Earnings Call Transcript - GSBC Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Great Southern Bancorp, Inc., Third Quarter 2020 Earnings Call. At this time, all participant lines are in a listen-only mode. I would now like to hand the conference over to your host today, Kelly Polonus, Investor Relations. Please go ahead.

Kelly Polonus, Investor Relations

Thank you, Sara. Good afternoon and welcome. I hope everyone is well. The purpose of this call is to discuss the company's results for the quarter ending September 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. Please see the forward-looking statements disclosure in our third quarter 2020 earnings release for more information. 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.

Joe Turner, President and CEO

Okay, thank you. Good afternoon. I also would like to thank everybody for joining us today. I hope everyone on our call is well. As we manage through the pandemic, now in its seventh month, we remain focused on the well-being of our associates, customers, and communities. I believe our associates are doing a tremendous job serving our customers through this difficult time. As we said last quarter, we are actively working with any customers who may be experiencing financial hardship caused by this pandemic. While there is still a lot of uncertainty about the months ahead, we are ready to respond to the challenges produced by the health crisis and are in a position of strength to do so with our strong capital, earnings, and liquidity. I'll provide some brief remarks about the company's performance during the quarter, and then I'll turn the call over to Rex Copeland, who will get into more detail on our financial results, then we'll open it up for questions. As expected in this operating climate, our earnings declined in the third quarter as compared to the year-ago quarter. Still, we achieved very good earnings of $0.96 per diluted common share in the third quarter. The primary driver of our earnings decline when comparing it to the year-ago period was a higher loan loss provision, but 100% or almost 100% of that provision went to grow our allowance for loan losses. We had very low charge-offs during the quarter. We did have lower net interest income than the year-ago quarter, I think by about maybe $1.8 million or so, over half of that, though, is attributable to the effects of the subordinated debt that we issued at the end of the second quarter. We had higher non-interest expense, which also affected us, including $1.1 million related to special bonuses for our associates. As I mentioned earlier, our associates are doing a tremendous job for the company; we know that this is resulting in unprecedented hard times for them. Many of our associates have school-aged children and are dealing with virtual schooling, and some of our associates have spouses who have lost their jobs, which is very difficult. We can't solve all their problems, but we do want to show that we are in the boat with them, and that's what the special bonus was for. Our performance metrics for the third quarter were good. Our annualized return on common equity, and I might add very high levels of common equity, was 8.48%. Our annualized return on assets was 0.98%. Our annualized reported net interest margin was 3.36%, and our efficiency ratio was 59.54. Our commercial lending production did decline in the third quarter as a result of activity in our markets slowing down a bit. Retail mortgage lending production has been very strong, continuing to be robust, driven by low interest rates. We typically sell the majority of the fixed-rate mortgages that we produce. Total gross loans, which include unfunded loan amounts, increased by $229.6 million since the end of 2019 but decreased by about $11 million during the third quarter. Outstanding net loan balances increased by about $260 million from the end of the year and increased by $14 million from the end of the second quarter. Our committed pipeline remains relatively steady and was about $1.2 billion at the end of September, a decrease of about $70 million since the end of last quarter. The unfunded portion of our commercial construction loans is about $715 million, a decline of $39 million from the end of June. I would remind you that if you're interested in more information on our loan portfolio, we file a loan portfolio presentation each quarter, and I think our third quarter presentation was filed yesterday. Asset quality is very strong. As of September 30, 2020, our non-performing assets were $5.5 million. Total net charge-offs during the quarter were $63,000. We actually had net recoveries in the commercial categories. One other thing I would mention is our internal loan classification watch list totals. At June 30, 2020, our loans classified as substandard were $9.3 million, and loans classified as watch were $73.8 million. As of September 30, 2020, our loans classified as substandard were $7.5 million, and the watch category was down to $64.4 million. The decreases during the third quarter were due to two substandard loans that paid off and some payments received on watch category credit. As I mentioned earlier, we fully understand that the difficulties we're in right now will likely persist and will result in challenging economic conditions as well. We have been increasing our allowance for loan losses, by nearly $14 million since the end of 2019. As a reminder, our provision for loan losses is currently under the incurred loss methodology. Had we adopted CECL on January 1, we would have put $11 million to $14 million in our allowance at that time, and I think our current expectation would be that at the end of the year, we would put a similar amount into our allowance. And as a reminder, that won't flow through earnings; that will be a cumulative effect of a change in accounting principle and will be a direct debit to our equity and a credit to the allowance. Loan modifications, at the end of June, we had over $1 billion in loan modifications that's down to $395.5 million. At the end of September, 70% of those are paying interest only, so the modification was to remove the requirement to pay principal for some period of time, up to maybe a year, but all different times, really three months, six months, and then seven to 12 months. Our capital continued to be very strong as I mentioned. From the end of 2019, our total common stockholders' equity increased by about $22 million, and our tangible book value per share increased by $2.71. Our book value increased from $44.50 to $45 at the end of the third quarter; it was $44.50 at the end of the second quarter. Our tangible common equity to tangible assets is also very strong at 11.4%. During the quarter, we did repurchase 206,400 shares of common stock at an average price of $37.39 per share. Additionally, we've paid a $0.34 per share dividend. In spite of the obvious economic challenges caused by COVID, we expect that we will continue to operate profitably, albeit not at 2019 levels, and we currently anticipate that our regular quarterly dividend can be maintained for the foreseeable future. Our Board of Directors has approved a new stock purchase program of up to 1 million shares, and we may continue to repurchase common stock over the next several quarters if conditions warrant. The amount and timing of stock repurchases will be determined by the company in light of overall capital and earnings levels, credit quality metrics, and the market for our stock. And we'll always maintain open communication regarding our plans with our holding company and bank regulators. Prior to recommencing our stock repurchase program, we did have those conversations with our holding company regulators. Over the course of about two or three weeks, we were not required to seek the permission of the Federal Reserve to repurchase our stock, but we wanted them to know what we were doing. At the end of those conversations, they said they had no objection to us repurchasing our stock in the manner that we were doing it. So that concludes my prepared remarks. I'll turn the call over to our CFO, Rex Copeland, at this time.

