Earnings Call Transcript - CIVB Q2 2020

Operator, Operator

Good day, and welcome to the Civista Bancshares Second Quarter 2020 Earnings Conference Call. 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 Dennis Shaffer, President and CEO. Please go ahead, sir.

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 second quarter 2020 earnings call. I'm joined today by Rich Dutton, Senior Vice President of the company; and Chief Operating Officer of the Bank; and Chuck Parcher, Senior Vice President 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 Second Quarter 2020 Earnings Call. I would like to begin by discussing our results, which were issued this morning. At the conclusion of my remarks, we will take any questions that you may have. This morning, we reported earnings for the second quarter 2020 of $6.5 million or $0.41 per diluted share and $14.3 million or $0.88 per diluted share for the six months ended June 30, 2020. This represents a decrease in net income from 2019 of $2 million for the quarter and $3.7 million for the six-month period. The COVID-19 pandemic has had several effects on our balance sheet and income statement during 2020. Our balance sheet has grown as a result of the Paycheck Protection Program, or PPP, makeup of our income statement shifted as well. The largest change in our income statement is an increase in provision for loan losses due to the economic uncertainty created by COVID-19, stay-at-home orders, and increased unemployment. Without the increase in provision, our net income would have exceeded 2019 levels. Our strong capital position and continued ability to generate core earnings allowed our Board of Directors to improve our quarterly dividend during the second quarter to $0.11 per share, which represents a dividend payout ratio of 26.8%. In these uncertain economic times, it is difficult to predict future performance, but our strong capital and liquidity should allow Civista to maintain this dividend level unless we experience a further deterioration in the economy for an extended period. Our return on average assets was 0.93% for the quarter and 1.07% year-to-date, while our return on average equity was 7.91% for the quarter and 8.70% year-to-date. Despite the lower interest rate environment, net interest income for the quarter was $22.1 million, which was consistent with the linked quarter and the prior year. Our net interest margin did contract to 3.61% compared to 4.1% for the linked quarter and 3.84% year-to-date. If we remove the impact of the PPP loans we originated that carry a 3.46% yield, our margin would improve by 22 basis points to 3.83% for the quarter and by 12 basis points to 3.96% year-to-date, which are in line with what we modeled at the end of the first quarter. During the quarter, noninterest income was consistent with that of our first quarter at $6.9 million and increased $1.8 million or 34.3% over the same quarter in the prior year. During the first six months, noninterest income increased $2.3 million or 20.6% over the prior year. Mortgage banking continued to be the largest driver of these increases. Second quarter gain on sale of mortgage loans was $1.4 million or 173.4% greater than during the linked quarter and $1.7 million or 307.4% greater than the second quarter of the previous year. Similarly, the year-to-date gain on sale of mortgage loans was $2.2 million or 248.5% higher than the previous year. During the quarter, we sold $91.5 million in mortgage loans at an average premium of 247 basis points compared to $35.4 million in the linked quarter and $27.9 million in the prior year. Year-to-date, we sold $126.8 million compared to $44.4 million in the previous year-to-date. Our mortgage pipeline remains very strong. The other significant driver of our noninterest income was swap fee income, which increased $426,000 or 126% from the linked quarter and $749,000 over the prior year's second quarter. Similarly, swap fee income was $1 million greater year-to-date compared to the same period in 2019. These increases continue to be fueled by the low interest rate environment and by more favorable pricing from our third-party swap debt, which we were able to negotiate late in the first quarter. We continue to be disciplined in controlling noninterest expense, which increased only 1.4% for the linked quarter and $2.9 million or 8.7% year-over-year. In both instances, the only significant fluctuation was in compensation expense, which centered on annual pay increases that go into effect each April, commissions attributable to increased mortgage loan activity, and overtime associated with commercial loan modifications and our participation in the SBA's PPP program. Our efficiency ratio was 61.7% compared to 60.7% for the linked quarter and 61.2% year-over-year. Excluding PPP loans, our loan portfolio increased $22.3 million during the second quarter and $56.4 million year-to-date. That equates to an annualized growth rate of 5.1% for the quarter and 13.2% year-to-date. Our growth came in every commercial category, our loan pipelines are strong, and we have $119.1 million in approved undrawn construction loans at June 30. While we continue to be pleased with our loan production across our footprint, it is difficult to project how our loan portfolio will grow until we begin to see some normalization in our markets. Our growth and essentially our entire portfolio comes