Earnings Call Transcript - CIVB Q1 2022

Operator, Operator

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., which involve risks and uncertainties. Various factors could cause actual results to differ significantly from any future results mentioned in these statements. These factors are detailed in the company's SEC filings, available on the company's website. The company does not have any obligation to update forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to complement, but not replace, the most directly comparable GAAP measures. The press release available on the company's website also contains the financial and other quantitative information to be discussed today, including the reconciliation of GAAP to non-GAAP measures. This call will be recorded and accessible on the Civista Bancshares' website at www.civb.com. At the conclusion of Mr. Shaffer's remarks, he and his Civista management team will address any questions you may have. Now, I will turn the call over to Mr. Shaffer.

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 2022 Earnings Call. I am 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. This morning, we reported net income of $8.5 million or $0.57 per diluted share for the first quarter of 2022. These results include approximately $0.03 per share of expense related to our Comunibanc acquisition. While these deal costs contributed to the 16.2% decrease in our earnings per share when compared to the first quarter of 2021, the primary reason for the decline was lower mortgage production. During the first quarter of 2022, our net loans, exclusive of PPP, grew by $48 million or at an annualized growth rate of 10%. We continue to be on track with the Comunibanc transaction that was announced earlier this quarter. We view this as a low-risk transaction with significant upside that will expand our footprint into Northwest Ohio and the Toledo MSA and look forward to welcoming our new shareholders, employees, and customers into the Civista family. We expect this transaction to close at the end of the second quarter. We continue to be active in repurchasing common shares. During the quarter, we repurchased 183,357 shares at an average price of $24.17 per share. We continue to view share repurchases as an integral part of our capital management strategy. At March 31, 2022, we had $4.9 million remaining in our current repurchase authorization plan. Our return on average assets was 1.07% for the quarter compared to 1.47% for the linked quarter and our return on average equity was 9.89% for the quarter compared to 12.49% for the linked quarter. Now let's turn our attention to our performance for the quarter and for the year. As I stated, we were extremely pleased with our loan growth for the quarter. Excluding the impact of PPP loans, our loan portfolio grew by an annualized rate of 10%, this despite having $42.5 million in loan payoffs during the quarter. At the end of the quarter, we had $15.5 million in PPP loans remaining. Our strategy of originating PPP loans to only our customers and those referred to us by known referral sources resulted in no fraud to date in the PPP loans that we originated. We have just $583,000 in PPP fees remaining at quarter end, and anticipate the forgiveness process to be essentially complete by the end of the second quarter. Despite solid loan growth, our net interest income declined $391,000 or 1.7% from the linked quarter, primarily due to the increased interest expense related to our subordinated debt issuance in November and declined $896,000 or 3.8% year-over-year for the same reason. Our net interest margin for the quarter was 3.38% compared to 3.42% for the linked quarter. While accretion of PPP fees boosted our first quarter margin by 16 basis points, excess cash generated by our income tax processing program negatively impacted our first quarter margin by 23 basis points. We expect our margin to expand as the PPP loan process concludes and the liquidity generated by our tax programs subsides. Assuming interest rates continue to increase, our asset-sensitive balance sheet should yield further expansion of our margins. During the quarter, non-interest income increased $832,000 or 12.2% in comparison to the fourth quarter of 2021 and declined $1.5 million or 16.8% year-over-year. The primary driver of the increase over our linked quarter was our income tax refund processing program, which 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. Service charge revenue declined by $234,000 or 12.9% compared to our linked quarter and showed an increase of $323,000 or 25.7% over our first quarter of last year. Decline in service charges for the linked quarter is due to the timing of when service charges were earned on tax program-related accounts. These charges are related to services we provide to the tax software providers. The service charges associated with this business were around $270,000 in the fourth quarter of 2021 and were $156,000 during the first quarter of 2022. These fees are charged annually and are typically charged late in the year. Interchange fees at $1.1 million were consistent with our linked quarter and that of the prior year. Mortgage banking continues to be a significant contributor to our non-interest income. However, like much of the industry, Civista experienced a decline in mortgage loan originations as interest rates increased in inventory of homes available for the purchase continued to be tight. First quarter gains on the sale of mortgage loans were $936,000, a decline of 36.2% from our linked quarter, which was $1.5 million and a 66% decline from the prior year, which was $2.7 million. We sold $38.2 million in mortgage loans during the first quarter of 2022 compared to $54.8 million during the linked quarter. The average premium recognized on the sale of loans declined 23 basis points from 2.68% to 2.45% compared to the linked quarter. Wealth management revenue of $1.3 million was consistent with that of the linked quarter and an increase of $131,000 or 11.4% over the prior year as gains in new accounts were offset by declines in the overall market. We continue to view the expansion of these services across our entire footprint as an opportunity to diversify and grow non-interest income. Non-interest expense increased $1.1 million or 5.6% year-over-year, which was primarily attributable to annual compensation increases that go into effect each April. Additionally, non-interest expense increased $3.1 million or 18% compared to the linked quarter as a result of increases in