Earnings Call Transcript - CIVB Q2 2024

Operator, Operator

Before we begin, I would like to remind you that this conference call may contain forward-looking statements with respect to the future performance and financial condition of Civista Bancshares, Inc., that involve 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, also available on the company's website, contains the financial and other quantitative information to be discussed today, as well as the reconciliation of the GAAP to non-GAAP measures. This call will be recorded and made available on Civista Bancshares' website at www.civb.com. At the conclusion of Mr. Shaffer's remarks, he and the Civista management will take 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, Inc. Thank you for joining us for our second quarter 2024 earnings call. I'm accompanied 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; Ian Whinnem, SVP of the company and Chief Financial Officer of the bank, along with other members of our executive team. This morning, we reported net income for the second quarter of $7.1 million or $0.45 per diluted share, reflecting a $700,000 or 10% increase over the first quarter of 2024 and a decline of $3 million from our second quarter in 2023. Overall, I am pleased with our quarterly results. As I noted during our first quarter call, this is a year of transition for Civista as we aim to replace the revenue and noninterest-bearing funding from the exited relationship with our income tax refund processor. Following the exit from this relationship, our overnight borrowings and broker deposits have risen due to strong loan demand, which is higher than we would prefer. This increased funding cost continues to pressure our net interest margin. To alleviate some of this pressure, we are implementing several deposit initiatives aimed at strengthening relationships and attracting newer low-cost deposits. These initiatives will take time but should reduce our dependence on higher interest funding sources and overall costs. I was also encouraged by our disciplined approach in pricing our deposits, which allowed us to lower our cost of deposits by 4 basis points to 210 basis points during the quarter, despite the highly competitive environment. Our ability to remain disciplined is commendable, especially as we observe a trend of moving from noninterest-bearing deposit products to interest-bearing money market and time deposits. Loan demand remains strong across our markets, with our loan and lease portfolio experiencing an annualized growth rate of 16% during the quarter, reflecting the persistent strength of our markets and organization. We have focused on maintaining higher loan rates to ensure appropriate returns on our liquidity and capital. For the quarter, our overall cost of funding rose by 6 basis points to 2.61%, while our yield on earning assets fell by 7 basis points to 5.58% as we retained more residential mortgages and leaned on wholesale funding. Consequently, our margin contracted by 13 basis points compared to the first quarter, settling at 3.09% for the quarter. Additionally, we saw an increase in our allowance for credit losses primarily due to strong loan growth, which included a $500,000 charge-off linked to a fraud-related incident involving one of our clients. We also announced a quarterly dividend of $0.16 per share, unchanged from the prior quarter. Based on our July 26 share price of $18.98, this equates to a 3.37% yield and a dividend payout ratio of 35.6% for the second quarter. Noninterest income for the quarter rose by $2 million or 24% from the first quarter and $1.3 million or 15% from the second quarter of 2023. The key contributors to the linked quarter increase were $1.7 million in fees from leasing operations, partially offset by a decline in service charges following changes last year in overdraft processing. The rise in income from the prior year second quarter was primarily driven by leasing fees and higher wealth management fees, exceeding the $475,000 loss in tax refund processing fees. Noninterest expense for the quarter was $28.6 million, an increase of $866,000 or 3.1% over the first quarter, driven mainly by annual merit increases effective in April. The decrease in equipment expenses was mainly due to reduced depreciation from maturing operating leases. Compared to the previous year’s first quarter, noninterest expenses rose by $906,000 or 3.3%, resulting from annual merit increases and software expenses tied to our digital banking platform. Our efficiency ratio for the quarter was 73.4%, which remains high due to the compression of net interest income and costs tied to leasing depreciation and digital banking investments. Our effective tax rate was 12.6%. Shifting to our balance sheet, total loans and leases grew by $116.9 million during the quarter, indicating an annualized growth rate of 16%. We saw increases in most loan categories, particularly in nonowner-occupied commercial real estate loans, residential real estate loans, and real estate construction loans. Our originated loans continue to predominantly be adjustable rate, and our leases have maturities of 5 years or less. During the quarter, renewed commercial loans were originated at an average rate of 8.20%, residential