Sb Financial Group, Inc. Q3 FY2024 Earnings Call

Good morning, and welcome to the SB Financial Third Quarter 2024 Conference Call and Webcast. I would like to inform you that this conference call is being recorded. All participants are in a listen-only mode. We will begin with remarks by management and then open the conference up to the investment community for questions-and-answers. I will now turn the conference over to Carol Robbins with SB Financial. Please go ahead, Carol.

Thanks, Dave. Good morning, everyone. I would 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; and Steve Watz, Chief Lending Officer. Today's presentation may contain forward-looking information, cautionary statements about this information, as well as reconciliations of non-GAAP financial measures included in today's earnings release materials, as well as our SEC filings. These materials are available on our website, and we encourage participants to refer to them for a complete discussion of risk factors and forward-looking statements. These statements speak only as of the date made, and SB Financial undertakes no obligation to update them. I will now turn the call over to Mr. Klein.

Thank you, Carol. And good morning, everyone. Welcome to our third quarter conference call and webcast. Highlights for the quarter include: Net income of $2.7 million, and when adjusted for the servicing rights impairment, net income was $2.4 million. Diluted earnings per share as adjusted increased to $0.41, a 3.3% increase from the adjusted $0.40 that we delivered in the prior year quarter. Tangible book value per share ended the quarter at $16.49, up from the $13.90 last year, a 26% increase. Net interest income totaled $10.2 million, an increase of 6.8% from the $9.5 million in the third quarter of 2023. From the linked quarter, margin revenue was up $527,000, or a 22% increase on an annualized basis. Total loans increased to $1.03 billion, up by nearly $41 million or 4.1% from the prior year quarter and higher compared to the linked quarter by nearly $25 million. The linked quarter growth would equate to an approximate 9.8% annualized increase. Our year-to-date return on tangible equity was down slightly from the prior year, but still a solid 10.4%. Mortgage originations for the quarter were $71 million, and year-to-date, we've now originated $188 million. The annual origination level is up 12% from the prior year-to-date. The servicing portfolio improved to $1.41 billion, which was up from both the prior year by 2.9% and from the linked quarter by approximately 4.7% annualized. Operating expenses for the first nine months were up approximately 1% compared to the prior year same period. Finally, asset quality metrics remained stable compared to the linked quarter. Our strategic path forward remains hinged on our five key strategic initiatives we've discussed in many quarters. First, revenue diversity. We remain focused on growing both our traditional margin revenue and fee-based revenue. A larger balance sheet is delivering the former, and the real estate mortgage business line continued to contribute to the latter. While the mortgage market remains challenging with persistent high rates constraining our momentum, we have fortunately seen continued growth in other fee-based areas such as wealth management and our title insurance business. Our goal remains to consistently drive our fee-based revenue to the 35% level, all else remaining constant. Current levels at approximately 30% still place us well into the top quartile of our peer group of 65 publicly traded U.S. banks between $500 million and $2.6 billion. Organic growth for greater scale. We achieved a double-digit annualized growth rate in our loan portfolio this quarter, and we continue to have a very strong pipeline in several of our markets. In fact, our Fort Wayne and Columbus markets were up 18% and 12%, respectively, from the prior year. However, our fractional market growth is not good enough for our model without all of our reasons contributing to our growth. We expect to have more of our reasons with a positive year-over-year loan portfolio growth in 2025. Deepening relationships, or more scope. Our deposit base grew by $74.2 million to $1.16 billion and was up over $44 million from the linked quarter. Revisiting the Homebuyer Plus program that we've discussed extensively, we have met our internal goal of $50 million and acquiring low-cost deposits, and we are always pleased to assist prospective homebuyers with a state of Ohio-subsidized initiative that for us included over 100 new client relationships. And of course, always operational excellence. We continue to add additional talent throughout the organization as we remain focused on using technology, market consolidations, and disruptions to acquire new client relationships, drive greater services per household in existing ones, and leverage customized communication channels to identify more diverse client opportunities in the digital space. Finally, asset quality was certainly stable compared to the linked quarter. Compared to the prior year, our level of criticized loans declined by 41%, and our classified loans were reduced by 11%. Taking a closer look at revenue diversity, our mortgage business line originated $71 million of volume, an increase of nearly 16% from the $61 million over the prior year quarter. Mortgage