compensation expense, data processing, marketing, and professional fees related to our Comunibanc transaction. Compensation expense, which increased $2.1 million accounted for the largest portion of the linked quarter increase in non-interest expense. Payroll taxes are typically higher in the first quarter and increased $411,000 from the linked quarter. Similarly, contributions to our employees' 401(k) are higher in the first quarter and increased $104,000. Health insurance and incentive expense also increased over the linked quarter by $604,000 and $647,000, respectively, as we trued up accruals at year end and then resumed our normal accrual levels in the first quarter of this year. Data processing expense increased $257,000 over the linked quarter due to $215,000 in conversion fees associated with the pending Comunibanc acquisition. Professional fees increased $589,000 over the linked quarter due to $268,000 in legal and investment banking fees associated with our pending Comunibanc acquisition. In addition to acquisition-related professional fees, $91,000 of the linked quarter increase in professional fees was the result of reversing accruals at the end of the prior year to bring them in line with our actual expense. The legal close of our Comunibanc transaction planned for the end of the second quarter and the system conversion scheduled for October, we anticipate recording most of the additional deal costs during the second and third quarters. Marketing expense increased $214,000 over the linked quarter, which was directly attributable to reversing our accrual by $214,000 in the fourth quarter to bring our budgeted marketing expense in line with our actual marketing expense. Our efficiency ratio was 65.2% compared to 56.2% for the linked quarter and 57.4% year-over-year. If we had adjusted for one-time deal costs, our first quarter efficiency ratio would have been 63.7%. Turning our focus to the balance sheet. During the first quarter, our total loans grew by $20.3 million. Backing out $27.7 million of PPP loans forgiven during the first quarter, our loan portfolio grew organically by $48 million or at an annualized rate of 10%. While non-owner-occupied CRE loans led the way, we had good demand in owner-occupied CRE, residential real estate, and residential construction loans in every market across our footprint. Along with strong first-quarter loan production, our undrawn construction lines ended the quarter at $120.2 million, giving us confidence that we will grow our own portfolio at a mid-single-digit rate for 2022. As I stated earlier, mortgage loan production is down. However, we are optimistic that our pipeline is solid with very few refinances. We are seeing a lot of pre-approvals, but unfortunately not enough inventory to keep up with the demand. On the funding side, total deposits increased $198.4 million or 8.2% since the beginning of the year. Increases in balances related to our income tax processing program of $199 million made up virtually all of this increase, although we did see some movement from time deposits into money market and interest-bearing demand accounts. Non-interest bearing demand accounts continue to be a focus, making up 37.6% of our total deposits at March 31 as we continue to attract the operating accounts of our business customers. Turning to asset quality. The segment with the largest number of criticized loans remains hotels and lodging. At the end of the quarter, total criticized hotel and lodging loans were $48.6 million. Most of these operators have experienced increased occupancy from leisure travel during the last four quarters. Despite the lingering effects of COVID on business travel, we anticipate continued leisure demand going forward, resulting in further reduction in our criticized portfolio. While there continue to be uncertainties associated with the economy, we continue to see improvement throughout our footprint in our customers' financial positions. As a result, we did make a $300,000 provision during the quarter, primarily attributable to growth in our loan portfolio rather than economic stress. In addition, we realized $92,000 in net recoveries during the quarter. The ratio of our allowance for loan losses to loans was 1.34% at quarter end compared to 1.33% at year end 2021. Our allowance for loan losses to non-performing loans also improved to 501.5% at the end of the quarter, up from 496.1% at the end of 2021. As a reminder, Civista met the guidelines for the delayed implementation of CECL and are on track to adopt the new allowance methodology beginning in 2023. The anticipation of a higher interest rate environment and the pressure it has had on the bond market resulted in a $29.5 million decline from December 31, 2021 to the end of the quarter in other comprehensive income related to our investment portfolio. As a result, we ended the quarter with tangible common equity of 7.85% compared to 9.25% at December 31, 2021. We continue to be comfortable with the credit quality and duration of our security portfolio at the end of the quarter. We continue to create capital through earnings. Our overall goal is to have adequate capital to support our organic growth and potential acquisitions. Two important parts of our capital management strategy continue to be the payment of dividends and share repurchases. We continue to believe our stock is a value and, as previously discussed, have taken advantage of the recent market conditions to remain active in repurchasing shares. As I indicated earlier, we continue to be on track to close our transaction with Comunibanc and their subsidiary, The Henry County Bank. Members of both companies have been meeting in anticipation of legally closing the transaction at the end of June and successfully integrating our systems in October. We look forward to welcoming their shareholders and customers to our Civista family as we grow into Northwestern Ohio and the Greater Toledo MSA. In summary, despite some of the noise in our numbers, we are pleased with another quarter of solid earnings, continued loan growth and solid credit quality. Despite economic and geopolitical uncertainties we are all facing and their impact on our local and larger economies, we remain optimistic. Businesses across our footprint continue to have strong balance sheets. Our loan pipelines are solid and we are well on our way to the successful integration of The Henry County Bank into the Civista family. Thank you for your attention this afternoon. And now we will be happy to address any questions that you may have.

