the reconciliation of the GAAP to non-GAAP measures. We will record this call and make it available on Civista Bancshares' website at civb.com. Again, welcome to Civista Bancshares first quarter 2021 earnings call. At the conclusion of my remarks, we will take any questions that you may have. This morning, we reported net income of $10.8 million or $0.68 per diluted share for the first quarter 2021. Our earnings per share increased 44.7% compared to the first quarter of 2020. This is a direct result of our continued focus on growing and diversifying non-interest income streams and our disciplined approach in managing the company. Our return on average assets was 1.36% for the quarter compared to 1.44% for the linked quarter and our return on average equity was 12.48% for the quarter compared to 11.79% for the linked quarter. During the quarter, we continued our focus on managing COVID-19 loan deferrals as well as our asset quality as a whole. We were proactive in working with our borrowers in the beginning of the pandemic and had some sizable deferrals. We feel that this approach was the right one, as many of our borrowers were able to resume normal payments throughout 2020. Our deferrals have improved modestly from 3.6% of total loans at December 31st, 2020 to 3.4% at March 31st. Some of these borrowers have seasonal businesses, which will not resume operations until late in the spring. Due to our diligent efforts to work with customers and strong borrowers, we have not experienced any defaults attributable to the pandemic and delinquencies are at historically low levels. Our mortgage banking business continues to drive non-interest income, generating gains of $2.7 million this quarter, nearly keeping pace with the $3.1 million record gain that we recorded in the linked quarter. Our Board of Directors approved our quarterly dividend on April 9th of $0.12 per share, which represents a dividend payout ratio of 17.7%. And earlier this week, we announced the authorization of a new $13.5 million stock repurchase program. Included in this morning's earnings release is an announcement that we will be closing two of our smaller branches in July. This decision isn't one we take lightly no matter what the size of the branch is. We understand that community banks are the lifeblood of many small communities. During the pandemic, we began a process to transform our online and mobile banking. Many of our customers are transacting their business digitally and we expect that trend to continue. We anticipate redirecting the cost to operate those small branches into our digital offerings. Getting back to the numbers, our net interest income increased $297,000 or 1.3% over the linked quarter and $1.7 million or 7.7% year-over-year. Our net interest margin for the quarter was 3.30% compared to 3.69% for the linked quarter. Let me first talk about the easy part of our net interest income and our net interest margin. That would be on the funding side. We were able to reduce our funding costs by $990,000 compared to the first quarter of 2020 and $293,000 compared to the linked quarter. The majority of this decline is due to rate. We believe there's still some room for the rates in our time deposit category to come down further. The earning assets side of this equation has a bit more noise included in it. There were really two pieces to discuss. The first piece is the income related to the PPP loans. Our PPP loans had an average balance of $248.7 million during the first quarter of 2021 and a yield of 6.07% when you factor in the accretion of the fees. This increased our yield on earning assets by 22 basis points and net interest margin by 26 basis points. The second piece is the increased liquidity generated by the federal government stimulus program. In early January, we mistakenly received nearly $5.6 billion in stimulus payments with no advance warning from the U.S. Treasury. These funds remained in our account at the Federal Reserve for several days before we could get them either distributed or returned, which increased the average balance of our interest bearing deposits in other banks by $258 million for the current quarter, earning 10 basis points and had the effect of reducing our yield on earning assets by 33 basis points and our first quarter margin by 30 basis points. This was in addition to extra liquidity normally generated by our tax refund processing program during the first half of the year. In past years, we have had short-term borrowings going into the tax season that we were able to pay off, which lessens the impact to the margin. This year our liquidity profile was such that all of these funds went into our Fed account, which further reduced our margin by 14 basis points. Certainly margin is important, but with all this noise surrounding this quarter's margin, I would like to reiterate that our net interest income increased over both the linked quarter and year-over-year. During the quarter, non-interest income increased $1.5 million or 19.9% in comparison to the fourth quarter of 2020 and increased $2.3 million or 33.7% year-over-year. Mortgage banking continues to be the largest driver of our non-interest income. First quarter gains on the sale of mortgage loans were $2.7 million, down slightly from our linked quarter, which was a record at $3.1 million and represented a $1.9 million increase over the prior year. We sold $77.6 million mortgage loans during the first quarter of 2021 compared to $91.8 million during the linked quarter as the strong mortgage demand that we saw during much of 2020 continued. The average premium recognized on the sale of loans increased 21 basis points from 3.34% to 3.55% over the linked quarter. Service charge revenue declined by $220,000 or 14.9% compared to our linked quarter, which was consistent with a $212,000 or 14.4% decline from our first quarter of last year. These declines are primarily attributable to the industry-wide decline in overdraft fees as our retail customer behavior patterns change during the pandemic. For similar reasons, interchange revenue increased $63,000 compared to the linked quarter. Typically, we experience a post-holiday season decline in debit card activity. However, this year was not the case. Interchange revenue increased $282,000 or 33.9% compared to our first quarter of last year. Wealth management revenue increased by $81,000 or 7.6% compared to the linked quarter and $140,000 or 13.9% year-over-year. We continue to view the expansion of these services across our entire footprint as an opportunity to diversify and grow non-interest income. Our tax refund processing program continues to be an important contributor to our non-interest income during our first and second quarters each year. Income from that program during the first quarter was consistent with the prior year at $1.9 million. Non-interest expense increased $2.3 million or 14.3% compared