sales of $61 million represented 87% of our total originations. Our capacity remains nearly double the level of our current trailing 12 months of origination volume, but we remain bullish on the business line and expect our 2025 volume level will be at least 20% to 30% higher than the 2024 forecasted level of approximately $265 million. Noninterest income was down slightly at $4.1 million as the impact of several non-core items, including the impairment of our mortgage servicing rights, halted the quarter-over-quarter growth that we had experienced during 2024. Our title business and wealth management services have steadily improved all year, and we remain positive about their continued contribution to our revenue and bottom-line net income. Regarding the wealth management business line, new sales this year have actually exceeded our expectations. We have added new sales talent that we expect to be fully integrated and delivering new clients and new assets under our care in 2025. On the scale front, deposit growth has accelerated. Again, as I indicated earlier, this quarter we were up by $44.3 million compared to the linked quarter and up 6.8% from the prior year quarter. Our deposit cost of funds was 1.94% this quarter, up from 1.86% in the June quarter and 1.53% in the third quarter of 2023. The trend line continues to move higher but certainly at a much slower pace. Given our neutral to slightly liability-sensitive balance sheet, we anticipate that a measured gradual decline in overall market rates will strengthen our net interest margin in the coming quarters. Loan growth continues to gain traction. In fact, this quarter, we had our strongest level of linked quarter growth in over two years. Pipelines are much stronger today, and Columbus is on pace to deliver over $50 million in growth for the full year of 2024. We've not touched on the quality of our ag portfolio much in the last several years, but our $65 million portfolio continues to perform very well with virtually zero loan losses, representing the prudent approach we take to providing liquidity to our ag producers. Farmers in our region continue to experience high yields, with over 80% of our clients now carrying some form of crop insurance. To supplement our net interest margin, we have aggressively pursued the State of Ohio Ag Link program, which has bolstered our deposit base by $14 million and improved margins on these funds by well over 200 basis points. A strong equity foundation remains a prerequisite to our growth, and this quarter it continued to improve. We are very comfortable with our capital strategy and feel we have a significant level of capital to continue to take advantage of multiple strategic options. In terms of deepening existing relationships, in other words more scope, we continue to embrace technology to enhance client engagement. This quarter, we expanded the services of our contact center to 7 a.m. to 7 p.m. This move has made a positive contribution to our level of client care and bolsters our quest for greater brand loyalty. Although slightly more costly, we feel this will be a strong differentiator for our company as we capitalize on market disruptions. Organic expansion continues to be a focus. We have selectively added to our account pool this year with expansions in Columbus and Cincinnati, new sales emphasis and capacity in wealth management, and recommitting to the Northern Indiana market. We believe that these selective growth strategies will deliver positive results through the fourth quarter this year and well into 2025. Speaking to operational excellence, the mortgage business line remains a key driver. Our levels of client care and the residential real estate business line have improved as we have maintained a stable portfolio of nearly 9,000 households that we service, generating over $3.5 million in fees annually. The headwinds that we have experienced this year continue to reflect both the lack of available inventory and the continued pressure of higher mortgage rates. That said, our pipeline has improved lately, exceeding $30 million, up 30% from the run rate, as slight movement down in rates has moved some clients from the sidelines. Although refinance volume is still well below our historical levels, it now represents 10% of our current pipeline. As we discussed in prior quarters, we've expanded our presence in a new market. Specifically, we are focusing on the Cincinnati market, which has similar characteristics to the Columbus and Indianapolis markets. We're now up and running with two MLOs in that market, and we closed our first deal in September with a solid pipeline scheduled for the fourth quarter. We think once fully integrated, that Cincinnati initiative will match and potentially exceed the production of our other urban markets. Finally, asset quality, always a hallmark of our company from origination to our expansive review process. We had minimal charge-offs in the quarter, with delinquencies slightly higher at just 65 basis points. Clearly, our commitment to growing our balance sheet and loan portfolio in Columbus and other markets will require us to remain steadfast in our credit underwriting and ensure that our loan review early warning signs are in tune with the ever-changing economic cycles. I'll now turn it over to Tony Cosentino, our CFO, for additional comments on the quarter.

