Sb Financial Group, Inc. Q1 FY2020 Earnings Call

Good morning and welcome to the SB Financial Group First Quarter 2020 Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Carol Robbins. Please go ahead.

Thank you, Elisa. Good morning everyone. I'd like to remind you that this conference call is being broadcast live over the Internet and will be archived and available on our website at ir.yourstatebank.com. Joining me today are Mark Klein, Chairman, President and CEO; Tony Cosentino, Chief Financial Officer; Ernesto Gaytan, Chief Technology Innovation and Operations Officer; and Jon Gathman, Senior Lending Officer. This call may contain forward-looking statements regarding SB Financial's performance, anticipated plans, operational results, and objectives. Forward-looking statements are based on management's expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied on our call today. We have identified a number of different factors within the forward-looking statements at the end of our earnings release, which you are encouraged to review. SB Financial undertakes no obligation to update any forward-looking statements except as required by law after the date of this call. In addition to the financial results presented in accordance with GAAP, this call will also contain certain non-GAAP financial measures. I will now turn the call over to Mark Klein.

Thank you, Carol, and good morning everyone. Thank you for joining us. Welcome to our first quarter 2020 conference call and webcast. As with prior quarters, comments today are supplemental to the earnings release we filed yesterday. These are uncertain times, and we have spent considerable time and effort in the quarter protecting our clients, employees, and our communities while preparing for our participation in the government stimulus program, and client forbearances that I'll discuss shortly. Reflective of the tangible capital we raised and have earned over the last five years, coupled with our historically strong credit quality metrics and liquidity, we feel we are well positioned to navigate this current crisis. We are confident that strong capital and a reputation for superior customer service and relationship banking will serve us well in these unprecedented times. All that said, highlights for the quarter, excluding the effects of the $2.2 million pretax mortgage servicing rights impairment, include net income of $2.4 million, down $350,000 or approximately a 13% decrease over the prior year quarter. Pre-tax pre-provision earnings resulted in a 3% improvement in our net income over the prior year. Adjusted return on average assets was 92 basis points, down from the prior year quarter of 95 basis points. Interest income expanded to $10.6 million, up $150,000. As a result, net interest income improved to $8.5 million, an increase of $210,000. Loan balances for the quarter grew $5.3 million, improving our year-over-year growth to over $48 million or 6.2%. Likewise, deposits grew and increased $24 million or 4.4% year-over-year. Expenses were up $800,000 due to higher mortgage commissions and a full quarter of our title insurance agency. Mortgage origination volume increased this quarter to a robust $101 million, up over $51 million or 97% year-over-year. Asset quality metrics were elevated a bit in the quarter due to the decline of an asset-based commercial loan, although our level of 61 basis points of non-performing assets remained strong. Finally, significant progress was made and is being made in processing customer forbearances and Paycheck Protection Program loans that we'll discuss shortly. We firmly remain committed to our five key strategic initiatives: growing and diversifying revenue, more scale to organic growth, as well as M&A that we have planned for the second quarter of 2020, more products and services with our 30,000 households, excellence in operation and more intimacy with client communications, particularly in these difficult times, and lastly, asset quality. First, revenue diversity. This quarter, mortgage volume and loan sale gains were up from the prior year, 97% on volume, 63% on loan sale gains. However, non-interest income declined to $2.2 million from the prior year quarter of $3 million due to the mortgage servicing portfolio impairment. Adjusting for that, non-interest income was up from the prior year over $650,000. Non-interest income, the total revenue declined to 20% but would have improved at 34% when accounting for the impairment. The mortgage pipeline continues to be near capacity with over 500 loans in process or approximately $117 million. Our numbers are spread across our four regions of Northwest Ohio and Northeast Indiana, $21 million; West Central Ohio Findlay at $16 million; Central Ohio Columbus was $69 million; and Central Indiana Indianapolis market for another $9 million. This quarter marked the one-year anniversary of Peak Title joining our company and the results have exceeded our expectations. Abby Waters and her team have integrated with our lending staff while they've maintained all of their prior banking client relationships. We continue to introduce Peak to our statement and commercial clients as appropriate. With a significant increase we're experiencing in mortgage volume, we certainly anticipate a record-setting second quarter for this newer division of SB Financial. Our SBA production came in at $1 million with loan sales of $436,000, a rather slow start to the year when compared to both the linked quarter and the year ago quarter with loan sale gains of just $79,000. For the last two months, this space was dominated by our participation in the Treasury PPP lending program. To date, under the first phase of the stimulus, we have approved over $74 million in loans to 414 businesses or over 99% of our clients that applied. All will be funded in a total of 10 days, and it might add no backlog. Over 95% of our commitments were to existing clients; the average loan amount is $178,000, median level just $71,000. We intend to take advantage of our preferred lending status to prospect for more new clients in the next phase of PPP funding, as we have plans underway to potentially deploy another $25 million. We currently have 133 additional applications or $6 million with 48 prospects and 85 clients already in the queue and ready for funding. We intend to expand these