real estate loans at 6.64%, and leases by our division at an average rate of 9.75%. Loans secured by office buildings represent 5.1% of our total loan portfolio, secured mainly by low-rise offices outside central business districts. Alongside our year-to-date loan production, our pipelines are robust with undrawn construction lines totaling $273 million at June 30. We project low single-digit loan growth for the rest of 2024. On the funding side, total deposits remained stable, declining only $3 million for the quarter. As mentioned, we are pursuing several initiatives to attract core funding. One initiative involves a new program for the State of Ohio called the Ohio Homebuyers Plus program, designed to incentivize savings among residents for home purchases by offering tax incentives to depositors and subsidizing banks. The state is set to deposit up to $100 million in low-cost funds at a rate of 86 basis points into participating banks. By the end of the quarter, we had opened 411 accounts as part of this program, with a goal of 1,000. Another initiative involves keeping cash balances for our wealth management clients at our bank, enabling us to maintain more deposits with anticipated rates slightly below 20 or 25 basis points. We expect to transition $75 million of those funds into the bank by the end of the third quarter. We are also taking a measured approach to reduce rates on some higher-tiered demand deposit accounts and CD specials. Consequently, our cost of interest-bearing deposits fell by 5 basis points to 2.75% during the quarter. Our deposit base remains granular, with an average account size, excluding CDs, around $18,000. Noninterest-bearing business operating accounts and deposits are a key focus, representing 37% of total deposits at June 30. Concerning FDIC insured deposits, excluding Civista's own accounts and those related to the tax program, 11.8% or $352 million of our deposits exceeded the FDIC limit at quarter end. Our cash and unpledged securities at June 30 stood at $456.8 million, covering these uninsured deposits. Besides $404.6 million in public funds across various municipalities, we had no significant deposit concentrations at June 30. Our loan to deposit ratio remained elevated, with commercial lenders, treasury management officers, and private bankers actively securing additional deposits and compensating balances. This success stems from ongoing initiatives, and we are exploring new tools for our sales teams to enhance these efforts. We view our low-cost deposit franchise as a critical asset, significantly contributing to our strong net interest margin and overall profitability. The interest rate environment continues to strain bond portfolios. As of June 30, all our securities were classified as available for sale, recording $63.2 million in unrealized losses, an increase of $8.6 million since December 31, 2023, consistent with the preceding quarter. Our securities portfolio was valued at $612 million, making up 15% of our balance sheet, and combined with cash balances, constituted 22.5% of our deposits. We ended the quarter with a Tier 1 leverage ratio of 8.59%, classified as well capitalized for regulatory purposes. Our tangible common equity ratio stood at 6.18% at June 30, slightly down from 6.28% at March 31, 2024. Civista's earnings continue to build capital, and we aim to maintain sufficient capital for organic growth and potential acquisitions. While we did not repurchase shares this quarter, we still believe our stock presents a value. Despite strong capital levels, we recognize that our tangible common equity ratio is low. Our previous guidance indicates that we aim to restore our TCE ratio to between 7% and 7.5%. We will maintain a focus on earnings while balancing any share repurchases and dividend payments with capital growth. Despite uncertainties in the economy and the pressures faced by our borrowers, our credit quality remains robust, and our credit metrics are stable. We did make a $1.7 million provision this quarter, primarily tied to financing loan growth and a charge-off connected to a fraud incident involving a commercial borrower. Our allowance for credit losses to total loans was 1.32% at June 30, reflecting a 2 basis point increase from 1.30% at December 31, 2023, due to the mix of new loans and quarterly update factors. Furthermore, our allowance for credit losses to nonperforming loans was 225% at June 30, 2024, down from 247% at March 31, 2024, and 246% at December 31, 2023. The increase in nonperforming loans included $1.5 million linked to the previously mentioned fraud incident. In summary, we are encouraged that our margin compression has slowed, and our margin remains strong as we take steps to secure more lower-cost funding. We expect low single-digit loan growth throughout the remainder of 2024 as we temper our pace with lower-cost funding. Although we face isolated credit issues, we have not observed any systemic decline in our credit quality. Overall, Civista continues to generate solid earnings, and our focus remains on creating shareholder value and serving our customers and communities. Thank you for your attention this afternoon and your investment, and we are now ready to address any questions you may have.

