Great Southern Bancorp, Inc. Q4 FY2020 Earnings Call

Thank you for joining us, and welcome to the Great Southern Bancorp’s Fourth Quarter 2020 Earnings Call. I will now turn the call over to Ms. Kelly Polonus. Please proceed, ma'am.

Thank you, Catherine. Good afternoon, and thank you for joining us for our fourth quarter earnings call. This is Kelly Polonus, Investor Relations for Great Southern Bancorp, Inc. The purpose of this call is to discuss the company's results for the quarter ending December 31, 2020. Before we begin, I need to remind you that in this call, we may make forward-looking statements about future events and financial performance. These statements are subject to a number of factors that could cause actual results to differ materially from the anticipated results. For a list of some of these factors, please see our current earnings release and other public filings. President and CEO, Joe Turner; and Chief Financial Officer, Rex Copeland, are on the call with me. I'll now turn the call over to Joe Turner.

Thank you, Kelly, and good afternoon, everyone. We appreciate you joining us today. I'm happy to share that 2020 concluded with strong operating results for us in the fourth quarter. Our performance highlights the commitment and hard work of our associates in serving our customers during this challenging time. I'm very proud of our team. I will briefly discuss our company's performance during the quarter, after which Rex Copeland, our CFO, will provide more details on the financial results, and then we'll open the floor for questions. In the fourth quarter, we earned $17.8 million or $1.28 per share compared to $17.9 million or $1.24 per share in the same period last year. The increase in earnings per share is due to the company repurchasing common stock throughout the year. We bought approximately 530,000 shares at an average price of $41.71. Our earnings decline compared to the previous year was primarily due to higher loan loss provisions, a slight decrease in net interest income, and increased noninterest expenses, particularly $828,000 from foreclosed real estate write-downs and higher compensation costs, especially in the mortgage sector. Our performance metrics for the quarter included an annualized return on common equity of 11.27%, an annualized return on assets of 1.31%, a margin of 3.41%, and an efficiency ratio of about 56.7%. Our loan production in 2020 was quite strong given the operating environment, exceeding $1.2 billion in commercial loan originations. With historically low mortgage rates, we achieved a record-setting $540 million in single-family mortgage loans. Total gross loans, including unfunded amounts, increased by $202 million since the end of 2019 but decreased by $27.6 million during the fourth quarter. From the end of 2019, outstanding loan balances rose by $143 million, which included about $96 million in Paycheck Protection Program loans still on our books at the end of 2020. In the fourth quarter, our loan balances fell by approximately $117 million due to payoffs, with around $26 million of those being PPP loans. Our pipeline of loan commitments remains strong, as illustrated in our pipeline chart and press release. This pipeline has been relatively stable since December 2018. On January 19, we began accepting PPP applications from our small business clients. During the first PPP cycle, we processed approximately 1,600 loans totaling $121 million. I also want to highlight that additional information about our loan portfolio was posted in our quarterly loan portfolio presentation yesterday. Our asset quality was historically strong as of December 31, 2020, with nonperforming assets at $3.8 million, roughly 7 basis points of loans. Total net charge-offs for the year were $422,000, which is about 1 basis point, primarily in our indirect portfolio, while the rest of our loan portfolios experienced net recoveries during the year. This reflects very strong credit quality. Regarding loan modifications, our total loan modifications stood at $251 million at the end of the year, and we expect this trend to continue downward through 2021. Our capital remains robust, with total equity to total assets at 11.4% and tangible common equity to tangible assets at 11.3%. These strong levels of capital provide us with considerable flexibility moving forward. As previously mentioned, we repurchased about 530,000 shares of common stock in 2020, with 140,000 of those shares bought in the fourth quarter at a slightly higher price than the average for the full year. That concludes my prepared remarks. I will now hand the call over to Rex Copeland.

