Great Southern Bancorp, Inc. Q2 FY2020 Earnings Call

Thank you for joining us for the Great Southern Bancorp, Inc. Second Quarter 2020 Earnings Call. I will now turn the conference over to Kelly Polonus from Investor Relations. Please proceed.

Thank you. Good afternoon, and welcome. I hope that everyone on the call is well. The purpose of this call is to discuss the company's results for the quarter ending June 30, 2020. Before we begin, I need to remind you that during the course of this call, we may make forward-looking statements about future events and future financial performance. You should not place undue reliance on any forward-looking statements, which speak only as to the date they are made. These statements are subject to a number of factors that could cause actual results to differ materially from the results anticipated or projected. For a list of some of these factors, please see the forward-looking statements disclosure in our second quarter 2020 earnings release. President and CEO, Joe Turner; and Chief Financial Officer, Rex Copeland, are on the call with me today. I'll now turn the call over to Joe Turner.

Good afternoon. Thank you, Kelly, and I appreciate everyone joining us today. I hope you have had a chance to review our second quarter earnings release. We are proud of our achievements during the second quarter despite a challenging environment. As we navigate through the pandemic, our top priority continues to be the well-being of our associates, customers, and the communities we serve. I want to express my gratitude to our nearly 1,200 Great Southern associates for their hard work and resilience during this tough time. I am very proud of our team and how they have responded to this crisis. As mentioned last quarter, we are committed to following CDC health guidelines while ensuring our customers have access to our products and services. We are actively supporting customers facing financial hardships. The ongoing duration and impact of the pandemic create significant uncertainty and challenges for the U.S. economy. We are prepared to tackle the challenges brought on by the pandemic and are in a strong position regarding capital, earnings, liquidity, and credit quality. I will provide some brief remarks on the company's performance for the quarter and then hand it over to Kelly Polonus for discussion on business initiatives, followed by Rex Copeland, our CFO, who will discuss financial results. We will then open the floor for questions. As anticipated in this operating environment, our earnings did decline in the second quarter compared to the prior year. The main reason for this decline was an increase in our loan loss provision expense, which was $4.4 million higher this quarter than in the same period last year. Despite this, we achieved earnings of $0.93 per diluted common share. Pretax pre-provision earnings decreased by about $1.3 million or 5.6% from last year. Rex will provide more details on our earnings. Our annualized return on common equity for the quarter was 8.45%, and our return on assets was 0.98%. Our net interest margin was 3.39%, with an efficiency ratio of 56.75%. Regarding loan production, it remained solid across all areas of the franchise in the second quarter. Unscheduled loan payoffs have decreased since February and March. Our outstanding loan balances grew by $246 million from the end of the year, increasing from $4.15 billion to $4.4 billion, and rising about $187 million from the end of the first quarter. Approximately $120 million of this increase was due to PPP. We observed increases in multifamily loans, commercial business loans, 1- to 4-family residential loans, and commercial real estate loans. Our committed pipeline remains strong at around $1.3 billion, though it has decreased by about $91 million from the end of last quarter. The unfunded portion of our commercial construction loans is approximately $754 million, down by about $56 million from the end of March. Our asset quality remains robust. Our charge-offs for the quarter amounted to $127,000, and for the year, they totaled $365,000, reflecting historically low levels of nonperforming loans and classified loans. However, we recognize that this challenging environment may lead to hardships for some customers. We have seen an increase of about $40 million in our watch customers, rising from $34 million to $74 million. This increase, while still classified as past credits, indicates a greater concern than standard past credits. Consequently, we are increasing our allowance for loan losses by about 25%, from $40 million to just under $50 million at the quarter's end to account for the added uncertainty in our loan portfolio. I would like to remind you that we did not adopt CECL. Had we done so on January 1, we would have increased our allowance by $11 million to $14 million. Our loan modifications related to COVID totaled $1 billion at the end of June. We modified 431 commercial loans with a principal balance of $931 million and 1,702 mortgage and consumer loans totaling $80 million. As mentioned in our meeting last year, we accommodated nearly all customers who requested modifications, regardless of need or credit concerns. About 75% of the $1 billion in modified loans were adjusted to interest-only for 90 days, meaning we deferred the principal payments for that period. Based on discussions with our customers, we believe that a significant number of those modified will revert to normal payment terms by the end of summer. Our capital position is strong, with stockholders' equity increasing by $24 million to $627 million since the beginning of the year. Our book value rose from $43.61 to $44.50 during the second quarter, with an increase of $2.21 over the first half of the year. Our ratio of tangible common equity to tangible assets remains robust at 11.1%. In the second quarter, we further strengthened our regulatory capital position by issuing $75 million in fixed to floating rate subordinated notes, due June 15, 2030. These notes will earn interest at a fixed rate of 5.5% until June 15, 2025; thereafter, the interest rate will float if not paid off. Additionally, we declared a regular cash dividend of $0.34 per common share, and we anticipate maintaining this dividend for the foreseeable future. That concludes my formal remarks. I will now turn the meeting over to Kelly Polonus, our Director of Corporate Communications, who will discuss our business initiatives from the quarter.