Operator, Operator

We will now start the question-and-answer session. The first question comes from Terry McEvoy with Stephens. Please go ahead.

Terry McEvoy, Analyst

Thanks. Good afternoon, everybody.

Dennis Shaffer, President and CEO

Hi, Terry.

Richard Dutton, SVP & COO

Hi, Terry.

Terry McEvoy, Analyst

Maybe first question, if we kind of exclude PPP and then the tax refund deposits, could you just talk about the core net interest margin trend as short-term interest rates go higher, and what percentage of the portfolio is variable rate? It will help us kind of understand the impact on a core basis of rising rates.

Richard Dutton, SVP & COO

Terry, this is Rich. I'll go through the analysis from the last couple of quarters. We reported a 3.38% margin, of which about 16 basis points were due to PPP. Excluding that would have lowered the margin. Additionally, 23 basis points were linked to the liquidity generated from the tax program. Considering all of that, I would estimate a normalized margin for Civista for Q1 was 3.45%. This is not too different from the number we shared at the end of last quarter and may reflect a fair amount of expansion. Is that better, Terry?

Terry McEvoy, Analyst

Yes, that's better.

Richard Dutton, SVP & COO

Okay. I didn't say any important numbers anyway.

Terry McEvoy, Analyst

No, I can hear you.

Richard Dutton, SVP & COO

Our model suggests that for every quarter basis point increase in short-term rates, our margin will grow by approximately 5.5 basis points.

Dennis Shaffer, President and CEO

About a third of the portfolio, specifically 33%, will adjust every 30 days or less.