new client loans into full banking relationships, since capacity at some competitors to fund these loans has been constrained. We are now roughly one year into entering the Indianapolis market with a mortgage LPO. As we discussed in prior quarters, we've targeted the Indie market due to its similar market characteristics to our Dublin, Ohio operation, which has been very successful. After some early growing pains, we now have three lenders originating saleable mortgages. Back this quarter, we closed $7 million on our prospects to deliver on our short-term goal of generating $50 million annually has improved. Wealth Management assets under our care now total $427 million, which is a pullback from the all-time high we achieved and reported December 2019 of over $500 million. Given the headwinds of market forces, we feel that this important business line, which is clearly unique to a bank our size, provides a full service that a relationship-based client we seek desires. Our second key initiative, more scale, came into 2020 with a very strong loan pipeline that has been impacted by the current pandemic situation, although we did grow loans in every month of the quarter. Back we were able to add $5 million to our loan balance to this quarter, but certainly well below our expectations and historical growth levels. Loan growth from the prior year was up by $48 million or 6%. Our Lima and Columbus regions lead the way growing 37% and 16% respectively. Net interest income increased to $8.5 million, which is 2.5% above the prior year but flat to the linked-quarter. Total assets now stand at $1.1 billion and reflect year-over-year growth of $67 million or nearly 7%. Our deposit base expanded to $864 million, up $24 million or 3%, which is a year-over-year increase of deposit growth of $36 million or 4.4%. The need for us to provide more options by which our clients can access our services and their financial assets has been made much more evident in this past quarter. We have become more flexible and innovative in how we engage with our clients, and the electronic aspect of client servicing engagement and delivery will continue to accelerate. Our third initiative is deeper relationships and more services per household. This quarter outside client calling efforts were re-channeled to phone calls and digital communications. When our economy literally shut down, we made a commitment to proactively contact 100% of our commercial clients to ensure them that we were prepared to provide for their liquidity requirements when called upon. We believe that this proactive calling effort was directly responsible for our successful participation in the PPP lending program I just mentioned. The requirements of the program in terms of documentation, quick funding, and tight approval window certainly put our commercial teams to the test, but they clearly delivered. Our dynamic referral process continues to be a differentiator for our company, and we've reported in prior quarters. This quarter, we added over $22 million in new business from 222 closed referrals; that's nearly double of what we achieved in the first quarter of 2019, and over the last two plus years, one of our better referring quarters. Our fourth initiative is operational excellence. We had a notable shift in our mortgage business mix in the quarter. For all of 2019, the split between internal refinance and new clients of State Bank was 19% internal, 81% new clients. In the first quarter of 2020, the percentage of internal refinance expanded to 24%, with the month of March coming in at nearly 30%. Given the size of our current pipeline, we expect that higher internal refinance volume will continue well into the second quarter. After the optimization at our processing locations has been a key focus, we were incredibly pleased to have been able to originate nearly $500 million in residential real estate loans over the last four quarters, quite a testament to the hard work done by our originators but clearly, it would not have been possible without support from our backroom and our operation staff. We have increased our servicing portfolio to over 8,200 loans, with a principal balance now of $1.2 billion; household is up 7%, balances up 11% from the prior year quarter. Expense levels for the quarter were up from the prior year, but when adjusted for the additional $50 million in mortgage volume, expense growth drops from 9% to 4%. We have implemented a cost reduction plan that includes a number of expense containment initiatives in response to not only the pandemic but the rapid decline in short-term rates reflective of our asset-sensitive balance sheet. We understand how critical expense control will be in 2020 given the business headwinds we're facing. Our fifth and final key initiative is asset quality. We have spent considerable time and effort in the quarter and thus far in April responding to our clients' needs for assistance and relief from the current business situation we find ourselves in. We have approved forbearances for our clients in nearly all business lines. Total of 588 loans representing balances of approximately $171 million; 231 in sold residential mortgages representing over $40 million in balances, 177 commercial loans representing over $107 million in balances, and the remainder of 67 loans for $14 million in consumer loan balances. This quarter we had a spike in charge-offs due to one asset-based inventory loan that we placed on non-accrual for $2.3 million. We were clearly disappointed about the sizable impact this client had on our historically strong asset quality metrics. As a result, our reserve to non-performing coverage declined to 136%, but still above the median of our peer group. Finally, we have taken an expanded look at new credit terms for businesses and clients as we anticipate the longer-term effects of a slower growth or no growth economy going forward. Specifically, we have reduced LTVs on CRE deals and increased requirements for borrower liquidity to ensure ample debt service coverage capacity while assessing and reassessing internal approval requirements. I continue to have great comfort with our historically strong credit approval process, including our dynamic loan review schedule. And now, I'd like to ask Tony Cosentino to provide some more details and color on our quarterly performance.