Operator, Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from Justin Crowley with Piper Sandler. Your line is now open.

Justin Crowley, Analyst

Hey, good morning, guys, or afternoon, rather. I wanted to start off on the leasing business. Obviously, a pretty impressive quarter here. And I think you guys have won in the past results here could be a bit lumpy. I wanted to see if you could unpack what drove some of the strength this quarter. If there's anything about pull forward in revenues? Or how you're thinking about that business going forward here?

Dennis Shaffer, President and CEO

Can you repeat the question again, Justin?

Justin Crowley, Analyst

Yes. It was just on the leasing business, just given the strong results for the quarter. I'm just curious if any of that revenue was pulled forward from later in the year? Or what's the best way to think about run rate there is.

Dennis Shaffer, President and CEO

Well, I think we'll continue to see continued success within that division, the residual and the renewal revenue that you see, I think, is in leasing is lumpy as we continue to learn about that business. It's just right now, I think it's hard to predict that revenue as it can be inconsistent and quarter-to-quarter, they usually the second half of the year is a little bit stronger, but we're really happy with Civista's leasing and finance group.

Richard Dutton, SVP and COO

Justin, this is Rich. The residual income is what makes it unpredictable. As Dennis mentioned, we can't predict when equipment will be bought out at the end of the lease. Traditionally, we've taken a conservative approach to pricing and valuation. Generally, this results in gains, and we rarely experience losses. However, I’ve spoken with many other bankers and leasing company owners, and I'm unsure how to project or forecast that aspect of our revenue.

Justin Crowley, Analyst

Okay. In terms of setting a reasonable expectation for the second half of the year, even though this period is usually seasonally stronger, does it seem that what we experienced this quarter was an exception rather than a trend we can rely on moving forward? I understand predicting this is challenging, but perhaps fees will be around $9 million.

Richard Dutton, SVP and COO

Yes. If you exclude the residual component, I would say that is likely indicative of what we might see in the future. However, I don’t have the information on the residual portion for the quarter with me, but I can retrieve it for you.

Justin Crowley, Analyst

Okay. Got you. That would be helpful. And then I guess just on the expense side of things, nothing seems to jump out as far as the quarter goes, but just thinking about run rate here. What we saw in the quarter, are you making any investments anywhere? Or what's the best way to think about costs moving ahead?

Richard Dutton, SVP and COO

So I think we got into $28.4 million last time. We came pretty close. And I would think that a good run rate for the rest of the year, the way we model it out is $28.3 million. So just about where we've been, maybe a little bit better. But I don't think we've envisioned any significant investments in any software or hardware or anything else for the balance of this year.

Justin Crowley, Analyst

Okay. I appreciate that. And then just stepping back here for a second. Acquisitions have certainly played a role over the years. And you've been pretty clear that M&A will be a part of the growth plan going forward. Curious as we sit here today, after some signs of life across the industry, what's your updated thinking on acquisitions, including what hurdles may still exist from a Civista standpoint, capital levels, et cetera, or whatever else do you look at?

Dennis Shaffer, President and CEO

Well, we'll continue to look for opportunities, as we've said really since the second half of last year and this first half of this year, we've really been focused on building capital up and so it's been tough to do any type of M&A activities. But I think with the recent movement in stock prices, particularly for publicly traded companies, the banks, we've seen a nice lift over the last three or four weeks in our stock price. Banks privately held banks, banks basically under maybe $2 billion in assets. They haven't seen that same lift. So that's something I think we can point to as we continue to have dialogue with some of our targets and say, look, we're starting to see some lift and hopefully that continues. But I think that may spur a little bit more conversations anyways. The math up to this point has been very tough to do. But we're going to continue to be opportunistic. And if we see something that's the right fit for Civista, we're not going to shy away from that.