Terry McEvoy, Analyst

Perfect.

Dennis Shaffer, President and CEO

And then it's 39%. If you add another 6%, adjusts in a year or less.

Terry McEvoy, Analyst

Okay, thank you for that. And then maybe if I follow up, are there parts of the portfolio you're just watching a bit closer given inflation and supply chain issues? And maybe how have you thought about the impact of higher rates on your non-owner occupied CRE customers?

Dennis Shaffer, President and CEO

We are monitoring the situation, especially the hotel portfolio, which we believe is performing well since it primarily caters to leisure travel rather than business travel. Therefore, we are paying particular attention to that segment. Overall, we are examining our portfolio in relation to potential interest rate increases, but we do not identify any specific areas as being at risk. I have been closely monitoring our lines of credit to see if there have been any significant draws. To date, we have not observed any major draws on our operating lines of credit; in fact, they have decreased slightly, with our utilization around 33%.

Richard Dutton, SVP & COO

As part of our underwriting process, we do analyze the interest rate. We underwrite at the actual rate and also conduct a stress analysis.

Terry McEvoy, Analyst

That's great. Thank you, guys.

Dennis Shaffer, President and CEO

Thanks, Terry.

Operator, Operator

The next question comes from Ben Gerlinger with Hovde Group. Please go ahead.

Ben Gerlinger, Analyst

Hi. Good afternoon, everyone.

Dennis Shaffer, President and CEO

Hi, Ben.

Ben Gerlinger, Analyst

From a high-level perspective regarding your clients, it appears that global economics are experiencing a slight slowdown and inflation is rising. However, from a more direct viewpoint, what concerns are your clients facing and what challenges are they addressing? How do these issues relate to loan demand?

Charles Parcher, SVP & Chief Lending Officer

Ben, this is Chuck. I believe there's concern mainly about the supply chain and labor issues, especially in terms of acquiring and retaining staff. The labor market is challenging right now, and inflation is currently a significant factor. Interestingly, some distributors we work with have retailers eager for products. As long as they can receive the product, they can sell it at nearly any price. While there are concerns, many of our clients are performing well and feel confident they will manage these challenges effectively.

Ben Gerlinger, Analyst

Got you. That's helpful. And then when you think about the expense, I know the closing is set 2Q. When you think about a core, do you have anything in mind for the latter half of the year, or any investments that might increase it over time that we're not necessarily seeing in today's numbers?

Dennis Shaffer, President and CEO

I'll let Rich answer that. If you remember, the increase in the expense number was largely due to accruals and some acquisition-related costs. Rich, would you like to provide a clearer figure on that?

Richard Dutton, SVP & COO

Yes. So, Ben, I think a good run rate for you guys to use going forward is probably $20.5 million on the non-interest expense. Remember, we've got annual increases that go into effect April 1 for our folks. That's probably the big thing that you haven't seen yet. But other than that, I don't know if we've got any significant investments other than the lumpiness that we've generated from The Henry County acquisition. But I think what we've got in terms of a run rate, what you see is what you get I guess is what I'm saying.

Ben Gerlinger, Analyst

Okay, that's helpful. I appreciate it.

Operator, Operator

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

Michael Perito, Analyst

Hi. Good afternoon, guys.

Dennis Shaffer, President and CEO

Hi, Mike.

Michael Perito, Analyst

Thank you for taking the questions. I wanted to start by asking about non-interest income. I may have missed this earlier, but there seem to be several factors at play. I heard you mention some of them in your comments. Are we correct to expect that we'll be around the mid 6 range? Additionally, will the deal influence this once it's finalized, or do you have a different perspective on it, Rich?

Richard Dutton, SVP & COO

I think that's a good position. If you look back, the tax program fees were 1.9 million for this quarter. We'll see another 0.5 million in the second quarter, bringing the total to 2.9 million. We're expecting around 1 million in the second quarter. Other than that, our forecast for mortgage fees is as reliable as anyone else's. However, the rest of the data suggests that modeling around 6 or 6.5 is reasonable.