Rex Copeland, Chief Financial Officer

Thank you, Joe. I'm going to start today by speaking a little bit about net interest income and margin. Our net interest income for the third quarter of 2020 decreased about $1.7 million to $44.2 million. That compares to about $45.9 million for the third quarter of 2019. The net interest income was affected negatively by the Federal Reserve's significant rate cuts that happened in March. We also have some additional lower earning assets – SBA, paycheck protection program loans, investment security purchases, and increased balances that we hold at the Federal Reserve in cash and cash equivalents, and then also more recently this quarter by the cost of the subordinated debt that we issued in mid to late June. The core interest margin, if you exclude the yield accretion from our acquired loan pools, was 3.27% for the third quarter of this year. That compares to 3.75% for the third quarter of 2019 and is the same 3.27% as where we were in the second quarter of 2020. The decrease is a result of the same things I talked about previously. One thing that is a little different when comparing Q2 this year to Q3, we did have about, on an annualized basis, about eight basis points related to our cost of the subordinated debt that we issued in June. So if you look at the core comparison, we were at 3.27% in Q2, 3.27% in Q3, but we had eight basis points of headwind from the subordinated debt costs. We had said in previous discussions and filings that the rate cuts would negatively affect our net interest income and margin in the near term because we have a lot of loans that are indexed to LIBOR. But over the course of the next several months and a few quarters, most of our liabilities are time deposits and some of our non-time deposits will re-price lower, and that in fact is what we've been seeing in the last quarter or two. If you look back and see where our cost of interest-bearing deposits was in the second quarter compared to the third quarter, our third quarter number was 21 basis points below where we were in the second quarter, and we were 62 basis points lower than we were in the fourth quarter of 2019. So our deposit costs continue to come down, and based on maturities coming up in the next couple of quarters, we anticipate that we will continue to reduce those deposit costs, maybe not quite as rapidly as we did in the last couple of quarters, but we should still see some improvement on the cost of funds side. We are still experiencing a positive impact on our net interest margin and income related to the yield accretion on our FDIC acquired loans. That impact in the third quarter of this year was about nine basis points. We have about $2.9 million remaining in the accreted portion that's going to come into income over the next several quarters; about $930,000 of that should come in for income in the fourth quarter this year. Non-interest income for the quarter increased about $811,000 to $9.5 million compared to the same quarter in 2019. Much of that increase came in the form of gain on loans payable. Joe mentioned earlier that we originated a lot of fixed-rate single-family loans. We typically sell those loans in the secondary market, and our gain on sale was about $1.9 million higher in Q3 this year compared to the same quarter a year ago, so quite a lot of originations there and income derived from those as we sold those loans. Service charges, debit card fees, ATM fees, we continue to see a decrease compared to the prior year, about $927,000 this quarter compared to the year-ago quarter. We're seeing that kind of across a variety of things. Overdraft and insufficient funding fees are lower as customers have opted not to use those services as much as they were. So our utilization of those is down. A bit of that is probably due to being proactive in waiving fees and similar things for customers as part of our efforts during the pandemic. Towards the middle or late part of the third quarter, we were probably not waiving as many fees and similar things as we were earlier in the year. Towards the end of the third quarter, that fee income picked up a little bit from there. We've also seen a bit less usage in income from our debit card and ATM fees. That may start to expand as well, but there was a lull there during the middle of the year. Other income decreased compared to the year-ago quarter by about $442,000. We had a larger number of originations of interest rate swap deals with our loan customers in the year-ago quarter compared to where we were this year. Those tend to be a little bit sporadic; we have them throughout the year, but not always at the same time at the same magnitude each quarter. Non-interest expense increased by $3.3 million to $32 million this quarter compared to the same quarter in 2019. The largest portion of that was an increase in salary and employee benefits, which were up $2.9 million compared to the prior year quarter. The largest part of that increase was, as Joe mentioned, the bonus that we elected to pay to our employees. That was about $1.1 million of the increase. We also had a higher level of compensation, both salary and incentive, and