Thanks, Mark. And again, good morning, everyone. For the quarter, we had GAAP net income of $681,000 or $0.9 per share. As Mark noted, our earnings were impacted by the $2.2 million impairment on our mortgage servicing rights and absent that impairment, that income would have been $2.4 million, down $0.4 million which is a 12.8% decrease. Highlights in the quarter included operating revenue, down 5.6% from the prior year, but up 7.3% when we adjust for the OMSR impairment. Loan sales delivered gains of $2.1 million for mortgage, small business and agriculture, and margin revenue was higher by 2.5%. As we break down further, the income statement beginning with our margin; net interest income as indicated was up from the prior year by 2.5%, and flat to the linked-quarter. Our average loan yield for the quarter of 4.74% decreased by 16 basis points from the prior year; overall earning asset yield was down 46 basis points. We had anticipated higher loan growth in the quarter and had been weighted in cash in anticipation of these fundings, as well as preparing for any client liquidity needs. These higher liquidity levels had a downward impact on earning asset yield, and we expect our mix to improve in the second quarter as we will reduce cash levels, and mortgage volume would be a positive to our margin while the PPP program will increase the dollars of NIM slightly. On the funding side, as expected, the quarterly increase in the cost of interest-bearing liabilities we experienced throughout 2019 discontinued this quarter. For the quarter, the rate on our interest-bearing liabilities was 1.12%, down from the prior year by 8 basis points, and importantly down from the linked-quarter by 30 basis points. Net interest margin at 3.48% was down 33 basis points from the prior year. Now as I said, we expect our margin to improve in the coming quarters with higher mortgage fees and continued declines in funding costs. Total interest expense costs are down by 3% from the prior year, but down 20% from the linked-quarter. Our margin income growth was also driven by loan interest income of $9.9 million, which is up $0.4 million or 4% from the prior year. Total non-interest income of $2.2 million was down from the prior year reflecting the impairment of our mortgage servicing rights and was offset by higher mortgage origination volume. Adjusting for the impairment, non-interest income would have been up $0.7 million or 18%. In the SBA arena, our originations were down from the prior year with a volume of $1 million compared to $3 million in the prior year quarter. Our results did include a full quarter revenue from our title agency, and compared to the first quarter of 2019, increased revenue by $0.3 million. Second quarter mortgage production should eclipse all records for our company. We also expect to improve upon our gain yields as hedge performance will trend higher, with reduced rate volatility expected. This quarter's real estate volume from new clients was down from historical levels but still was 76% of total volume. Total gains on sale came in at $1.9 million which was 2.3% on our sold volume of $84.4 million. Our servicing portfolio of $1.22 billion provided revenue for the quarter of $756,000 and is on pace to deliver $3.1 million in total revenue in 2020. The market value of our mortgage servicing rights declined significantly this past quarter. Calculated fair value of 74 basis points was down 32 basis points and 25 basis points from the prior year and linked-quarters and did result in a $2.2 million impairment. At March 31, 2020, our mortgage servicing rights were $9 million, which is down 17% from the first quarter of 2019 and down 19% from the linked quarter; total impairment currently remaining is $3.5 million. Total operating expense in the quarter of $9.4 million was up $0.8 million or 9% from the prior year, but compared to the linked-quarter expenses were down $0.8 million or 7.6%. The higher level of mortgage volume drove compensation higher versus the prior year in addition to