to the linked quarter and $1.5 million or 8.6% year-over-year. In both cases, the increases are primarily the result of increases in compensation, occupancy, and taxes and assessments. Compensation expense, which increased $1.4 million, accounted for the largest portion of the linked quarter increase in non-interest expense. Payroll taxes are typically higher in the first quarter as our contributions to our employees' 401(k) plans and pension plans. Merit increases, which occur each year in April, averaged 3.3% in 2020 and accounted for $199,000, and increased commissions to our mortgage lenders accounted for most of the increase in compensation expense year-over-year. Other drivers of both the linked quarter and year-over-year increases were occupancy expenses with additional cleaning and sanitation supplies related to the pandemic and some significant snow removal costs incurred in February 2021. Taxes and assessments expense also drove up both the linked quarter and year-over-year expenses. The increase from the prior year was the result of the FDIC small bank credit that was applied against our first quarter 2020 assessment and an increase in our FDIC accrual as our balance sheet has grown. Our efficiency ratio was 58% compared to 53.7% for the linked quarter and 60.7% year-over-year. During the first quarter, our total loans grew by $2.7 million. PPP loans were the primary reason for the increase. If we back out the PPP loans originated during the first quarter, our loan portfolio would have contracted by $26.6 million or 1.4%. Demand for commercial real estate loans across our footprint continued with strong demand in our non-owner occupied category. However, construction loans declined slightly as projects were completed and draws on those projects that were not under roof slowed due to weather. In addition, the influx of stimulus money from both PPP and payments to individuals provided the liquidity to pay down $21.2 million on lines of credit, which are included in commercial and agricultural loans. While our first quarter loan production was less than what we would have liked, demand has picked up. Strong demand and the fact that our undrawn construction lines are near an all-time high gives us confidence that we will grow our loan portfolio at a mid-single-digit rate for 2021. I talked before about the gains we recorded on the sale of mortgage loans; our mortgage pipelines remain very strong. With respect to PPP, we originated over 2,300 loans for $267.8 million during phase one of the program and over 1,300 loans for $119.8 million during phase two of the program. At the end of the quarter, $246.6 million in PPP loans remained on our balance sheet. Of the $9.9 million in fees generated by phase one, we have recognized $7.6 million, of which $2.9 million was recognized during the quarter. So far phase two PPP loans have generated $5.7 million in fees, of which $220,000 were recognized during the quarter. Of our phase one PPP loans, $141 million or 52.7% have been forgiven through March 31st, 2021. On the funding side, we experienced growth in virtually every category, with total deposits increasing $286.5 million or 13.1% since the beginning of the year. Non-interest bearing demand accounts, which made up 37% of our total deposits at March 31st, grew by $196.8 million compared to December 31st, 2020. While balances related to our income tax processing program made up $136.9 million of the increase, we also experienced $37.9 million of growth in non-interest bearing business accounts as our business customers deposited PPP loan proceeds. We also experienced a $77.8 million increase in our interest bearing demand accounts driven by a $62.5 million increase in public fund accounts. During the third quarter of 2020, we automatically downgraded each commercial loan that requested concessions beyond the initial 90-day modification we offered in the beginning stages of the pandemic. We continue meeting with our customers to better understand how they have been impacted and their plans for operating as we move forward. That said, our total criticized loan portfolio, which includes all classified and substandard loans, remained consistent at $149.7 million at March 31st, 2021. The largest segment of criticized loans are hotel loans totaling $80.2 million. During the quarter, we did realize $275,000 in net recoveries. However, there are still uncertainties associated with COVID-19 and its impact on the economy. As a result, we recorded an $830,000 provision expense for the quarter. The ratio of our allowance for loan losses to loans increased from 1.22% at year-end 2020 to 1.27%. Exclusive of the PPP loans, this ratio would have been 1.44%. Our allowance for loan losses to non-performing loans also increased to 423.09% at the end of the quarter from 343.05% at the end of 2020. While these reflect very strong credit metrics by historical standards, given the uncertain nature of our current economy, we will continue to monitor our portfolio and the economy making further adjustments as our model dictates. We ended the quarter with a tangible common equity ratio of 9% compared to 9.98% at December 31st, 2020. The extra $136.9 million of liquidity related to our income tax refund processing business at quarter end combined with the $246.6 million in PPP loans had the effect of reducing our TCE ratio by approximately 133 basis points. Our strong earnings continue to create capital, which allows us to consider several options in managing our capital. Our overall goal is to have adequate capital for growth, both organic and for acquisitions. We continue to give dividends to our shareholders as one way to manage capital and we were happy to be able to increase our dividend in January of this year to $0.12 per quarter. We also view share repurchases as an integral part of our capital management strategy. During the quarter, we repurchased 181,627 shares of common stock for $3.9 million for an average price of $21.39. We expect to continue to repurchase shares with our new authorization through the remainder of 2021. In summary, we are pleased with another quarter fueled by solid earnings. While there are several challenges that lie ahead for us in 2021, we remain optimistic as restrictions are lifted and the economy continues to open up. Our loan pipelines are solid. We anticipate that many of the remaining PPP phase one loans will be forgiven during the balance of 2021. In the second quarter of 2021, we look forward to rolling out many new digital tools focused on improving the customer experience. Our digital initiatives are aimed at improving our account onboarding process, customer communications, the digital delivery of treasury management services, as well as how we deliver retail services to consumers. Thank you for your attention this afternoon. And now we'd be happy to address any questions that you may have.