additional personnel in the mortgage area. So that income I mentioned earlier was offset by compensation to the producers and the servicers in that area. We also had a few people out as part of needing exposure to COVID or similar things; they were quarantining at home, and we're continuing to pay people in that regard. So we incurred some costs associated with that. These are costs for part-time personnel, which are a little over a couple hundred thousand dollars. So those are the main drivers. I've also focused on additional insurance costs because we no longer have the credit on our FDIC insurance. We had a full credit last year, and now we have had only a partial credit and we had to start paying the full amount again this year, which contributed to higher insurance costs. Occupancy expense was also higher than it was a year ago, about $530,000. Some of that was depreciation. We rolled out some new ATM and ITM units late last year, and we've accounted for the depreciation on those, which is higher this year. We also had around $250,000 of repairs and maintenance costs in the third quarter. Non-interest expense related to other real estate owned and repossessions was lowered by about $400,000 compared to the prior year period. We are doing a good job working down the foreclosed assets we have; the repossessed autos show much lower levels than they would have been in the last couple of years, so we have less cost associated with foreclosed real estate and with repossession of autos and our auto portfolio. As mentioned before, our efficiency ratio for this quarter was 59.64%. That compared to 52.63% in the third quarter of last year. The higher efficiency ratio was mainly due to the higher level of non-interest expense that I mentioned and some reasons I just talked about. We also had a small decrease in total revenue; non-interest income was higher, but net interest income was a bit lower. So despite these increases in costs, our non-interest expense to average assets remained at 2.34% for the quarter this year versus the quarter last year. Assets have continued to grow, and the average assets for this three-month period were about $550 million higher or about 11% higher than they were in the third quarter of last year. Just a couple of last items to mention as we wrap up: income taxes; we had a bit higher than normal effective tax rate in the third quarter of 2020 and that was a bit higher year-to-date. We've got state taxes that we're paying in various states, and some of those were a little bit higher this year compared to previous years, which will likely impact our future effective tax rate. The gain we had when we terminated the interest rate swap earlier this year is flowing through our state taxes, creating a little higher taxable income in certain states, some of which have higher tax rates than others. The effective federal rates are pretty much the same; it’s a result of various state rates. We expect to refine our estimates throughout the year, but our effective rate for this year may be a little higher than our nine-month effective tax rate and may revert to a more normal level in 2021. Lastly, Joe mentioned CECL. We anticipate that we will adopt CECL with our fourth quarter information. It will be retroactive back to the beginning of the year and will flow through our full year numbers. Based on previous analysis, we do not believe there are any material deviations from earlier discussions. We will provide additional information during the fourth quarter. That concludes my prepared remarks. This time, we will entertain questions. I'd like to ask our operator to remind the attendees how to queue in for questions.

Operator, Operator

Thank you. Our first question comes from the line of Andrew Liesch with Piper Sandler. Your line is now open.

Andrew Liesch, Analyst

Hey, good afternoon, everyone. How are you?

Joseph Turner, President and CEO

Hi, Andrew.

Andrew Liesch, Analyst

Hi. So just want to focus on expenses right now a little bit. Higher this quarter than I was forecasting. You guys had a pretty good run rate below $30 million. It seems like maybe some of it was affected by the mortgage business this quarter. But is this the new run rate we should be using, or do you think it's probably still in that $30 million level?

Joseph Turner, President and CEO

Well, I mean, $1.1 million of it was for the special bonus, and so you need to back that out. There are some other COVID-related costs that relate to supplies and cleaning and equipment that will be with us for a while. I would estimate that probably $350,000 of our costs during the quarter were payments made to employees in quarantine. These costs will likely continue until we get out of the pandemic. I think the two factors that could adjust that would be the $1.1 million bonus adjustment and our mortgage-related compensation, which has increased by $800,000 from the third quarter of 2019. If you back those two numbers out or maybe normalize the mortgage volume, you would see an adjustment to around $30 million, but our mortgage volume continues to be strong. It's hard to see that changing as long as we maintain that volume.