Michael Perito, Analyst

How do you view the customer mindset? It seems you have a clear perspective on the near-term loan outlook. As we approach the latter half of the year, what is your confidence level regarding loan growth and budgeting, especially considering that rates are expected to increase by 100 basis points by mid-year? I'm interested in your thoughts on growth for the second half of the year based on the current consensus outlook.

Charles Parcher, SVP & Chief Lending Officer

Mike, this is Chuck. I previously mentioned that we aimed for mid single digits for the year, and I still believe that projection looks solid. We surpassed that in the first quarter, and our pipeline is very robust at the moment. In fact, the deals we're currently reviewing are likely at record levels. While interest rates are slightly impacting the amount of funds some can generate from projects due to cash flow concerns, we haven't seen a significant drop in demand. Based on conversations with our customers, cities like Columbus are thriving, and we're experiencing strong growth in Cleveland and the Cincinnati area as well. We don't anticipate any of these cities slowing down too much. We're also optimistic about demand from Toledo following our acquisition. Overall, I feel positive about demand right now. I’ll provide an update in 90 days regarding any impact from rising rates, but for now, the outlook appears strong.

Dennis Shaffer, President and CEO

And we're hoping to add another lender too. We had budgeted just ourselves in Columbus, because we are expanding with another office in Gahanna, Ohio, New Albany area, which is really close to where Intel is starting to make their investment. And also in the Toledo market, we already had that budget, we're still moving forward with that, because we think The Henry County Bank acquisition will be a platform for us to do some lending there. And with Chuck's background, having spent almost his entire banking career in Toledo, we just think there's opportunity there as well. So we still feel pretty bullish on hitting that mid-single-digit number and continuing to do that over the next couple of quarters just with that and the things that Chuck mentioned.

Richard Dutton, SVP & COO

Mike, before I let you go, the tax income in the second quarter will be $0.5 million, which is exactly the same as it was last year.

Michael Perito, Analyst

So a better number. Thank you, guys.

Operator, Operator

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

Nick Cucharale, Analyst

Good afternoon, everyone. How are you?

Dennis Shaffer, President and CEO

Hi, Nick. Good.

Richard Dutton, SVP & COO

Hi, Nick.

Nick Cucharale, Analyst

Just to follow up on your commentary with respect to the buyback in light of the reduction to tangible book value, given the FCI mark this quarter, do you see any change to your anticipated level of repurchase or capital deployment more broadly?

Dennis Shaffer, President and CEO

No, I think we'll continue to be active with the buyback. As the market is down, we're buying it at a lower price. We have a target level that we set, and I believe that will remain consistent. We see it as a great way to deploy our capital, and we will continue to be active in that area.

Nick Cucharale, Analyst

Can you share with us where new loan yields are coming on relative to the portfolio, Rich?

Richard Dutton, SVP & COO

That's a great question. From that perspective, Nick, I think that's the hardest thing in banking right now is trying to price these loans as the rates are bouncing around. But I will tell you they're coming out a little bit higher, probably in the, I'd say, 4.75% range of new stuff, give or take, on a five year. We're starting to obviously quote some rates over 5 now, and we've got some still to close that are in the pipeline that are probably in the mid to lower 4s. But I would tell you, probably a good number is 4.75% right now, and then we'll continue to push that up as the back end of the five and 10-year yields get pressed up.

Nick Cucharale, Analyst

I wanted to ask about the loan growth guidance. You are projecting mid-single digits, and while the first quarter usually sees a slight slowdown, you mentioned a 10% annualized pace. Is the mid-single-digit guidance a reflection of some caution regarding the second half of the year?

Charles Parcher, SVP & Chief Lending Officer

Yes, sure. The nice part is, Nick, as I looked at the numbers, it grew 48 million this year. In the first quarter last year, we went backwards 26.5 million. And you're right. Usually the first quarter is relatively soft. So we're really excited about that growth box. I will tell you, we may press it up a little bit. I'd like to get through another quarter to make sure demand stays where it's at. But where we're at right now, the trajectory it's on is pretty good.