Thank you, Joe. In my thoughts today, I'd share some activities in our banking center network. As of today, we closed 2 banking centers located in Hy-Vee stores in our Quad Cities Iowa market. We were notified in April that Hy-Vee was making store infrastructure changes, thus necessitating these closures. That will leave us with 3 banking centers operating in the Quad Cities area with approximately $110 million in deposits. In August, we'll consolidate a stand-alone drive-through office into our downtown office in Parsons, Kansas. When this consolidation occurs, it will ultimately leave our company operating a total of 94 banking centers in the franchise. While we're on the subject of banking centers, there has been a lot of talk about how COVID-19 may be speeding up rationalization or closures of brick-and-mortar banking centers since customers have been driven to more self-service delivery channels, and I thought I'd share some of our statistics today to let you see how it's affected us. Looking back at our statistics since March, which is about when stay-at-home orders went into effect in most of our markets, we have seen a general uptick in self-service channel usage and adoption. In late March, our banking centers began providing drive-thru service only and in-person service by appointment only. We experienced a dramatic decrease in customer traffic in our banking centers, but only really at the beginning of the pandemic period. From the end of March, when it first started till the end of April, we saw customer traffic decrease by about 50% in our banking centers. The total number of transactions decreased by about 16%. Since then, though, as our communities have opened up more, we're seeing a return to near-normal levels of customer traffic and transaction activity. From a big-picture perspective, it is important to note what near-normal levels are. We have, in the past few years, experienced a steady trend of fewer teller transactions in our banking centers, and we expect this to continue. In looking at our self-service channels during this time, we believe that the pandemic presented an opportunity to introduce more of our customers to our self-service channels and promote more usage. For example, our mobile check deposit, which is included in our mobile app, allows customers to take a picture of their deposit check, and it will be deposited automatically into their account. This service was utilized more than normal, and we had an increased enrollment rate since the beginning of March. We saw a 28% lift in the number of transactions with that service and a 12% increase in enrollment. We also saw more usage of our person-to-person, P2P service with a 21% increase in transaction volume since March. We experienced a significant increased log-in activity in our online banking platform and mobile app, especially around the times that the government stimulus checks were paid. We have seen an uptick in new online banking customers and mobile app users since the beginning of March. With all this said, we will continue to evaluate our banking center network and rationalize where appropriate, having closed or consolidated more than 36 offices in the last 6 years. We'll continue to focus on investing in digital channels for our customers. For now, what we're seeing is a mix and availability of convenient access channels is important to our customer base. From our recent survey data that we conducted with J.D. Power, we found that a significant number of our customers still enjoy utilizing our banking centers and consider a branch as a main point of access. At the same time, many of these customers are also utilizing self-service channels. However, the banking center is still very relevant to their service preference. This includes the younger generations, Gen X and Gen Y. We fully understand that our industry is evolving and the traditional banking center is a part of that evolution. In that light, we're currently engaged with a vendor that is conducting an in-depth study of our banking center network. The study is nearing completion right now, and we expect that the subsequent results and recommendations will ultimately guide us to ensure that our network is optimized and competitively positioned for the future.