higher medical costs. Other expense growth from the prior year was driven by higher digital banking costs as we had more users and some higher legal expenses. We also incurred higher costs related to our mortgage hedging activities as we discussed, due to not only the higher volume but also the higher volatility in the secondary markets. A full quarter for Peak Title compared to the prior year increased operating expenses by $0.2 million. Now let's return to the balance sheet; loans outstanding to March 31 stood at $830.8 million, which was 76.3% of the total assets of the company. We had growth of $48.2 million and asset growth of $67 million from the prior year, and we're up $5 million and $50 million respectively from the linked-quarter. Compared to the prior year, loan growth is driven by two categories mainly: commercial real estate at $34.3 million, followed by commercial loans at $15.3 million. Deposit levels are up 4.4% from the prior year as we lessened our aggressiveness on deposit gathering in response to our lower loan originations. Also, with our eye on the Edon acquisition scheduled for the second quarter, we will have significant funding surplus of lower-cost core deposits when the transaction closes. As Mark indicated, we are participating fully in the PPP funding facility and we have structured the borrowings to fund the bulk but not all the $74 million in PPP loans. We are prepared to expand that borrowing capacity as needed to fund the second phase of this small business lending facility. Looking at our capital position, we finished the quarter at $135.9 million, which is up $4.4 million or 3.4% from March 31 of 2019; and our equity to asset ratio stands at 12.5%. In addition to our reported loan balances, our clients could draw an additional $200 million on approved lines and commitments. In the unlikely event that that would occur, our capital ratios would still be above our internal targets. For this successful conversion of our preferred shares in late 2019, tangible equity is up from the prior year by $18.4 million or 18.4%. On a per-share basis, tangible book is up $1 per share from the first quarter of 2019. We have been able to buy back a number of shares below book value this year, and we still have shares left under our current authorization. Regarding asset quality, total non-performing assets of $6.7 million are up $2.4 million from the prior year, but flat to linked-quarter. Included in our numbers are $0.8 million in accruing restructured credits. These restructured loans elevate our non-performing level by 8 basis points. In absence of those restructured credits, total non-performing ratio would reduce to 53 basis points. We understand that certain segments of the economy will have an oversized negative impact from the buyers. For our portfolio, we have $73 million in these at-risk segments, half of which is in the hotel category. However, only 15% of that $73 million is related to restaurants, bars, and sports facilities. Taking into account these levels, our overall diverse portfolio concentration levels and appropriate allowance levels by category, we are cautiously positive regarding credit deterioration. Provision expense for the quarter was $0.6 million, up from both the prior year and a linked-quarter. As Mark indicated, we charged off an asset-based loan in the quarter of $400,000. Our absolute level of loan loss allowance at $9 million is up from the prior year by 10.3%, and our allowance to loan loss percentage has increased from 1.04% a year ago to 1.08% currently. Absent the impairment, our results were largely in line with expectations in the quarter. Looking forward, we will see delays in the loan pipeline as our clients have hit pause a bit, and potential credit metric weakness will be offset somewhat by the impact of not only the PPP program but our forbearance activity. And as we have also indicated, we were trending toward a record mortgage origination and mortgage revenue quarter in Q2. I'll now turn the call back over to Mark.