Justin Crowley, Analyst

Understood. I’ll leave it there. Thanks for taking the questions.

Dennis Shaffer, President and CEO

Yes, Justin.

Operator, Operator

Your next question comes from Brendan Nosal with Hovde Group. Your line is now open.

Brendan Nosal, Analyst

Hi, good afternoon, folks. I hope you are well.

Dennis Shaffer, President and CEO

Hi, Brendan.

Brendan Nosal, Analyst

You're going have to folks will be doing well. I just want to start off here just on the Ohio banking environment. Obviously, a pretty big deal announced in your deck in the woods on Friday. I know that it's early days following that. But just wondering what the initial playbook is for Civista to potentially capture talent and clients. And then specifically on talent adds, where in the bank you most like to take advantage of that dislocation.

Dennis Shaffer, President and CEO

Yes, disruption can be beneficial for us. We recognize that Premier had a significant presence in Northwest Ohio, and we acquired a bank in that region about two years ago. We believe this disruption could provide advantages in Northwest Ohio, particularly with potential talent becoming available. This area stands out to us due to their strong presence, especially around the Defiance area, indicating opportunities for growth. While there are other markets where we compete, their presence in those areas, like Youngstown, was not substantial, and their Cleveland branch presence was minimal. Nonetheless, we anticipate opportunities arising there as well, with regards to both people and customers.

Brendan Nosal, Analyst

Got it. Got it. Thanks for the color there. Okay. One more for me before I step back. Just kind of curious what drove the decline in loan and overall earning asset yields this quarter versus the prior quarter? And then I guess, more broadly on the margin as that filters through, what trend are you expecting to see in the margin in the back half of the year? Thanks.

Dennis Shaffer, President and CEO

We believe things are starting to stabilize a bit, and we're beginning to notice some signs of that. The decline in earning assets was partly due to us adding more portfolio residential loans to our balance sheet, which we originated in the second quarter. We have a significant amount of these loans on our balance sheet for a few reasons. Firstly, we expect interest rates to decrease, which should also lower mortgage rates. If they drop by about 0.5%, we believe we can refinance some of these mortgages into fixed-rate salable products, leading to gains that would enhance our income. Moreover, most of the loans we added to our portfolio are residential construction loans, and there isn't really a saleable product for those. Therefore, we are targeting a number of physicians and high-net-worth borrowers, as we believe that by offering them mortgage loans, we can attract their deposit business. If rates decline, we anticipate we can remove these loans from our balance sheet while still being their primary bank due to their deposits. We're planning to slow this process a bit, as it does put pressure on our borrowings and affects earning asset yields. However, we remain optimistic that moving forward, our margin will begin to stabilize.

Brendan Nosal, Analyst

Okay. Very good. Thank you for taking the question. Appreciate it.

Operator, Operator

Your next question comes from Terry McEvoy with Stephens. Your line is now open.

Terry McEvoy, Analyst

Hi, good afternoon, everybody.

Dennis Shaffer, President and CEO

Hi, Terry.

Richard Dutton, SVP and COO

Hi, Terry.

Terry McEvoy, Analyst

Hi, good afternoon. Wondering if you could talk about what you're seeing in the nonowner-occupied CRE portfolio in terms of underlying credit trends. Clearly, a lot of concerns across the industry there. And the company overall just had 10 basis points of charge-offs. So really, really not much for us to see externally.

Charles Parcher, SVP and Chief Lending Officer

This is Chuck, Terry. Asset quality has been quite strong. We continue to analyze the portfolio for any risks related to interest rate increases or occupancy issues, and it has remained stable from that perspective. I'll have Mike Mulford, our Chief Credit Officer, share his thoughts as well, but he isn't seeing much deterioration.

Michael Mulford, Chief Credit Officer

Yes. This is Mike. Thanks, Chuck. No, we've not seen any real significant issues, systemic issues anywhere any of the portfolios, whether geographic or industry type portfolio still remains very strong.