Andrew Liesch, Analyst

Okay, thanks. That's helpful. And around the margin, it sounds like there are still some good opportunities on the funding side to improve some costs. What are you seeing on yield pressures right now? Is the funding cost benefit greater than what you're seeing on the yield side right now?

Rex Copeland, Chief Financial Officer

Probably; I mean, I think the funding costs are coming down a bit more. We have seen a slight decline in the yield on loans, as many of those are typically tied to higher rates than the new loans. I mean, if you look at our press release on Page 19, you can see our average yields and costs as of September 30. Those are point-in-time numbers. You can see where yields are on different asset classes. On the liability side, our cost of deposits as of September 30 is 67 basis points; it was 79 basis points for the quarter. We anticipate that we will see those costs come down a bit more. The other areas probably aren't going to change much. The subordinated notes are fixed-rate, and the cost associated with those is tied to LIBOR, which hasn't been changing much. The reduction on the funding side will come from deposits, and the yield will see a slight reduction as well, but the yield that we give you on the loans does exclude the yield accretion. So in the third quarter, we had a nine-basis-point benefit, which may indicate that yields are slightly higher than what we show.

Andrew Liesch, Analyst

Okay. That's very helpful commentary. I really appreciate it. I will step back. Thank you.

Operator, Operator

Thank you. Our next question comes from a line of Michael Schiavone with KBW. Your line is now open.

Michael Schiavone, Analyst

Hi, good afternoon. How's everyone doing?

Joseph Turner, President and CEO

Good. Thank you.

Rex Copeland, Chief Financial Officer

Good. Thank you.

Michael Schiavone, Analyst

Good. So fee income, in particular, mortgage sales, were really strong in the quarter. Can you just share some color on the mortgage pipeline going forward as well as your outlook for fee income in general?

Rex Copeland, Chief Financial Officer

I think we're still originating quite a lot of mortgage loans, and we've got quite a few commitments out there.

Joseph Turner, President and CEO

Do we have the mortgage pipeline in our pipeline numbers?

Rex Copeland, Chief Financial Officer

Yes, it's about – well, it's lower here. No, I'm sorry. It's a little bit lower than it was at the previous quarter end, but it's still around $94 million in commitments that are not closed. We've had a couple of quarter ends that were higher than that, but it's substantially higher than it was a year or two ago. I don't anticipate any significant decreases in the fourth quarter compared to the third quarter. I believe we're still busy in the mortgage group and producing quite a bit in new loan commitments. There may be some slowdown around the holidays, but so far in the early part of the quarter, not much has changed.

Michael Schiavone, Analyst

All right, thank you; that helps. The release noted some initiatives the bank is making toward modernizing and consolidating branch and office space. When you review your overall footprint, do you see further opportunity for larger-scale rationalization of offices or branches?

Joseph Turner, President and CEO

I don't really think so. Keep in mind, we've probably closed about 25% of our branches over the last four or five years.

Rex Copeland, Chief Financial Officer

35 branches.

Joseph Turner, President and CEO

Yeah, maybe more than that, maybe 30%. There could be further consolidation, but it would likely only be one or two banking centers here or there. I don't expect large wholesale changes. That's assuming customer behavior remains consistent; if it changes in 2020, and people start to use banks for different transactions, they still prefer to do in-person for significant transactions.

Michael Schiavone, Analyst

Okay, thank you. Last question: capital is at pretty healthy levels and you guys have actively been buying back shares and refreshed your share repurchase program, but can you just talk about your capital allocation priorities in terms of M&A, buybacks, dividends, organic growth, etc.?

Joseph Turner, President and CEO

We see the ability to continue to pay our dividend. Obviously, we’re going to seek growth wherever possible. We believe we can grow a lot without impacting our ability to maintain the dividend. The third priority would be buying back our stock, and we would prefer to buy our stock back at 80% of book or 90% of book rather than buying someone else's stock at a multiple above book. That's how we would prioritize.

Michael Schiavone, Analyst

Great, thank you. Thanks for taking my question.

Rex Copeland, Chief Financial Officer

Thank you.

Operator, Operator

Thank you. We have no further questions in the queue at this time. I would now like to turn the call back to Mr. Joe Turner for closing remarks.

Joseph Turner, President and CEO

We appreciate, as I said earlier, we appreciate everybody being on the call today. We'll look forward to talking to you after the end of the year, and hopefully, we will have a President and a vaccine that will provide hope. I certainly hope everybody has a wonderful and healthy holiday season. We'll talk to you in about three months. Thank you.

Operator, Operator

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