Thank you, Tony. No doubt this quarter presented some opportunities as well as challenges, including the servicing portfolio impairment that Tony discussed. We anticipate that the economy and our markets will trend in much the same direction as the rest of the country, albeit with, again, slower growth or no growth in the next six months. That said, we remain quite optimistic that our commercial mortgage and SBA business lines will continue to provide the inertia for more earnings momentum well into the second quarter. Also, we just announced an 11% increase in our common dividend. As we sit today, we expect the dividend level would continue our measured pace upward throughout 2020. I want to thank all of our more than 250 employees for helping our clients and communities with their everyday financial needs over the past few months. Clearly, our senior leaders have demonstrated exceptional flexibility and leadership under some pretty difficult times. Now, I'll turn the call back over to you Carol for additional questions.

Thank you, Mark. I'd like to remind everyone on the call today that this webcast will be available on our website at ir.yourstatebank.com. Elisa, we are now ready for our first question.

Thank you. We will now begin the question-and-answer session. The first question today comes from Brian Martin of Janney Montgomery, please go ahead.

Hey, good morning guys.

Good morning Brian.

I appreciate your comments, Tony, regarding the industries and potential risks or key issues in hospitality and restaurants. Can you provide some insight into how those sectors are currently trending? Additionally, could you offer some reassurance about the loan-to-value ratios for those properties? I'm looking for your perspective on how you believe they will perform as we navigate this potential downturn.

Hey Brian, just a couple of comments. Jon Gathman is with us and rather than speculate a bit, if you don't mind, I'd like to ask Jon to give us some few comments with regard to those particular sectors.

Sure. The short answer to your question is that we have entered into forbearance agreements for nearly all commercial loans that have requested one. Currently, 79% of those industries are deemed at-risk according to our definition, representing about 7.5% of our portfolio. Although there has been no increase in delinquency for those under forbearance, and we anticipate some pressure to emerge. The average loan-to-value ratio is 66%, but this figure can be misleading. For the at-risk loans, we have not engaged in any high-risk loan-to-value business that exceeds 80%. Most of these loans are likely in the 60% to 70% range, and we expect to see some marginal additional losses from the at-risk industries, which account for 7.5% of our total portfolio.

Okay. As for the current situation, no one is making any moves yet, they are in forbearance. The largest portion of the portfolio seems to consist of hotels, which account for half, and you mentioned that restaurants make up about 15%. Perhaps I missed that part of Tony's comment.

No, that's correct. Yes, of the 7.5%, almost exactly half are hotels. For those hotels, we have an average loan-to-value of 56%. Averages can be misleading; there are a few very strong performers among them. Out of the total hotels, which represent $35 million, $16 million have not requested forbearance and are currently in a position to handle the situation for the next three to six months, provided there isn’t a prolonged impact from the virus. As of now, we haven't observed any increase in our delinquency rates. The remaining approximately $20 million worth of hotels are under some level of forbearance, primarily not due to inability but rather because they chose to. We have entered into specific negotiations on two hotels that I am aware of, which total $12 million, accounting for about 8% of the 7.5%. This means we have less than one-tenth of the $7.5 million at risk. One of these hotels is located in Indianapolis near an airport, and the other in Columbus; both are well-positioned to rebound when travel restrictions are lifted.

I understand. There was a larger provision this quarter, and as you evaluate the situation, do you expect to build reserves going forward? How should we approach this as the situation develops and you receive more inquiries from customers? Many banks seem to be proactive with reserve building this quarter, and I'm curious about how we should view this for your company in the upcoming quarters.

Brian, I have a few general comments to share. The PPP program and forbearances have both been a bit of a mixed bag. However, they are providing significant relief to our clients and helping them manage their liquidity needs. We're optimistic about the loans we've issued over the past decade, especially during the favorable market conditions. Jon and I, along with our Strategic Management team, have discussed the opportunities the PPP program may present for our clients and the associated potential fees. It's important for us to consider how we might prepare for any future challenges in our portfolio. Jon, feel free to elaborate on what I've just mentioned.

Well, I would just add, certainly your comments are well-founded. As we look to triple-off for the first quarter, which as you know, a triple is largely looking backwards model. Our credit quality has been so good for such a long time that we were somewhat limited but we did make significant adjustments in environmental factors, as you might have imagined, reflective of the current environment. I think the increase in provision was as much about those changes in environmental factors as it was that specific credit where there was room in the reserve to handle a specific credit. But we are certainly keeping our eye on the future and adjusting those environmental factors as mentioned.

Okay. Can you discuss the PPP and confirm if it was around $75 million? What do you anticipate the rate will be on that? If it's a 3% rate, it seems like it could generate a couple of million dollars, maybe over $2 million in fees. Are you expecting to receive most of that benefit in the second and third quarters, or will it come in more gradually? I'm interested in both the percentage and your thoughts on how it will impact the income statement.