Operator, Operator

Our first question today comes from Terry McEvoy from Stephens. Please go ahead with your question.

Terry McEvoy, Analyst (Stephens)

Hi, good afternoon, guys.

Dennis Shaffer, President and CEO

Hi Terry.

Terry McEvoy, Analyst (Stephens)

First off, thanks for running through the inflow of stimulus funds. I thought that was a typo when I saw billion. So, thanks for addressing that in the prepared remarks.

Dennis Shaffer, President and CEO

We thought it was a typo when we saw it as well.

Terry McEvoy, Analyst (Stephens)

Your surprise was larger than mine, I'm sure. I guess first question — could you just run through where you are on the expense side for the digital investments on online and mobile banking? And will it be fully offset with the branch actions? What I'm getting at is looking ahead, should we expect to step up in expenses at all because of technology spending?

Rich Dutton, SVP and Chief Operating Officer (COO)

Terry, right now we still haven't expensed anything with regard to what we're rolling out in June and later this year. We continue to operate under our current Jack Henry contract. We're trying to time those up so that when the new expenses roll on to the books, the Jack Henry costs will reduce. Net-net, starting sometime in the second quarter and certainly into the third quarter, it's going to increase by about $200,000 a quarter. We'll work to manage that, but I think that's how it looks right now.