Thank you, Kelly. I'm going to start this afternoon by talking about net interest income and margin. Our net interest income in the second quarter of 2020 decreased about $1.4 million to $43.5 million compared to about $44.9 million in the second quarter of 2019 and also in the first quarter of 2020. Net interest income was affected by the Federal Reserve's significant interest rate cuts that occurred in March and additional lower-earning assets that were put on the books in the second quarter this year, which included the PPP loans that Joe mentioned before, some investment securities that we added, and also just increased cash balances that are held at the Federal Reserve Bank. Furthermore, the subordinated debt offering that we completed in mid-June also had a minor negative effect on our net interest income. We believe that this subordinated debt offering will probably impact our margin going forward by about 8 basis points on an annualized basis. The net interest margin in the second quarter this year was 3.39%, compared to 3.97% in the year-ago second quarter and 3.84% in the first quarter of 2020. The decrease in the margin from the prior year second quarter was roughly half due to the decrease in the average yield on our loan portfolio due to market interest rate cuts in March. The other half related to liquidity items or other items I mentioned earlier: the added PPP loans, the additional cash equivalents, and the additional investment securities. All those things combined accounted for about another $500 million of assets that we added. The rate cuts negatively affected our net interest margin in the near term, as a large portion of our loan portfolio is indexed to 1-month LIBOR rates, and those declined almost immediately with the rate cuts. Our deposit portfolio will reprice lower as well, but not as quickly as time deposits have to mature over a period of time. To provide some comparisons, on June 30 of this year, our cost of deposits was 29 basis points lower than it was on March 31 of this year. So in that 3-month time frame, we were able to reduce our deposit cost by about 29 basis points overall. We expect to continue to make further progress in reducing our funding cost of deposits in the remainder of this year. Cumulatively, we have about $540 million of time deposits that will mature and reprice in the next 3 months, which grows to about $842 million through 6 months' time. Then 12 months out from June 30, the cumulative total of all those time deposits would be about $1.4 billion. Thus, we have quite a bit of deposits coming due and repricing in the next 3 to 6 months, with the weighted average rate on that time deposit portfolio around 1.5%, give or take a little, depending on which timeframe you consider. The company's net interest margin has been positively impacted by significant additional yield accretion recognized related to the FDIC acquisitions that we've done several years ago. In this quarter, the impact on our net interest margin was a positive about 12 basis points. Remaining yield accretion that we have is about $4.2 million, with an expectation of around $2.2 million to be recognized in the remainder of 2020. Next, I want to talk about noninterest income. For the quarter ending June 30 this year, our noninterest income increased $1.1 million to $8.3 million compared to the year-ago quarter. The increases were primarily seen in a couple of areas. Net gains on loan sales were up about $1.5 million compared to the prior year quarter, primarily due to a rise in fixed-rate loan originations, which we sell primarily in the secondary market. With rates dropping significantly, there has been an uptick in refinance activity, leading to a higher level of loan originations, many of which have been sold in the secondary market. Additionally, we saw other income that increased about $667,000 compared to the year-ago quarter, driven by several new interest rate swaps that we entered into back-to-back with our loan customers and the counterparties, resulting in fee income of a little over $800,000. Nonetheless, we experienced declines in our service charge and ATM income, with a decrease of around $1.2 million compared to the year-ago quarter. This decrease is the result of lower usage by our customers, insufficient fund overdraft products, and a more lenient approach on our part regarding waiving fees related to the pandemic. As for noninterest expenses, we're still tracking well regarding core expense containment and operational efficiency, with noninterest expenses increasing about $966,000 to $29.3 million this quarter versus the year-ago quarter. The main drivers for that increase were primarily related to salary and benefits, including incentives in our mortgage lending area due to the higher levels of originations, alongside slightly higher occupancy expenses. Those have been partially offset by expense reductions related to travel and marketing initiatives owing to the pandemic and lower FDIC insurance premiums attributed to some credits. Joe earlier mentioned that the efficiency ratio for the second quarter was 56.75%, compared to 54.50% for the second quarter of 2019. The increased efficiency ratio in 2020 was linked to somewhat higher noninterest expense levels. However, looking closely, the company's ratio of noninterest expense to average assets dropped from 2.35% a year ago to 2.17% in this June 30, 2020 quarter, related to the substantial increase in assets I referenced earlier. The last point I want to touch on today is liquidity. At the end of June, our liquidity position was very good. We had deposits at the Federal Reserve Bank and Home Loan Bank and unplanned securities aggregating roughly $580 million, which represents total liquid funds on balance sheet. Additionally, off-balance sheet, we have the ability to borrow about $1.1 billion on our secured line at the Home Loan Bank, with further capacity if we decide to add broker deposits. Therefore, we believe our liquidity position is strong as of the end of June. Our deposits increased during the second quarter by about $333 million. Checking accounts rose by about $500 million, somewhat offset by declining balances in various time deposit categories. Some of the increase can be attributed to stimulus funds deposited into customer accounts, alongside PPP loan proceeds and other additions via reciprocal securitized money market deposits through the ICS product. We expect some of these funds to be gradually withdrawn from our deposit accounts over time, and we have prepared for that. We have already observed some of the PPP funds being withdrawn as businesses have been fulfilling employee and rent obligations. We anticipate that some of these other balances may also be withdrawn over time throughout the rest of this year, but we have developed plans accordingly. That concludes my comments for today, and at this time, I'll turn it back over to our moderator for any questions.