from organic production. As I have outlined in prior calls, we have no exposure to nationally syndicated loans. We like knowing who our customers are and having the ability to work directly with our borrowers should conditions dictate. During last quarter's call, we addressed Civista's participation in the SBA PPP program. I can report that we originated nearly 2,300 loans for $257.6 million. This resulted in $9.8 million in deferred fees that will be earned over the lives of these loans. However, we are most proud of the fact that we were able to help nearly 2,300 small businesses throughout our footprint and over 36,000 employees that are employed by them. In regard to COVID-19 loan modifications, we took a very proactive approach to the first round of modifications. Essentially calling all of our loan clients that were in good standing, offering the deferral of interest and/or principal payments for 90 days. Year-to-date, we modified 723 commercial loans, totaling $417 million, which represents 25.6% of our commercial loan portfolio. We are meeting with all of these customers now to determine who will need an additional 90 days of relief. Based on our very preliminary discussions, we anticipate that approximately $150 million of our commercial loan portfolio will need some form of additional relief. We believe that we have greatly enhanced our credit underwriting over the last 10 years. Our loan portfolio is diversified throughout our footprint with none of our operating markets holding more than 25% of our assets. While we do have a concentration in commercial real estate, we do not believe that any single industry represents a significant concentration risk. As a percentage of total loans, net of our PPP loans, 7.05% of our portfolio is in guest lodging, 2.01% in restaurants, 2.75% in entertainment and recreation. In a broad sense, 18.91% of our portfolio is in retail with 4.07% of that being mixed retail office, 2.25% mixed retail residential, and the remaining 12.59% being strictly retail. We have no exposure to what we call big box retail. On the funding side, our deposits increased $390.5 million or 23.3% since the beginning of the year. While we saw increases in every deposit category, the most significant increases came in our demand accounts, where the proceeds from the PPP loans were deposited. In addition, over $85 million of our deposit growth came in personal checking and savings accounts. The increase in deposits allowed us to reduce our reliance on our FHLB advances by $101.5 million or 44.8% since December 31. In addition, we borrowed $183.7 million from the PPP liquidity facility to assist with funding the PPP loans originated during the quarter. These borrowings carry a low rate of 35 basis points and also provide for advantageous regulatory capital treatment of the PPP loans. Our nonperforming loans were $7.8 million at the end of the quarter, a 14.6% decline from year-end, which represented 0.28% of total assets. A ratio of allowance for loan losses to loans increased to 1.01% from year-end, which was 0.86%. And note that if we back out the PPP loans, this ratio would have been 1.16%. Our allowance for loan losses to nonperforming loans also increased to 262.13% at the end of the first quarter from 161.95% at the end of 2019. 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 to our model as our model dictates. Given the uncertainties associated with the COVID-19 and its impact on the economy, we did adjust the qualitative factors in our allowance for loan loss model. As a result, we have recorded a $3.5 million provision expense for the quarter and a $5.6 million provision expense for the year. As a reminder, we did meet the guidelines for the delayed implementation of CECL and will not be required to adopt it until 2023. In spite of the challenges of the current environment, we are pleased with another quarter fueled by solid core earnings. The COVID-19 pandemic continues to affect our nationwide economy in Ohio, which comprises most of our footprint. We were under a stay-at-home order for much of the second quarter. This presented challenges to many of our customers and the communities we serve. I am proud of the way Civista and our employees have met these challenges. I have received many notes of thanks for the way our employees were able to assist our customers as they navigated through the early weeks of the crisis and how we are continuing those efforts today. On March 19, due to the COVID-19 pandemic, we limited our branch lobby services to appointment only to help protect the safety of our employees and customers. After implementing a number of safety protocols to safeguard against the spread of the virus, we began reopening our lobbies for walk-in service during limited hours on June 15. Excluding our retail staff, we currently have approximately 60% of our employees working remotely. The COVID-19 situation remains fluid, and we will continue to monitor and assess the information provided by our local, state, and federal agencies as we make decisions on how best to operate going forward. While the next several months will continue to test the banking industry in the larger business world, we are well-positioned with a strong balance sheet, strong capital levels, and a diverse revenue stream. Thank you for your attention this afternoon, and now we'd be happy to address any questions you may have.