Dennis Shaffer, President and CEO

And the branch closures will net us about $200,000 in total savings for the year, Terry. They were relatively small branches and we didn't have a lot of employees there, so it will offset and it helps a little bit.

Terry McEvoy, Analyst (Stephens)

Thank you. As a follow-up, the 3.4% loan deferral is about two times what I put together for other banks across the country. I know you addressed it in terms of seasonality in some of your customers, but could you expand on that? Of those hotels, what are you expecting in terms of stronger occupancy and provide a little more color?

Rich Dutton, SVP and Chief Operating Officer (COO)

We do have a number of hotels. The income drivers of those hotels are primarily destination related to Cedar Point and Kings Island, as well as the islands of Put-in-Bay, and they are mostly leisure-focused. We have seen occupancy creeping up as we go and we expect payments to start to resume. We think probably half of that $70 million should resume in the second quarter to early in the third quarter, but it's really more timing as it relates to revenues and original payment schedules.

Dennis Shaffer, President and CEO

Terry, we're hearing positive comments from some of our hotel operators. We do want to see at least a couple months that they return to pre-pandemic revenue levels. Even though we're hearing positive comments, we want to see a couple months or maybe even a quarter of revenue numbers that are somewhat close to pre-pandemic levels before we fully upgrade our outlook.

Rich Dutton, SVP and Chief Operating Officer (COO)

Bookings and reservations are strong right now.

Dennis Shaffer, President and CEO

We're optimistic, but being conservative; we don't want to upgrade and then downgrade again next quarter, so we're trying to be measured.

Terry McEvoy, Analyst (Stephens)

I appreciate that. Thank you and enjoy the weekend.

Dennis Shaffer, President and CEO

Thanks Terry.

Operator, Operator

Our next question comes from Nick Cucharale from Piper Sandler. Please go ahead with your question.

Nick Cucharale, Analyst (Piper Sandler)

Good afternoon, guys. How are you?

Dennis Shaffer, President and CEO

Nick, how about that operator getting your name right too?

Nick Cucharale, Analyst (Piper Sandler)

Amazing. Just to follow up with the expenses after the digital commentary, where do you see the overall run rate in future periods? And what type of year-over-year growth are you expecting?

Rich Dutton, SVP and Chief Operating Officer (COO)

Nick, in the first quarter we had a fair amount of commissions and incentive payments that went out, and each year in April we have our merit increases. We have a run rate going forward of probably $18.9 million a quarter. I don't have the exact year-over-year growth percentage in front of me, but that run rate is a good starting point.

Nick Cucharale, Analyst (Piper Sandler)

That's plenty, thanks. And secondly, on loan growth, which took a bit of a breather, was this a function of a strong fourth quarter and the pipeline building back up? I'm trying to get a sense of the outlook for loan demand across your geographies.

Chuck Parcher, SVP and Chief Lending Officer

No question. We had a really big fourth quarter. We had a few payoffs that we expected in the fourth quarter that leaked into the first quarter, so payoffs were a little higher than normal. Our pipeline was okay coming into the year, but in the last 30 to 45 days we've seen a big uptick in loan demand. We feel good about that. We've got a lot of construction projects we'll need to fund over the summer, so we still feel like we'll end up in that mid-single-digit growth rate for the year. As Dennis mentioned, our lines of credit were paid down about $20 million due to PPP funding being deposited back into accounts. Our residential mortgages went down another $11 million as we continue to refinance some of the loans on the books, which created pressure in the first quarter, but we feel like we'll grow through that in the next three quarters.

Nick Cucharale, Analyst (Piper Sandler)

Okay. Lastly, the gain on sale margin in the mortgage business improved again. We touched on this last quarter's call, but do you see that as sustainable in the near-term?

Chuck Parcher, SVP and Chief Lending Officer

I don't see the 3.55% number as sustainable. I think it will come down, probably moving closer to the 3% area, especially in the second quarter.

Dennis Shaffer, President and CEO

If the margin narrows, we'll have to be more competitive on pricing. But pipelines are still full right now.