Brian, this is Mark. Just one comment; from my seat, I'm really optimistic about the applications we've taken, with the average of $170,000 and a median of $71,000. We've clearly held the line on 414 applications that go to where the government had intended, which is to small businesses. That said, John, I know there are some weighted numbers out there as to what it is potential that we might realize on fees on those 414 loans.

Yes, that is correct. We expect to provide additional guidance, as some details regarding the fees were released yesterday. However, I am very pleased with our approach at State Bank to inform our customers with the knowledge we have, given that the SBA program has been rushed. We are focused on ensuring that our borrowers and lenders understand the program's expectations. In response to your question, we anticipate that most of this will be fully forgiven, and when everything is settled, only a very small proportion of the additional credit may not be forgiven by the federal government.

Yes. And Brian, I would just add; in terms of as Mark and John both have said, in terms of the forgiveness of the client, relative to the fee side indications and guidance today are that we will get that within 10 days of funding. So, our expectation is all of our first tranche will be funded by the end of the day today. So we would anticipate by no later than mid-May at the worst that all those fees would endure to us.

Okay. If you start collecting the fees as mentioned, and considering that they might only be available for 90 days, would the majority of the revenue then be realized in the third quarter? If you think about it, you would collect some fees during the two months they are available in the second quarter, and then most of that revenue would spike in the third quarter. Is that how we should understand this?

I would be the opposite. We would ignore all of the fee side in Q2, and then whatever else on the margin side, at that 60 to 65 basis point spread between the one and the 35 ongoing; our expectation is 80% of our $75 million will fully get provided and forgiven in the eight-week period. So we'll have an increase in balances on an average basis that will flow back down by 3Q and 4Q.

And Brian, one comment; as I've said in my remarks, we were quite pleased with 95% of our numbers going to known clients that we have. So we've not taken a flyer on anything yet where we've just allowed anybody to come in the front door and do a PPP. I mean this is clearly for small businesses and our clients predominantly. That said, this next round, we're looking at taking just a little bit of a bigger bite on the prospect side because we literally think there are a number of competitors out there who never want and are not prepared to handle the backlog, and we think we can marginally move to a little higher level with this new $310 billion that was just approved.

There is still a lot of uncertainty. Some banks have indicated they will implement the fee gradually over a 24-month period, starting with a portion of it and receiving the bulk when it is paid off. Until we have more clarity, this will remain a moving target for many. Regarding the margin, there are many factors at play. Considering the emergency rate cuts, the mortgage fees expected in the next two quarters are common, along with your proactive approach on the funding side. To sum it up, how are you approaching the margin for the second quarter today, and what is your outlook going forward, given the current rate environment?

Yes, I'm sure Mark will have some comments. As I mentioned earlier, we may have been a bit too cautious regarding liquidity. We weren't entirely certain about the situation with some of our clients and their expectations. We discussed a potential utilization of $200 billion; however, our clients have remained relatively stable and secure, which we felt good about, but we didn't want to be caught off guard. As a result, we held a bit more cash, which did affect us in one quarter, but this is expected to change in the second quarter. We will fund the PPP program, with part of that coming from internal sources, and we started cutting deposit rates around March 1, continuing to lower rates positively. Most of these changes will be reflected in the second quarter. I believe we will also see a significant increase in mortgage activity in that period. While the growth in our earning asset balance was somewhat balanced out by pricing, we ended up in the same position we were before. I anticipate that pricing will improve slightly in the second quarter, but our earning asset balance may decrease by about $15 million to $20 million because the loan pipeline is not as strong as we had hoped.

And the other part to that comment Tony, it does not generally include the $48 million that we anticipate coming from the Edon acquisition, albeit at most likely would have 36 basis points, probably going to go down dramatically, not any better than the 35 basis points we have with the Fed, but clearly a lot less than our current marginal cost of funding at 1.12 or so. So that'll help us on a little bit upfront, give us a little bit of margin left.

Yes, okay. So that's the direction, Tony. It should increase in the second quarter and then probably rise even further in the third quarter. I’ve noticed something regarding the acquisition of Edon. I’m not including the PPP for now, just focusing on the other components; so on the liquidity and funding side, you're making adjustments but to say, it should increase in the second quarter and maybe even a bit more in the third quarter as it stands today?

I agree with that. Yes, that's our expectation.