Thanks, Mark, and good morning, everyone. Net income for the year is $7.8 million, delivering a full-year EPS of $1.17. When we adjust for the non-core servicing rights impairment, the year-to-date EPS is slightly higher than the prior year for the first nine months. Total operating revenue was higher this quarter, improving by 4.4% year-over-year and by 1.8% from the linked quarter. Loan growth and the improvement in our asset mix with securities now a less material portion of our earning asset base were the major factors in the improvement. As Mark touched on, we had an impairment in our mortgage servicing rights revenue this quarter as the significant volatility in rates, and especially prepayment speeds, reduced the valuation of our servicing portfolio. At quarter end, the servicing portfolio was valued at $1.41 billion, up from both the prior year and the linked quarter. Additionally, we completed the sale of a vacant lot in the quarter that resulted in a gain of $205,000. On net interest margin, the net interest margin improved, ending the quarter at 3.19% on a tax-equivalent basis, reflecting a 10 basis point increase from the prior year quarter and higher by 8 basis points from the linked quarter. From that linked quarter, the yield on earning assets was up 14 basis points, and the rate on interest-bearing liabilities was up 6 basis points. As we indicated last quarter, we felt that the second quarter was the low point of our margin compression. We feel that the remainder of 2024 and 2025 will show gradual improvement in the NIM as rates decline and our asset mix adjusts. The efficiency of our balance sheet has always been focused on maintaining a healthy loan-to-deposit ratio, which was stable at 89% and has improved our asset mix while driving margin revenue higher. Loans as a percentage of assets now stand at 73.9%, stable to the prior year. Our investment portfolio is calibrated to support projected loan growth and provide a base level of liquidity. We continue to utilize the contractual runoff of the portfolio, approximately $25 million annually, to reinvest either at the Federal Reserve daily or longer-term in our growing loan book. Every incremental dollar of maturity adds at least 300 basis points in margin currently. On expense management, given the commission-driven nature of several of our business lines, expense growth was in line with or just slightly below revenue growth and played a key role in stabilizing our profitability. This quarter, when we adjust for non-core revenue and expense items, revenue grew 3.3 times faster than expenses compared to the linked quarter. Now as we turn to balance sheet management. Due to our deposit growth, we have no overnight wholesale funding. We do have a small level of fixed-term wholesale funding that provides us with some stable funding. We have held back on any new bond commitments and are comfortable with excess funding invested at the Fed until we see a few more quarters of our loan pipeline. We also know that Marblehead will provide another boost to liquidity in the first quarter of 2025 with approximately $35 million in lower-cost liquidity. On our investment portfolio strategy, we've not added any bonds since early 2022 and have seen the portfolio decline by $57 million since the peak, now falling below 16% of total assets. Our AOCI improved by $9 million in the quarter and has responded favorably to the yield curve. Regarding credit losses, we took provision this quarter of $200,000, as our CECL model, coupled with funding for several commercial loan commitments in the Columbus market required a small increase in provision expense. Given the quality of our portfolio, we are comfortable with a slight reduction in our reserve ratio that stood at 1.48% at quarter end, with nonperforming loan coverage of nearly 300%. As we indicated last quarter, the three credits that were added to non-performing are all well secured, and we anticipate resolving these credits relatively quickly and without material write-downs. Our capital strength and shareholder value were positively impacted by rate reductions on our AOCI in the quarter, with total capital ending the quarter at $132.8 million, or 9.5% of assets. When we exclude all of the remaining AOCI impact, the equity to asset ratio improved to 11.3%. Stock buybacks continued in the quarter at a much higher pace, repurchasing over 66,000 shares at levels at or near tangible book value. This is the highest level of shares repurchased in five quarters. Even with our capital needs for growth and the Marblehead acquisition, we have modeled share repurchases to continue without a material decline in our capital ratio. I will now turn the call back over to Mark.

Thank you, Tony. Certainly at a high level, our progress this quarter has positioned us nicely to finish the year strong as our asset mix changes, the yield curve steepens potentially, and margins expand marginally, and profitability improves. We announced a dividend increase this week to $0.145 per share, which is nearly a 35% payout ratio with a yield of approximately 2.95%. We have been making solid progress on the Marblehead acquisition that we announced previously. We are very excited to add their client base to our portfolio in early 2025, and we continue to believe it will be solidly accretive to our earnings and to our franchise value. In closing, while the current economic environment presents some challenges, we remain optimistic about our prospects for continued growth. Our diversified business model, strong client relationships, and conservative risk management, we think will allow us to continue delivering solid results for our shareholders into 2025. Now, I'll turn the call back over to Carol for questions and answers.