Dennis Shaffer, President and CEO

Yes, I think we are being a little cautious because we hear discussions about seven, eight, or nine rate hikes. I believe that will eventually slow things down a bit. However, we have had a fantastic start with our loan portfolio and the loan growth we experienced in the first quarter. Typically, we go backwards during that first quarter, and last year was no exception. So we are really pleased with our loan growth for the quarter.

Nick Cucharale, Analyst

All right, very helpful. Thank you for taking my questions.

Operator, Operator

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

Russell Gunther, Analyst

Hi. Good afternoon, guys.

Dennis Shaffer, President and CEO

Hi, Russell.

Richard Dutton, SVP & COO

Hi, Russell.

Russell Gunther, Analyst

Hi. Circling back to the margin discussion, I appreciate your thoughts on what every 25 basis point move means. Could you let us know what you're expecting from a deposit data assumption in that 5.5 basis points, and maybe what you're thinking about first 100 versus next 100?

Richard Dutton, SVP & COO

I think it's quite clear that we are lagging behind. Our non-mature deposit betas are just under 13 basis points, which aligns with our modeling. Over the years, as you know, we tend to be quite aggressive when rates decline. In the last cycle, we were among the last to increase rates, and we never fully recovered. It's important to note that a significant portion, 37%, of our deposits are in non-interest DDA, which certainly helps.

Dennis Shaffer, President and CEO

The operating accounts of our commercial customers are not very sensitive to rates and are stable. We have established strong connections with treasury services. I may not be fully addressing your question, but I believe this reflects a favorable deposit beta for us. Ultimately, it will depend on the speed and magnitude of the rate increases. We tend to be among the last to respond as rates rise on the deposit side.

Russell Gunther, Analyst

I appreciate it, guys. Thank you both. Another question I had was just on the tax processing program and related revenue. I appreciate the look into next quarter. Just remind us what type of line of sight you have into future revenue there as we look out a year, maybe even two?

Richard Dutton, SVP & COO

Our agreement remains unchanged. It is a three-year rolling contract reviewed at the end of each tax season, typically in the latter part of the year. After our partners complete their marketing efforts, we determine the expected revenues for the following year and extend the contract by another year. Over the past two years, our revenue has remained the same. I cannot predict what it will be for next year, but I will have a better idea later in the year. We will be engaged in this business for at least two more years, possibly three.

Russell Gunther, Analyst

That's a helpful reminder. Thank you. And then the last one for me, guys. You've described the pending transaction as a low-risk deal. Just curious as to continued appetite for M&A here and just any general color on pace of conversations and what you'd be interested in?

Dennis Shaffer, President and CEO

Much of our situation relies on our stock price, which we believe is currently undervalued. However, we are actively pursuing our calling efforts and have established strong relationships that focus on banks with assets between $300 million and $1 billion. This range seems ideal for us, as there is likely less competition for banks around the $500 million mark. Larger players with assets in the $7 billion to $9 billion range generally overlook these smaller institutions. We aim to continue growing, which helps balance our expenses and enhances our efficiency as a company. We've successfully integrated past acquisitions from a cultural perspective, such as our last acquisition in late 2018, where we gained 45% deposit market share in Ripley and Dearborn counties in Southeastern Indiana, located about 3.5 hours from our headquarters. Our market presence has expanded since then, and we have not lost ground; rather, we've increased our deposit market share. We believe we can integrate future deals effectively, decentralize some functions, and maintain our commitment to growth and relationship-building.

Russell Gunther, Analyst

I appreciate it, guys. Thank you for taking my questions.

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 joining us today and for those that also participated on today's call, and again look forward to updating you again in a few months to share our second-quarter results. So thank you for your time today.

Operator, Operator

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