Dennis Shaffer, President and CEO

And then actually, delinquencies bounced down pretty significantly for the quarter. And in criticized, we're up a little bit, but they were related to those isolated instances that we really identified late in the fourth quarter and early in the first quarter of this year. So credit quality is really holding in there nicely.

Terry McEvoy, Analyst

That's great to hear and good color. Thank you. And just as a follow-up, the other expense line had kind of SBA SEDARs and then also additional ATM debit card losses, which I didn't see in the prior press release. So could you shed a little bit of light on particularly the ATM and debit card losses last quarter?

Ian Whinnem, SVP and CFO

Yes. Terry, this is Ian. Nothing significant around the ordinary is the change in author of how we wrote that out of capturing it. But in terms of the run rate of those ATM allows us to is in line.

Terry McEvoy, Analyst

Great. Thanks for taking my questions.

Operator, Operator

Your next question comes from Tim Switzer with KBW. Your line is now open.

Tim Switzer, Analyst

Hey, good afternoon. Thanks for taking my questions. You guys have talked more about wanting to build the TCE ratio to about 7%, 7.5%. Do you have a timeline for when you want to achieve this or when you think you will? And like does it preclude you from doing buybacks at all? Or are you kind of balancing the capital of the old laws of valuate something like that?

Dennis Shaffer, President and CEO

It doesn't prevent us from doing buybacks, but currently, our earnings have decreased from last year, so we're concentrating on building capital. We believe our stocks are valued appropriately, but for now, buybacks are not part of our strategy. We consider it a beneficial way to manage our capital, yet our priority is to build it up. As our margins recover, we anticipate our earnings will improve, and that will allow us to retain more of those earnings for capital enhancement. Additionally, if interest rates decrease, we expect that to help as well. I'm eager to see the impact of a potential rate reduction in September. Ideally, we would like to see this happen sooner rather than later, but we do not have a specific timeline.

Tim Switzer, Analyst

Yes. Okay. And do you guys have any projections or what do your models say of the impact of a Fed rate cut initially? Is the immediate impact? Did you see some lagging deposit repricing so that maybe there's some data and when it recovers? Or how are you guys modeling that?

Richard Dutton, SVP and COO

Right now, Tim, this is Rich. The model has really, it doesn't change much. I mean 25 basis rate cut and our model is a basis point at most is just not a lot of improvement up or down and 25 or even 50 basis point movement.

Dennis Shaffer, President and CEO

Yes. I would love to say that yield curve become uninverted. I guess, from that perspective, that would help us quite a bit. But if we do get a look down in the treasuries and the longer-end treasury, we do feel like we've got a nice refinance opportunity in the mortgage loan area.

Tim Switzer, Analyst

Yes, that was going to be another follow-up. Do you think the rates would maybe help the loan growth side here?

Richard Dutton, SVP and COO

I am not sure if it will aid our growth. To be honest, we are hoping that we will see a decline in long-term rates, even if just temporarily, as we would like to eliminate some of those mortgage loans from our balance sheet, sell them, and realize the gain on sale. We will likely reduce our loan balances slightly. Long term, we have been maintaining higher rates than our competitors across most of our products, especially in commercial. If we see a more favorable yield curve, which makes borrowing more advantageous for new production, we can increase that a bit more at any time.

Dennis Shaffer, President and CEO

So Tim, to provide some details, we have around $700 million to $750 million in loans that would be immediately affected. These loans are linked to prime or super rates that will adjust. By the end of the third quarter, we had $500 million in borrowings that we would benefit from. This brings us to about $200 million to $250 million in loans. Additionally, we have broker deposits that will also adjust downward. We have approximately $0.5 billion in broker deposits, and those will decrease as well. As Rich mentioned, I believe the overall impact will be fairly neutral considering these factors.

Tim Switzer, Analyst

Yes. No, that makes sense. I appreciate that. Those numbers are helpful. Thank you, guys.

Operator, Operator

Your next question comes from Manuel Navas with D.A. Davidson. Your line is now open.

Manuel Navas, Analyst

Hey, good afternoon. I just want to clarify on loan growth. You said low single digits pace from here or for the whole back half of the year, low single digits from now?