Operator, Operator

We will now begin the question-and-answer session. And the first question will come from Nick Cucharale with Piper Sandler.

Nicholas Cucharale, Analyst

So I wanted to make sure I understood the commentary on the loan modifications. It struck me that you guys were especially proactive with your borrowers, which contributed to the mid-20s deferral rates as a percentage of loans when you back out the PPP. Understanding the environment is uncertain, is your expectation that the $431 million number at June 30 comes down meaningfully in the near term?

Dennis Shaffer, President and CEO

Yes, I'll have Chuck elaborate a little. I believe I touched on that in my earlier comments. It's still quite early, as we completed most of those modifications by mid-April, so they are just now starting to take effect. We've run some projections based on that, which is the $150 million I mentioned. Chuck, would you like to add anything?

Charles Parcher, Chief Lending Officer

Nick, it's Chuck. We had all our lenders kind of go out and pull all the customers that took deferrals and obviously, they continue to come up, and we continue to look at those. But we're looking in that 10% range, as Dennis mentioned, that around $150 million. Even from that perspective, we moved a lot of them that took full payment deferral in the first piece to interest-only deferrals in the second piece. So when you think about that $150 million, I would tell you probably $95 million to $100 million of that's going to be interest-only with the other $50 million to $60 million being full principal and interest payment deferral.

Nicholas Cucharale, Analyst

Okay. Thank you for clarifying. So you guys had a big quarter for swap fees, as you mentioned in the prepared remarks. Has customer appetite continued since the end of the quarter?

Charles Parcher, Chief Lending Officer

Yes. I would tell you, customer appetite is still as strong. Based on the rate environment today, we have tried to widen those margins out some, Nick. We were doing a lot of stuff, pretty big rate reduction in that LIBOR plus 2.25%, 2.50% range. We've kind of moved those swap rates up to LIBOR plus 3.00% to 3.25%. It sort of helps save our margin. At the same time, we're also examining whether we're better off putting those on short-term swaps or putting some balances on the books as far as straight loans like a 4%, 5-year fixed or 7-year fixed as compared to that swap fees. So we're trying to blend that out, but the customer demand to go along is definitely there.

Dennis Shaffer, President and CEO

And Nick, we also have been successful in reinstituting some floors. We've been able to push that up a little bit. It's kind of gone away as rates have gone up. Now as rates are coming back down, we are implementing a few floors now, but when you widen the spreads and start to put floors in, I think it will slow some demand because all banks haven't adjusted to that. But we're getting our first look at deals.

Charles Parcher, Chief Lending Officer

This is Chuck again, Nick. The one thing that Dennis mentioned in his commentary, we did renegotiate our swap contract with our provider. So our cut of the swap fee is a little bit higher going forward.

Nicholas Cucharale, Analyst

Okay. Great. And then can you just help us think about how you're viewing expenses in the near term? And just given the operating environment, do you see any opportunity for some cost savings longer term?

Richard Dutton, Chief Operating Officer

Nick, this is Rich. I think the run rate of what we did this quarter, while maybe the composition of it might change a little bit, I think that's a pretty good number for the next quarter and probably the next two. What we're saving on travel, we're spending on janitorial services as we clean up after exposure to COVID and whatnot. But I think in terms of big-ticket items, I don't know that anything is going to change dramatically.

Dennis Shaffer, President and CEO

Yes, I believe it's going to become more challenging for banks in the future, especially with the lower interest rate environment we are entering. Our focus has always been on increasing revenue, and we will continue that effort. However, we also need to reassess some of our noninterest expenses, and we are ready to do so. Since we are still in the early stages of this situation, we will need to find ways to optimize both revenue and expenses moving forward.

Nicholas Cucharale, Analyst

That's very helpful. And then just lastly, I see you noted the settlement impacting the ATM interchange line. Do you have that amount by any chance?

Paul Stark, Chief Credit Officer

I'm sorry, could you ask me that question again, Nick?