Thank you, Joe. I want to start off today with a brief discussion about our adoption of CECL. As you all know, there was legislation at the end of 2020 that enacted a lot of things, but notably, it included an optional additional deferral period for CECL implementation. We chose to initially adopt this in January of 2021. Therefore, the fourth quarter information and the full year of 2020 have been prepared under the incurred loss methodology. Beginning in the first quarter of 2021, we will implement the CECL methodology moving forward. This means there will be a cumulative adjustment at the beginning of this year, increasing our allowance for credit losses. Additionally, there will be an allowance for potential losses related to the unfunded portion of our loans and commitments. All of this will affect our retained earnings, and we estimate that the allowance will increase on the outstanding loan portion by approximately $10 million to $13 million, with the unfunded portion being about $7 million to $8 million. Consequently, the after-tax effect will result in a decrease in retained earnings of about $13 million to $15 million upon implementation. This initial adoption will not impact the income statement. Now, regarding net interest income and margin, our net interest income for the fourth quarter of 2020 decreased by approximately $365,000 to $44.6 million compared to $44.9 million for the fourth quarter of 2019. This decrease was influenced by the Federal Reserve's interest rate cuts in March, as well as lower-yielding earning assets such as PPP loans, investment securities, and increased funds at the Federal Reserve Bank, along with interest expenses related to subordinated debt issued in June 2020. The net interest margin for the fourth quarter was 3.41%, down from 3.82% in the fourth quarter of 2019 and compared to 3.36% in the third quarter of 2020. In comparing the two fourth quarter periods, the average yield on loans fell by about 82 basis points, while the average rate on deposits dropped by approximately 77 basis points year-over-year. Most margin compression originated from changes in the asset mix, with average cash equivalents increasing by about $212 million and average investment securities growing by around $63 million. The yield on cash equivalents decreased by 153 basis points from the fourth quarter of 2019 to the fourth quarter of 2020, accounting for about 16 basis points of the decrease, with the issuance of additional subordinated notes accounting for another 8 basis points. Additionally, the yield accretion on our FDIC-acquired loan portfolio was about 12 basis points lower in the fourth quarter of 2020 compared to the same quarter in 2019. The core net interest margin, excluding additional yield accretion on acquired loan pools, stood at 3.34% in the fourth quarter of 2020 compared to 3.63% in the fourth quarter of 2019 and 3.27% for the third quarter of 2020. The increase in the core net interest margin compared to the third quarter of 2020 was mainly due to lower deposit costs between those three-month periods. Now, let’s discuss deposit costs. During the three months ended December 31, 2020, our cost of interest-bearing deposits was 15 basis points lower than in the three months ended September 30, 2020, and was 77 basis points lower than the three months ended December 31, 2019. We expect to continue making progress, though perhaps not as significantly, in reducing interest rates on our deposits throughout at least the first half of 2021. As mentioned earlier, the impact of accretion income from FDIC-acquired loans has continued for many years. In Q4 2020, it had a positive impact of 7 basis points on our margin, with approximately $2 million remaining as accretable yield affecting future income. We anticipate recognizing about $1.5 million of that during the full year of 2021. Now, regarding noninterest income, it increased by $2.3 million to $10 million when comparing the fourth quarter of this year to the fourth quarter of 2019. The main contributors to this increase were net gains on loan sales, which rose by about $1.8 million due to a significant volume of originated residential loans, most of which are fixed-rate and typically sold in the secondary market. Other income also increased about $404,000 compared to the previous year, largely due to improved performance from fixed asset sales, resulting in gains this year versus losses last year. We recognized about $76,000 more in income from interest rate swaps with customers and an increase of about $58,000 related to tax credit partnership activities. In terms of noninterest expenses for the quarter, we saw an increase of approximately $1.6 million to $31.1 million compared to the fourth quarter of 2019. Major increases were in salary and employee benefits, which rose by $782,000 due to merit increases and typical yearly adjustments. The mortgage division also saw increased incentives, costing about $220,000 more compared to the previous year. Insurance costs increased by about $389,000 due to FDIC insurance premiums, as we no longer benefitted from prior-year credits related to overfunding of the insurance fund. Other real estate owned and repossession expenses rose by about $535,000 compared to the previous year, primarily from write-downs taken in 2020 that were larger than those in 2019. The total impact from various write-downs amounted to approximately $839,000. Our efficiency ratio for the fourth quarter of 2020 was 56.98%, an increase from 56.11% in the same quarter of 2019. This increase was mainly driven by noninterest expenses, although some increase in total revenue provided partial offset. Nevertheless, we managed to reduce the net interest expense to average assets ratio to 2.29%, down from 2.38% in the previous year's quarter. That concludes my prepared remarks. We will now turn it over to any questions you may have.