Dennis Shaffer, President and CEO

Yes. For the second half of the year, we are aiming to slow growth. Some of the increase we saw this quarter was due to residential construction loans and certain portfolio loans we added. We plan to slow that by increasing rates, which should help reduce growth. Our commercial rates have been high for a while, and we are noticing a slight slowdown there, but we will be much more selective moving forward. Until we observe more activity with our overnight borrowings and similar factors, we want to manage loan growth and hopefully enhance our margin.

Manuel Navas, Analyst

I was going to address that next. Would the funding be the factor that could potentially enable you to increase loan growth again? I'll wait for that. Is that a...

Dennis Shaffer, President and CEO

Yes, absolutely. It's all dependent on the funding, Manuel. Additionally, we didn't mention in the call that deposits remained relatively stable, showing a decrease of about $3 million. However, there are some fluctuations because we are seeing growth in core deposits, but we still have some tax money left in the first half of the year. Remember, we exited the program in November, and we still had tax money on the balance sheet, which is now decreasing. So when we say deposits were flat, part of that is due to losing around $50 million in tax deposits during that period, and we still have a bit more to lose. I typically refer to this as a transition year, partly due to the fluctuations in these categories.

Manuel Navas, Analyst

I just like to clarify on the deposits. You have those two initiatives that should add $175 million in balances in the third quarter. Have you gotten some of that already? I know you had accounts open up, but how much balances of that $175 million have you already added to your deposit base?

Dennis Shaffer, President and CEO

At the end of the second quarter it was $44 million or so.

Manuel Navas, Analyst

And is that $175 million still the rough target?

Dennis Shaffer, President and CEO

And on those two initiatives, we also have several other initiatives that are just kicking off that we think will bring some other deposits and we hope to share some of that with you in the third quarter; with our third quarter results because some of them have kicked off, and we're gaining some traction in those.

Manuel Navas, Analyst

Could that get you to the point where you have a better NIM and could potentially have a little bit increased loan growth into 2025 from current levels?

Dennis Shaffer, President and CEO

Sure, it's not just about attracting deposits; we are also looking into other options. We're seeing a decrease in rates, and there may be loans we can refinance that would contribute to our funding. We're exploring several other initiatives in this area, so it's not only about gathering deposits but also optimizing our loan portfolio and other assets.

Richard Dutton, SVP and COO

Yes, Manuel. I was just going to add, what we're really doing is balancing to make sure that we make an appropriate return on the liquidity and the capital that we're investing out there to make sure that we get the appropriate return. So it's easy to go get some deposits that are really high priced. We just think that would make our margins suffer.

Manuel Navas, Analyst

Do you feel like you've hit like peak deposit costs now that you've started to come back down linked quarter? Or could that fluctuate from here just based on?

Dennis Shaffer, President and CEO

We believe that deposit costs have peaked, and we reduced them in the second quarter. We anticipate being able to further decrease those costs in the third quarter as we progress.

Manuel Navas, Analyst

That's great. And just shifting gears for a second. I would love for that leasing residual number when you guys get it, that would be helpful on the fee side. And on this I think actually what was the loan yields on the real estate added this quarter? I think you went through some of the commercial yields being really high, like 8% plus. I'm sure resi is a little bit lower. I understand that it's a lower-yielding asset. but I might have missed it before.

Dennis Shaffer, President and CEO

I think I believe it was... 660 or 665%, looking for that number right now... Year-to-date, 2024, 663.

Manuel Navas, Analyst

Okay thank you. I'll step back into the queue. I really appreciate the commentary.

Operator, Operator

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

Dennis Shaffer, President and CEO

Well, in closing, I just want to thank everyone for joining and those that participated on today's call. Again, this quarter's results were due in large parts of the hard work and the discipline of our team. We will continue to focus on growing Civista and growing it the right way. And again, this is a transition year for us that I believe our focus on improving our strong core deposit franchise and our disciplined approach to retake the pricing loans and deposits and the managing the company does position us well for future success. So I look forward to talking to you all again in a few months to share our third quarter results. Thank you for your time today.

Operator, Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.