Nick Cucharale, Analyst (Piper Sandler)

Makes sense. Thanks for taking my questions.

Dennis Shaffer, President and CEO

You bet.

Operator, Operator

Our next question comes from Michael Perito from KBW. Please go ahead with your question.

Michael Perito, Analyst (KBW)

Hey guys, good afternoon.

Dennis Shaffer, President and CEO

Hey Mike.

Michael Perito, Analyst (KBW)

Thanks for taking my questions. I want to start on the technology investments. Could you give more insight into the goals, whether financial or conceptual, that you're trying to achieve with these upgrades and how we should think about what the platform will look like versus what it is today once the rollouts are completed?

Dennis Shaffer, President and CEO

Financially, most of the benefits are in the back end. You absorb most of the costs going in and then you hope to open more accounts, get more interchange fees, and drive card usage and digital wallet adoption. We expect revenue recognition from service charges and interchange over time. The whole goal is to improve the overall customer experience. The design and platform will be competitive with what's out there. You'll be able to link other accounts — currently you can only see Civista accounts, but you'll be able to link other reward cards and external accounts. You'll be able to get one financial snapshot, do some budgeting through the app, and eventually do online account opening. I read recently that 55% of accounts opened last year were opened online; we did not have that capability. Eventually we'll have online account opening toward the latter half of this year. This will also improve account opening times in the branch, making them quicker and easier. There are a ton of customer experience benefits.

Chuck Parcher, SVP and Chief Lending Officer

I want to add that once we're on the new platform, we also expect significant improvements in our treasury area. We'll get much better reporting and we see growth opportunities there.

Michael Perito, Analyst (KBW)

That's really helpful and to make you feel a little better, Dennis, that 55% number is skewed by larger banks; for community banks it's much lower. But it certainly makes sense. To follow up, Rich, on expenses: it sounds like there's probably $400,000 to $500,000 of elevated expense in the first quarter that drops to the $18.9 million run rate, and then from there normal low single-digit growth on merit increases. In third and fourth quarters you expect another couple hundred thousand a quarter related to tech. Is that a fair holistic capture?

Rich Dutton, SVP and Chief Operating Officer (COO)

Absolutely. That's our conservative best estimate. If we're able to be more aggressive with Jack Henry, it might be better than that, but if you are modeling it, model it that way.

Dennis Shaffer, President and CEO

The revenue benefits from the tech piece won't start recognizing until the latter half of the year and then into 2022.

Michael Perito, Analyst (KBW)

Got it. Lastly, any thoughts on M&A in the Ohio marketplace? You've seen activity in other parts of the country pick up. Curious what you're hearing and where your focus and appetite are.

Dennis Shaffer, President and CEO

Our goal remains to grow as an independent bank. We've been proactive in outreach to organizations we think would be a good fit. Discussions focus a lot on culture and social issues; we believe we can be a friendlier partner than some larger competitors. We're focused mostly on Ohio, eastern Indiana (Indianapolis north and south), northern Kentucky, southern Michigan, and potentially western Pennsylvania near the Ohio border. That's where we've been focusing our efforts. We haven't seen a ton of activity in Ohio within our footprint as of today.

Michael Perito, Analyst (KBW)

Great, makes sense. Very helpful. Thank you for the color.

Dennis Shaffer, President and CEO

Thanks Mike.

Operator, Operator

Our next question comes from Russell Gunther from D.A. Davidson. Please go ahead with your question.

Russell Gunther, Analyst (D.A. Davidson)

Hey, good afternoon guys.

Dennis Shaffer, President and CEO

Hey Russell.

Rich Dutton, SVP and Chief Operating Officer (COO)

Hi Russell.

Russell Gunther, Analyst (D.A. Davidson)

I appreciate all the color on the puts and takes for the margin this quarter. Could you extend your thoughts to the upcoming couple of quarters if we assume some of those idiosyncratic events ease? You mentioned additional room on the funding side — how do you expect the margin to trend over the remainder of the year?