Dave, we're ready for questions now.

Okay. We will now begin the question-and-answer session. Our first question comes from Brian Martin with Janney. Please go ahead.

Hi, good morning, guys.

Good morning, Brian. Nice to have you with us.

Yes, thank you for having me. Mark, you've mentioned some new hires and new talent. I'm not quite sure if that was referring to the mortgage side, the lending side, or both. Could you provide a brief update on any recent changes?

Yes, we've added, again, two MLOs in the Cincinnati market, and they're up and running and producing. We've added some additional talent in the back room in the quality control department. We've added a new leader, so to speak, for the Wealth Management division to take a little bigger bite and presence out of the 401(k) market. That individual is onboard. We've actually brought in some additional talent in the commercial arena. Of course, with Adam Russell that we talked about some time ago, I think probably last quarter, again, he's doing very well and bringing on roughly $50 million this year and also an additional administrative assistant for him, who's now leading the charge and leading our commercial loan processors in our market. So that pretty much comprises the additional talent, but some back room to make sure that we have the compliance piece covered nicely as well as the impending volume.

Got you. Was the commercial producer working in the Columbus market or was it for all markets, overseeing things?

Yes, primarily, we believe we can grow significantly in the Columbus market. While we're excited about the opportunities, we're also exercising caution due to the numerous projects in that area. We want to ensure we adhere to our careful underwriting process. Regarding our projections, we feel optimistic about achieving $50 million. Fort Wayne has been positive for us, but it's essential that our other markets also improve. We need to diversify our growth to ensure balance in 2025.

Got you. Okay. That's super helpful. And then just on the loan growth outlook, I think you seem pretty optimistic heading into the fourth quarter and then kind of carrying that momentum into 2025. Is that pretty accurate where loan growth ought to be in the mid- to upper single digits in terms of how you're thinking about the growth?

Well, sure. As you know, we've historically been in that high single digit, and that's where we love to be. We don't want to be the market leader. We don't want to take everything. But single high digit is where we like to be. We've exceeded that a little bit this past quarter at the 9-plus percent kind of thing annualized. But we've had a really good pipeline. We've got certainly loans that are on a construction basis or a little bit of a development that has yet to draw up. But we remain optimistic about all of our markets. But clearly, expanding into the Columbus market with a new leader has certainly put a bit of a charge in our commercial production.

Got you. Okay. That's perfect. On the mortgage side, you seem quite optimistic about a 20% growth outlook for 2025. This appears to take into account new entrants into Cincinnati and the current rate environment. Are these the main factors driving that outlook? Do you believe that a 20% production growth is realistically achievable?

Absolutely. We've made it clear that our focus is on the $500 million range, which is what our operations are designed for. We're working diligently to maintain the margins we've experienced on sales, which fuels our interest in Freddie Fannie deals as well as some private client loans. We certainly aim to return to the $350 million to $400 million range next year. However, we can't predict payoffs or the rate environment, and the insights from November 5 will help us understand what 2025 may look like. The mortgage business is a vital part of our company. We value the households we acquire and, more importantly, the chance to cross-sell into those households. Over the past decade, we've expanded from a few hundred to several thousand households, and we’re pleased with our position.

Got you. Okay. Yes. And then let's see, the other one was just on for Tony on the margin. It sounds as though the base was built last quarter or the second quarter, and the outlook is pretty favorable. Can you just talk about some of the dynamics of how, if we do see a steady easing cycle here, you think the margin plays out and how Marblehead contributes to that baseline would be helpful.

Yes. I think, Brian, the margin expanded a little bit wider this quarter than I had really thought. I mean, I thought we'd be maybe 5 basis points, 6 basis points up, kind of 8 basis points over the linked quarter was a pleasant surprise. I think the mix is moving a little bit faster in our favor. I think we'll add another $25-ish million of loan growth here in Q4, kind of similar to what we had in Q3. On the funding side, I think as Mark said, it's been gradually increasing, but certainly at a slower pace. Most of our rollovers, most of the market, other than a few outsiders, have kind of settled in where we are today. So as the CD book rolls over, there's not as much of a significant increase. The key in 2025 is contractual maturities, getting to a high single-digit growth rate on the loans, which will improve our mix and really stable funding. I think we'll get our margin to the 330 range by the time we're sitting here 335 by the end of 2025.