And our first question comes from Michael Schiavone with KBW.

So my first question, I was wondering, do you guys have any target capital levels you are aiming for? And can you provide an update on your deployment priorities in 2021?

I don't think we have a specific target capital level. I believe we have more than enough capital. Our main focus will always be to use capital for organic growth. Even with high growth rates, we have enough capital to manage that. Additionally, we might use the capital opportunistically for potential acquisitions that make sense. More likely, we would repurchase our stock if it remains at attractive levels. Another option could be a special dividend, as we have done a few times before.

Okay. Regarding fee income, do you feel that service charges have returned to more typical levels since the pandemic lows? Do you expect this trend to continue? Also, can you provide an update on the mortgage banking pipeline and whether you anticipate that strength will persist?

Rex, why don't you answer it?

The service charges have indeed normalized. We expect them to remain similar, but we might see a decrease in overdraft charges, NSF charges, and some service fees in the first quarter due to additional stimulus checks. It’s hard to predict exactly how this will unfold, but it is a possibility as we noticed this trend during the last round of stimulus payments. Fees from point-of-sale transactions have stabilized and appeared normal in the fourth quarter, and I anticipate this will continue, so those areas of fee income should be reasonable. Regarding the mortgage loan pipeline, I don't have a specific figure, but interest rates have slightly increased, and many people who could refinance probably already have. Therefore, I don’t expect the same level of activity and profit from loan sales as we experienced in the fourth quarter, but I believe it will still be fairly active.

Okay. And then just my last question. I was wondering if you can provide a little color on that the bank of the future prototype you guys are working on. And how many of those you expect to roll out over the years?

I think we have one banking center currently being built and that our rollout will be modest. We'll take our time to work out any issues, and once we have a solid plan, I anticipate adding about four or five more centers each year following that.

Our next question comes from Andrew Liesch with Piper Sandler.

Just on the PPP, the latest round here, you said you're participating. Any early indications on number of applications or volume dollar amount what you're seeing so far?

We've got the numbers. Overall, we would expect that our totals will not be as significant as the first round. As a reminder, we did about $120 million in the first round. So far, we've received about $27 million in applications, and approximately 11% or 12% of those are first draw requests, meaning customers that didn't participate back in the spring, while the rest are from customers who did participate in the spring. There is obviously some interest, but right now, we believe it probably won't reach the same level as it did in the spring.

Got it. Okay. Looking at the strong deposit growth this quarter, interest-earning cash was notably high at year-end. What trends are you noticing there? Has any of that moved off the balance sheet, or will it be retained as cash? I'm trying to understand how liquidity will evolve early in the quarter.

We've experienced significant growth throughout the year, with a notable surge at the end of December. If you examine our earnings release, you'll notice that as of December 31, the average net interest rate spread was 3.08%. This was somewhat negatively affected at the year's end by a substantial influx of funds that we had to place as cash equivalents at the Fed since we had no immediate use for them. While some of those deposits have begun to roll out, the amount has been minimal. We are managing this through various means, including brokered deposits and some national deposits, which we've scaled back a bit as they mature. We're gradually utilizing some of those maturing deposits, but the non-time deposits are proving to be quite stable. We're continuing to see high levels there, although we are starting to draw down on the excess funds at the Fed over the next month or two.