Rich Dutton, SVP and Chief Operating Officer (COO)

From where it's at right now, with the current noise removed, add back the roughly 30 basis points that were compressed by the stimulus inflow and tax-related liquidity, and you get closer to a 3.70% margin. The big unknown is how quickly PPP loans get forgiven and how those fees roll through. Excluding PPP timing, I think a 3.70% margin is a reasonable number and it may drift downward modestly from there.

Dennis Shaffer, President and CEO

We are sitting on a lot of liquidity and could get more because of additional stimulus. For example, there are allocations to public entities and schools in Ohio, which could increase deposits. How fast that money flows out and how aggressive other banks are on lending could force some competitive pricing. We'll stay disciplined and be selective in pricing if we pursue opportunities.

Russell Gunther, Analyst (D.A. Davidson)

Very helpful. With the renewed buyback program, what's your appetite to repurchase stock at current levels?

Dennis Shaffer, President and CEO

We still have appetite. Most analysts covering us rate us as a buy or outperform, and we still think we're undervalued. We believe repurchasing at current levels makes sense.

Russell Gunther, Analyst (D.A. Davidson)

Thanks guys for taking my questions.

Dennis Shaffer, President and CEO

Yes.

Operator, Operator

Our next question comes from Bryce Rowe from Hovde. Please go ahead with your question.

Bryce Rowe, Analyst (Hovde)

Thanks. Happy Friday. Good afternoon.

Dennis Shaffer, President and CEO

Hi Bryce.

Bryce Rowe, Analyst (Hovde)

I wanted to ask about the allowance and some commentary around the improving economic situation and credit. We're seeing the allowance continue to build a bit. At what point do you think the allowance peaks? Could you run into a situation where you have to release some of the allowance if conditions continue to improve?

Paul Stark, CFO

As we look at this, vaccinations and the overall COVID situation are key. While vaccination pace has been good, it's starting to slow. For borrowers, we've had two quarters of stability in criticized loans and some improvement in non-performing loans, but the big chunk of our criticized loans are hotels and their recovery is likely toward the end of the year. We're being cautious. We've slowed the provision since we're seeing improved bookings, but until we see revenue streams resume to normal levels and can assess balance sheet impact, we'll maintain a cautious posture.

Dennis Shaffer, President and CEO

We did slow down the provision from the previous quarter. We want to see performance in the portfolio. Conditions appear to be improving, but our deferral number didn't move significantly this quarter. We hope to see movement by the end of the second quarter. Remember, we were a slow build — we didn't move aggressively — and we make adjustments each quarter as the economy and qualitative factors change.

Bryce Rowe, Analyst (Hovde)

Good commentary. Shifting to margin on the funding side: transaction accounts' funding costs are low and likely can't go much lower, but the average cost of CDs continues to work lower. How are you thinking about CD retention and re-pricing?

Dennis Shaffer, President and CEO

CDs are about 13% of our book. Some were 18-month specials from a year or more ago. Many of those are repricing down; we had some on the books at 1.60% to 1.80% and today we are at 0.30% to 0.35% in market. We think we'll be able to bring those costs down as they re-price. We haven't lost too many because rates are low everywhere and liquidity is high, so we don't expect big shifts out of CDs into competitors. I think the CD portfolio will stay fairly consistent but we'll be able to lower costs as contracts re-price.

Bryce Rowe, Analyst (Hovde)

Okay, thanks Dennis. That's all for me. Have a good weekend.

Dennis Shaffer, President and CEO

Thanks Bryce.

Rich Dutton, SVP and Chief Operating Officer (COO)

Thanks Bryce.

Operator, Operator

At this time, I'm showing no additional questions. I'll turn the conference call back over to management for any closing remarks.

Dennis Shaffer, President and CEO

Thank you. In closing, I just want to thank everyone for listening and thank those that participated in the call. Again, we were pleased with our first quarter results and we look forward to talking to you again in a few months to share our second quarter results. Thank you for your time today.

Operator, Operator

Ladies and gentlemen, that will conclude today's conference call. We do thank you for attending. You may now disconnect your lines.