Our first question comes from Andrew Liesch with Piper Sandler.

The loan book growth was stronger than I anticipated, not including the PPP. I'm curious if there's more information available regarding that. We might consider some draws on construction, but what are your customers' business development plans?

I'll take a shot at that, Andrew. I mean, obviously, we have the loan portfolio where you can see exactly where the loan growth came from. I would say loan growth generally, though, is being driven less by new origination activity, although we do have new origination activity occurring across our franchise, and probably a little bit more by slower repayments. We had a lot less refinancing occurring than we did, say, this time last year. So I think that's what's driving loan growth, maybe more than origination activity.

Okay. What is the current outlook regarding your customers and the PPP loans? How long do you anticipate those will stay on the balance sheet? How quickly do you expect them to be paid off or forgiven?

I would think they're going to be paid off sooner rather than later. Most of ours were originated under 2-year notes, and I expect they will be paid off well ahead of that. I don't know, Rex, if you've had more recent discussions about those than I have, but I think we would expect a big chunk of those to be paid off by the end of the year.

I believe that is correct. It may be more applicable in the fourth quarter, depending on the paperwork that needs to be completed. There have been talks about a shortcut process for loans under $150,000, and since many of our loans fall into that category, those could potentially be expedited into the third quarter. However, I expect that most of the loans will be settled in either the third or fourth quarter of this year.

Okay. And then just one follow-up question. Kelly, you guys got that in-depth study of your branch network, banking center network that's going to be finalized soon. Are there any early conclusions that you're able to share with us? Or is it just too soon to tell?

I really think it's too soon to tell. We are in the early phases, but they are looking at the entire network and considering demographics, market potential, the building itself, branding opportunities, and we're examining a full spectrum of variables for all of our banking centers.

Our next question comes from the line of Michael Perito with KBW.

I wanted to stay on the branch topic. I was curious if you guys could tell us who the vendor is that you're using as you go down this path of analyzing the branch network?

We're using La Macchia, based out of Milwaukee, Wisconsin.

And obviously, the process is ongoing based on your response to Andrew's question, so not necessarily looking for takeaways yet. But I'm curious about what the actual review process looks like and what metrics you guys are considering in the decision-making process?

As I mentioned, we're evaluating many different variables. We're looking at this also from the standpoint of the branch of the future, considering what technology we might incorporate into our branches, if there are any necessary changes. We're not expecting to overhaul the entire network; rather, we're looking for opportunities to improve. We're assessing the customers in the market, its growth potential, population, demographics, transaction counts at those locations, and how those branches are utilized. We also consider branding and how we project ourselves to the community we serve. It’s a comprehensive study.

Yes.

Interesting. And I guess, from a higher-level standpoint, I mean, if we try to marry that internal review that you're doing with your financial strategic planning, the high-level hope would be that there are probably some investments you need to make on the digital side, but also some cost savings that could come from rationalizing the physical office side. The hope is that net-net, you'll be in a better position to serve your customers in each local market, while helping to protect your pre-provision earnings given the lower margin. Is that a fair summation?