Okay, that's helpful. Can you provide an update on your mortgage outlook, specifically regarding production for the year? Additionally, how has the gain on sale margin changed this quarter, considering the refinance activity? I'm trying to understand that dynamic as we move forward.

Thanks Brian, this is Mark. I remain very optimistic about mortgage lending; we are currently operating at a run rate of $500 million. We are in discussions with Ernesto Gaytan to strategize on how we can optimize our operations in the markets of Indianapolis, Columbus, and Northwest Ohio. We aim to enhance our efficiency and potentially reach $750 million by leveraging new software and processes. As we anticipate that rates will stabilize, we expect the refinancing activity in our portfolio to decrease over the next couple of quarters. That said, we are observing improvements in the purchase side, while some competitors have set restrictions on purchases requiring 20% down and a 700 credit score. We see opportunities in this area, though we remain cautious with our PCG mortgages, as well as Freddie and Fannie products. Overall, we are still optimistic about this business segment, but we expect a decline in refinancing activity once rates settle at around 3%.

If I might add, Brian; I think Mark is spot on in terms of volume. I think we're going to have, as we said, a record setting level in the second quarter based upon what's already closed and what we anticipate in the pipeline. And I would say, candidly, I've been around the mortgage business a long time, it was one of the tougher pricing markets we've ever seen in terms of secondary, in terms of correspondent pricing, in terms of what people were giving you on the backend to buy product and there were a lot of lenders that got kind of caught out with bad pricing, and we hung in there a little bit. But we paid a little bit of price on the hedge and what we backed off on due to volatility. I anticipate rate volatility to significantly subside, and we'll start to make a little bit more money on the yield side and on our hedge side; so that's why I anticipate that it's going to be much better here in 2Q.

And Brian just one sidebar, we have begun to do a little bit more strategic thinking about how it is we can potentially differentiate how we approach pricing in four distinct different markets, which we think will give us a little bit of opportunity to again, determine how do we go from a $500 million run rate to $750 million, albeit with a little bit more of a regional approach to pricing and closing and processing. And Ernesto is leading the charge for us in that arena.

Got you, okay. I was just going to ask Tony or Mark if the gain on sale margin might be a bit lower than it is today as we move into the next couple of quarters. I think it is around 2.3% right now.

I would expect that to be the baseline we consider moving forward. We were looking at about a 2.5% range for 2019 overall, so I anticipate we'll perform slightly better in the second quarter.

Okay, perfect, that's helpful. And maybe just one more, it was just on the cost reduction plan. If you can just give a little bit of color on; I guess the impact or just simply look at the current level of expenses, however, you can talk about that, just your expectations for the expenses as you go forward here outside of the ebbs and flow that come with the incentive for mortgage, just kind of the core rate that we're looking at from an expense standpoint.

Yes, as we examine the operating expenses for the quarter, we see some fluctuations due to the higher mortgage volume and the Peak Title impact compared to the previous year. However, when looking at the previous quarter, we had certain incentives that were removed in the first quarter of '20. We believe this provides a solid baseline moving forward. Currently, we are uncertain about how reopening locations will affect customer interactions and the associated costs. Although we have some insights, the exact nature of cost containment and differentiation remains unclear. We have implemented strategies regarding compensation and other factors that we believe will support us in the future.

Yes. From a detailed perspective, we are observing very limited changes in compensation, if any; we are reviewing our contributions to the ESOP, our incentive plans, travel expenses, marketing costs, and conference expenditures. We have implemented a hiring freeze to ensure we are not operating in a business-as-usual manner. Just because someone held a position doesn’t mean we will automatically replace them. A few years ago, we were fully optimistic, but in 2018 and 2019, our outlook shifted to about 80% optimistic and 20% pessimistic, and as we entered 2019, we became even more pessimistic. Now in 2020, our cautious approach to business has served us well during this unexpected pandemic. We are examining everything closely, aware that conditions may become increasingly challenging in a no-growth economy. We believe we have demonstrated our competence in underwriting credit, and our process of involving multiple people in reviewing credits has been effective. Thus, we remain cautiously optimistic about our direction amidst reduced activity and tighter expense management.