Okay. And that kind of contemplates Marblehead in there with that as well?

Yes. Interestingly enough, their loan book is significantly higher than ours on the loan pricing model. Their deposit base is similar to ours and actually, the funding is a little less than ours. The key is we're going to reposition that portfolio and take their $35 million of kind of 2.5% bonds and figure out what we can do. If we can rapidly get that in the loan book, it's going to be significant. If it's just kind of a Fed funds, and we stay roughly in this range, you're going to add to 250 basis points to 300 basis points of margin improvement for them out of the gate.

On $35 million, Tony.

Okay. And the transaction right now, time-wise as for how you're thinking of when that closes, what's the timeline there? Late first quarter. Is that how you're thinking?

Yes. I think we're deep in the application process. They obviously need their shareholder approval, which all signs suggest is full steam ahead. We'll get our approval, hopefully here prior to the end of the year. We'll close it, call it, late January, first part of February, and we'll have it on our books for 11 months here in 2025. I don't think we'll actually convert the clients until later in the year based on the system constraints we have with our provider. But I think out of the gate, we'll be able to get them onboard and have that accretive to our earnings base.

And Brian, their shareholder meeting is on the 30th, and they've already received roughly about 85% of their proxies positive. So we're steaming ahead nicely. We just have to get the Fed onboard here.

Yes. Okay. That sounds good. And maybe just one or two others just on the expense side. You guys have done a great job managing and controlling expenses. Just how do we think about the next couple of quarters or just into 2025? How are we looking at the run rate, including Marblehead and what that adds and how you're thinking about the expense capabilities?

I believe we had $11 million in expenses this quarter, which I consider a solid baseline. We're aiming for $70 million to $90 million in mortgage amounts each quarter, so expenses may shift slightly in relation to that figure. I don't expect a significant increase in talent acquisitions from our current level, but we will see a moderate year-over-year increase. Like many banks of our size, we have ongoing technology needs and constraints that require investment for improvement. The challenge is to drive revenue growth to balance those. We're dedicated to keeping expenses in check with growth expectations slightly below our expense growth, and that's our goal.

Brian, we are working to balance the increase in expenses with some strategic growth opportunities in nearby markets. Some competitors are exiting certain markets, which has created disruptions that we plan to leverage. It may involve incurring some costs before we see revenue, but we are keeping this in perspective.

Got you. No, that's helpful. And Tony, just one back for the margin, just so I kind of think about it. The margin expansion next quarter, next year, just rolling forward, inclusive of the rate outlook. I mean, I guess it really is predicated on getting the loan growth because right now, it sounds like the pickup you're getting absent any more competitive loan pricing is kind of in that 300 basis point range. So really, the way to think about the margin is the funding costs are flat to down, and really, it's just putting the liquidity from Marblehead into work at higher-yielding loans and just kind of remixing. I guess that's kind of what drives the margin expansion here.

Yes, absolutely. I think my base model is kind of stable funding costs. Look at kind of $25 million of bond amortization at a 2.75% to 3% range. At a minimum, you get 5.5%, which doesn't get you a whole lot of margin improvement. However, if we can get $85 million of loan growth, call it, at that 8.5% next year, that will not only take up that liquidity but the $35 million from Marblehead. We're not stressed on the funding side to have to go to higher pricing to fund that growth. We should be able to remain fairly stable with our current base and not have to engage in the funding chase. I think 2025 is an excellent window for us to really improve margin with loan growth; that's the critical factor for us next year.

Got it. Okay. Well, it sounds pretty positive, and the momentum on the loan side heading into 4Q, the rate environment, and the new market mortgage certainly give you some tailwind there in terms of the outlook heading into 2025. So congrats on a nice quarter and thanks for taking the questions.

Thanks, Brian.

Thanks for joining, Brian.

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, thank you all for joining us this morning. We certainly look forward to having you with us in January for the update on the final quarter of the year and the full year of 2024. Thanks for joining, and goodbye.

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