Nicholas Cucharale, Analyst

Yes, there was a settlement that you mentioned in the earnings release just impacting the ATM interchange line. Do you have that amount?

Paul Stark, Chief Credit Officer

I do. It was $150,000.

Operator, Operator

Our next question will come from Michael Schiavone with KBW.

Michael Schiavone, Analyst

So can you guys tell us your thoughts on the deployment of the excess liquidity build in the quarter and the trajectory of the net interest margin for the remainder of the year?

Richard Dutton, Chief Operating Officer

In terms of excess liquidity, I don't know how familiar you are with our balance sheet and the tax program and how those funds flow in during the first half of the year and out in the second half. By June, we were down to just $50 million of tax funds regarding liquidity. We also drew approximately $180 million from the SBA's PPP loan facility, which is another significant liquidity component. I'm not sure if you're referring to something else. Regarding the margin, we indicated at the end of the last quarter that we anticipated about 30 basis points of compression, and excluding the PPP impact, that’s roughly what we experienced. We recorded 28 basis points of compression. Our balance sheet is quite asset-sensitive, and repricing occurs rapidly. As long as our loan team continues to effectively manage asset pricing, we believe we've handled the compression's impact. While it will keep contracting, it won't be as severe as it was in the second quarter.

Dennis Shaffer, President and CEO

We have a lot more assets that will reprice, and with the rate drop towards the end of the first quarter, a third of our portfolio will be affected. This will lead to some compression in the future, as noted earlier. Additionally, the PPP money was deposited into several of our accounts, but that will deplete over time. We've seen $87 million in personal deposit growth, which is likely influenced by the COVID-19 pandemic since people are not spending due to stay-at-home orders. In Ohio, personal spending decreased by approximately 6% to 8% this quarter, contributing to the increase in liquidity.

Michael Schiavone, Analyst

Okay. That's a lot of color. That's helpful. Can you also provide some color on the loan growth pipelines outside of PPP? And what you are expecting for the remainder of the year?

Dennis Shaffer, President and CEO

Chuck and Paul, I'll have Chuck Parcher, Chief Lending Officer; and Paul Stark, Chief Credit Officer, address that.

Paul Stark, Chief Credit Officer

Yes. Our pipeline stayed relatively strong throughout the entire time period, Mike. Obviously, we had a little bit of growth or quite a bit of growth in the commercial real estate bucket. We had quite a few projects that were taking place across, especially our metro regions, and those projects continue from a construction perspective. We're just talking about this morning, I think we only had one construction project that I'm aware of that actually got stopped during the whole COVID process. So those dollar amounts continue to fund out. Columbus has been a very hot market for us as far as from a construction area. There's still a lot of demand there, especially on the multifamily side, and a need for product. So we can see that to continue going forward. Obviously, like everybody else, we've kind of shut down the hotel lending and the restaurant lending, etc. But we still feel good about where our pipeline sits looking from here into the next few months anyway.

Dennis Shaffer, President and CEO

And we've got businesses that have flourished during this time. It's general logic; you have about half the businesses that struggle and half of them are just flourishing.

Paul Stark, Chief Credit Officer

Well, the unique thing about this cycle is the fact that every company is being impacted differently. And there's still a lot of liquidity in particular in investors, and they're moving forward. On the other hand, you've got some that are really struggling to recover from that business disruption and the revenue disruption. So we're looking at each of them separately, but it's amazing how strong parts of it remain.

Charles Parcher, Chief Lending Officer

I'll say the nice part, Mike, is as I was looking at some of the data, we're getting growth out of every marketplace, which feels really good. We're led a little bit by Columbus so far year-to-date, but we've got growth in Cleveland. We've got growth in that Southeast Indiana, Cincinnati market. And then we've got growth also in our legacy markets through the center of Ohio.

Operator, Operator

Our next question will be from Russell Gunther with D.A. Davidson.

Ryan Griffin, Analyst

This is Ryan on for Russell. I just had a quick question on the $9.8 million in deferred fees. Are you able to provide any thoughts on the recognition of the PPP fees throughout the next couple of quarters?

Richard Dutton, Chief Operating Officer

Yes. We think most of that will recognize most of that income as points from the forgiveness piece in the fourth quarter or first quarter of next year. We will take that in over 24 months. So I think it equates to about $400,000, maybe around $410,000 a month.