I believe that's accurate, Mike. We don't believe there’s a significant amount of low-hanging fruit, keeping in mind that over the last 6 or 7 years, we've closed around 25% of our banking centers. Thus, there will not be a lot of consolidation opportunities. However, there may be some here and there. Ultimately, we would like to establish a banking system of centers that best meets our customers' needs at a sustainable cost.

Okay. Just curious, from an economic standpoint, you have exposure to a few different markets, and it's kind of a moving target for the entire country. Things look better than they could be worse. Are there any specific markets that you feel better about today compared to the first quarter, or conversely, do you feel a little worse about today as the last 90 days have unfolded?

Not really. I don’t think we are significantly more or less concerned about any particular market than we were at the end of the first quarter. Generally, we hoped, like everyone else, that our new cases of COVID-19 would not be as high as they currently are. Our overall concern levels are somewhat elevated from where we expected them to be at this time, but I do not think it reflects a specific market.

Helpful. And then just lastly, Rex, sorry if I missed it, but you walked through some of the liability repricing opportunities in the margin that are coming down in the near future here. Could you summarize how we should think about the margin's direction? Obviously, the PPP loans can affect that, but if we back that out, is the expectation that most of the pain from the reduction in Fed funds and LIBOR was felt in this current quarter? While there might be some more in the next quarter, do we hope that some of those liability repricings will help offset that to a greater degree? Is that the message?

Right. That's correct. In the past, we noted that typically when we experience a significant rate drop, the initial impact is felt in the first 2 to 3 months. Loans tend to reprice quickly, while non-time deposits can be reduced but require time for maturity. Our modeling suggests we take a hit in the early months, but that will begin to ease as time deposits mature over the next 6 to 9 months. Therefore, our expectation now is that while our loan yields have dropped significantly already, our deposit costs will keep declining, particularly from the time deposits we plan to reprice in the coming months. We anticipate reducing costs meaningfully as these time deposits mature and we can replace them at lower market rates.

Our next question comes from John Rodis with Janney.

I hope you guys are well. Rex, just as far as the balance sheet goes, would you expect this level of higher liquidity to stick around for at least a few quarters? And along those lines, the securities portfolio, where do you see it?

Sure. I think overall liquidity is solid. We'll likely draw down some of that liquidity held at the Fed over time. There's a healthy balance, so some of that will offset the reduction of funds at the Fed, which is earning 25 basis points. I've seen some growth in the investment portfolio. We attempt to be selective when growing it. Part of the growth in the second quarter was due to some short-term pre-refunded municipals as an alternative to parking funds at the Fed; however, the yield has been minimal. We do not anticipate significant growth in that area. However, I expect we'll maintain a level of excess liquidity moving forward that exceeds what we've managed in the past.

Okay. Along those lines, concerning the previous question on margin, you'll have a full quarter's impact from the subordinated debt. Wouldn't that offset a sizable portion of the savings you would see from the CD book?

Yes, I believe it will. It should cost about 8 basis points annualized compared to what it would cost us before, so there will be some incremental costs we didn't have prior.

Okay. And then just, Rex, in the second quarter, what was the impact on interest income from the PPP loans? Was that around $500,000 or $600,000?

Probably more than that. The fee income on that would have been around $400,000, so yes, it's probably between $500,000 and $600,000.

Okay. And then, Joe, you talked about modified loans. Is there an update on some of those loans as they approach their 90-day mark? Have any matured, and have they rolled off yet? Any updates there?

Yes. Some have matured and rolled off. I believe, as I mentioned, that most of them will return to normal payment terms. So I don’t have a lot more to add, but I do not foresee any significant challenges there.

Okay. One final question regarding opportunistic M&A. Is it too early to discuss that or what's your perspective?

Yes. As a buyer, we are more focused on value purchases. If an opportunity arises where the FDIC is selling banks again, we would certainly be interested. If sellers are selling under significantly reduced expectations, we might consider it. However, this is not our primary focus; instead, we focus on acquiring customers and growing our company organically.

So the emphasis is more on internal improvements through your branch rationalization as opposed to acquisitions right now?

That’s correct, yes.

I'm showing no further questions at this time.

Well, thanks, everybody, for being on the call.

Take care.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.