Got it. You mentioned that loan growth is a bit slower, which is understandable. As you reflect on your outlook for 2021, are you adjusting your growth projections based on the current situation? Additionally, could you provide an update on the timing of the Edon transaction and how that’s progressing? That’s all I have.

Yes, this is Mark. I would like Jon to share his insights. Regarding loan demand, we have previously mentioned that we are pleased to be at the median level of growth, and we don't aim for the 75th percentile like we do in other areas. We have been satisfied with the 5% to 7% medium to high single-digit growth in lending. This aspect will be beneficial for our current position in 2020. Jon will provide additional comments on that. As for Edon, we are progressing well and expect to complete the financial aspects and integration in the second quarter. Operationally, we anticipate full integration and a name change in the third quarter. Jon, could you provide more insight on loan demand expectations for 2021?

Yes, I agree with what Mark said. You know, we have the right people and we're in the right markets, we expect to be at that median or slightly above median level with some really, really key people in those markets and in the right markets. That said, what that median level of growth is as we look at the third and fourth quarter; that'll be the challenge, and we have realistic expectations of what that might look like, but we expect to fare as well or better than our peers.

That's a great comment, Jon. What's the new normal? What's the new median? So that'll be the key, Brian; what's the new normal and new median, and what's GDP going to be, and what do we have here and how many more stimulus programs are left or how many can they monetize and going forward?

Yes, there is a lot of uncertainty. The Edon deal was intended to utilize some of that excess liquidity, so it may alter the dynamics slightly or extend the timeline depending on the level of growth we should consider, especially if it's expected to be high.

Yes. I think Brian, at high level and you know all this. Clearly, with forbearances; and Jon and I have talked about this, with forbearances and PPP, we're going to delay principal pay down just by default. And if we do that for three to six months and get some regulatory guidance on how far we can go, and you add PPP in that, and some clients are still taking advantage of the landscape, the people that put themselves in a position with liquidity and have a good business model; we think we've put ourselves in a position to capitalize on whatever small growth is going to be out there. So, we remain cautiously optimistic and we hope we can come through this at the end of 2020 looking like we had a pretty good solid model coming into the beginning of the year.

Yes, okay. Well, that all sounds good. Well, I appreciate all the color. Thanks for taking my questions.

Thanks, Brian.

Take care, Brian.

The next question comes from Toni Molinari of Cutler Capital Management, please go ahead.

Good morning, Toni.

Hi, how are you doing?

Just great.

I was hoping you could shed some color on the credit stress testing that you've done to your commercial portfolio and what the results look like? And if you can include things like unemployment rate and cap rates, that would be helpful.

What I can tell you is that we have evaluated 7.5% of our first wave at-risk industries. We have completed reviews on all of those. As Mark mentioned earlier, we expect our borrowers to be able to endure a short-term setback if we are conducting proper underwriting, and I think that's what we have observed as we sit here in April. We have assessed all those for cash liquidity and capital going forward in terms of actual cap rates and stress testing; however, we have not conducted that at this moment.

Okay, thanks. And then, if you could provide a little more color on the forbearance program that you're offering, is it 60 days, 90 days, four months?

Yes, I would say with the exception of Freddie Mac that has their own set of rules or SBA, any government agency that has their own set of rules. On our internal portfolio, we've started with the policy, we've done a 60-day curtailment waiver on all four plans and three months or 90 days of principle, largely principle forbearance and principle interest for all categories of loans with the knowledge that three months may not be enough, and we'll be assessing that here in probably early May.

Toni, interesting to note, of course, as you're well aware, we have probably a residual portfolio of maybe $20 million, Jon, on SBA, on our books that awaited yield of 7% plus. And recently, we did the calculation with a six-month forbearance coming from SBA; we're going to receive about $500,000 to $550,000 per month for six months on behalf of our residual portfolio for the clients that we've done SBA loans on. So that's going to be great relief, as you're well aware to all of our SBA clients, hard to figure out where the government's getting all the money but we kind of sort of know where but that's got to be a positive for the business line that we've been doing for actively five years now or so.

Great, thank you. That's really helpful.

Take care.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Klein for any closing remarks.

Once again, thanks to everyone for joining us this morning on our first quarter webcast and conference call. We look forward to certainly connecting with you in July for our second-quarter results, which should include the closing of our acquisition of Edon State Bank. Thanks for joining, and goodbye.

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