I understand. Considering that, liquidity might be a bit higher, but you also have some more expensive funds that you might not be renewing or are allowing to expire. Overall, the funding benefit might not be as strong as it was in the fourth quarter. However, if we factor in another solid quarter of PPP recognition, this could result in a slightly higher margin on a reported basis in the first quarter before it trends down. Does that sound like a reasonable perspective?

We expect that any time deposit maturities we have in the first quarter will either not be replaced or will be replaced at significantly lower rates than they are currently. This should provide some benefits moving forward. The balances of our non-time deposits, which are substantial, have seen rates decrease by about one or two basis points on average each month. We plan to continue working to lower those rates slightly, but the changes will be incremental and not significant.

What you're seeing, Andrew, is probably a decline in margin because the amortized fee on the PPP loan will go away.

Well, it will be higher this quarter, and as time progresses, that will gradually change.

Yes. I think it was about $1 million in the fourth quarter, which annualizes to about $4 million. This gives us roughly a 4% yield on those PPP loans, and we're also earning about 1%, so it's possibly around 5%. It's not a significant moneymaking opportunity or a strong yield portfolio, even considering the amortized fee. As that portfolio rolls off, if we can replace it with other loans, those would typically offer yields in the 4% to 5% range, but likely closer to 3.5% to 3.75%. Thus, there isn't a substantial difference between the yield on PPP loans and the yield on other loans we're issuing.

Our next question comes from John Rodis with Janney.

I guess, Joe or Rex, maybe could you provide any more color on the loans that are still under the deferral? I guess, specifically, maybe the hotel, motel and then the retail portfolio. Those are your 2 biggest buckets. You said you expect continued improvement, but is that a quarter? Or do you think that plays out throughout the year?

No. I believe it will occur gradually throughout the year. Firstly, I want to clarify that we do not categorize those loans as impaired credit. If we believed there was an issue, those loans would be classified accordingly. Currently, with our classification level at around $8 million, none of those loans are classified. Therefore, we do not see any impaired credit. We are actively working with our customers, who are typically paying interest only, without making principal payments. To add, in some cases, for continued interest-only payments, they may have pledged additional collateral or provided cash. This indicates ongoing negotiations, and our customers have demonstrated good faith, though they remain in this situation. Our expectation is that the total amount will decline by $250 million gradually throughout the year.

Okay, that's helpful, Joe. Regarding loan growth for the year, excluding PPP, loans increased by about 1.5%. As you look ahead to 2021, do you think you can achieve better than that 1.5%? What are your thoughts on core loan growth excluding PPP?

It's difficult to provide a clear picture. There are areas where we lack significant visibility. I believe our origination looks promising, although there will be times throughout the year when it slows and speeds up. Our pipeline totals have remained fairly stable for the past three to five years, so I feel optimistic about that. However, we are uncertain about the competition's actions. I can say that we have strategically positioned ourselves with a strong loan portfolio that appeals to many long-term lenders. These lenders are willing to provide funding to our customers at rates lower than what we currently have on our books, which may limit or eliminate guarantees. While this makes it challenging to maintain our loan balances, I think it's a positive aspect overall. In summary, we will continue our current approach and see how things unfold.

As for the indirect portfolio, most of that runoff has happened, correct? Or do you expect something else?

Yes. I think that portfolio is like $48 million now.

Right. Yes. Okay. Guys, just one final question. The buyback, what's currently remaining under the buyback?

Yes, we just approved a new 1 million share buyback, John. So I mean, there's probably 900,000 shares left, something like that, maybe around 900,000.

And there are no other questions in the queue. I'd like to turn the call back to Mr. Joe Turner for closing remarks.

Okay. Well, we appreciate everybody being on the call with us today, and we'll look forward to talking to you in April after our first quarter earnings release. If you have questions in the meantime, please don't hesitate to give Kelly Polonus a call. Thank you.

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