Dennis Shaffer, President and CEO

$410,000 a month.

Richard Dutton, Chief Operating Officer

So, but we think that most of that we'll recognize in the fourth quarter of this year or first quarter of next year. We expect the majority of that to be forgiven. Most of our loans, 80% of our loans had an average loan balance of around $120,000 or so. So there's been talk that anything under maybe $150,000 is a one-page forgiveness type application, some sort of easy process. So we do expect the bulk of those to be forgiven.

Ryan Griffin, Analyst

Got it. And then just one more on the retail portfolio. Just was curious how those conversations with borrowers have been going and any more detail you're able to provide on either the coverage ratios or LTVs there?

Dennis Shaffer, President and CEO

As far as growth or as far as asset quality?

Ryan Griffin, Analyst

As far as asset quality?

Dennis Shaffer, President and CEO

Okay. So as far as our retail portfolio, we don't have a large consumer portfolio, most of it is HELOCs and residential mortgages. We've been really pleased with the performance of the payment streams on the mortgage portfolio. Our deferrals are less than 100, and a lot of those are going back to payments. Now it will be interesting to see what happens when the unemployment benefits, the rich unemployment benefits phase out here pretty soon. But thus far, it's been less than 1% deferrals.

Operator, Operator

Our next question will come from Kevin Swanson with Hovde Group.

Kevin Swanson, Analyst

Just one follow-up here on the PPP. Remind me again, the percentage of non-clients you did with PPP. And then I guess the follow-up to that would be, how are you guys thinking about traction and keeping those clients with the bank? And what do you see as kind of an offensive move utilizing that program?

Paul Stark, Chief Credit Officer

Kevin, this is Paul. Regarding the origin of these customers, I would estimate that the vast majority of them were already our customers. We did accept some loans from non-customers as well, but we didn't specifically track that. Looking back, probably at least 80% were customers. We have been focusing on retention as well.

Charles Parcher, Chief Lending Officer

Yes, we've been working really hard on that. To be honest with you, Kevin, this is Chuck. And we put together a list of the target pieces. And I will tell you, even the non-customers that we took, the bulk of them were referrals from our sources, our accounting firms, our law firms, etc. They called us and said, 'Hey, you guys are doing this very successfully. We can't get these through the regionals. Can you take care of these clients for us.' Because we were able to do that, we generated quite a bit of goodwill across all our marketplaces. We've had quite a bit of success, right now, more so on the deposit side than the lending side, but we're working through very quickly. I just looked at one the other day; we just brought a new $4 million client in, based solely on our PPP work. We've got a lot of those opportunities bubbling up right now, then I probably have a little better idea of what those total numbers will be at the end of the third quarter, to be honest with you.

Dennis Shaffer, President and CEO

Kevin, the opportunities we're seeing with the deposit accounts being opened go beyond just the business deposit account. We've connected many of those clients with our retail managers and private bankers, and I've received numerous emails confirming that people are opening their personal checking, money market accounts, CDs, wealth accounts, and mortgage loans as a result. We've effectively identified these customers, and they have expressed great satisfaction with how smoothly we were able to assist them. We successfully got 87% of our clients through Round 1 of the PPP, a significantly high percentage compared to many banks. The feedback has been positive, and we have been able to leverage this success to strengthen relationships with both existing and new clients.

Charles Parcher, Chief Lending Officer

And I can't emphasize enough the amount of goodwill we generated with the referral bases. I mean they kept saying, 'Hey, we've got a client that we really need to get through this.' Even if we couldn't pick that client upfront right away, we built goodwill there. But we really built a lot of goodwill with all the accounting firms around the state.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Dennis Shaffer for any closing remarks.

Dennis Shaffer, President and CEO

Well, in closing, I just want to thank everyone for listening and thank those that participated in the call. Again, given the low interest rate environment and the fact that a lot of the economy was shut down for a good portion of the quarter, I was extremely, extremely pleased with our second quarter results. The balance of 2020, we know will continue to be a challenge. We do look forward to meeting that challenge and to talking to all of you again in a few months to share our third quarter results. So thank you for your time today.

Operator, Operator

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