Earnings Call Transcript - SBFG Q2 2024

Operator, Operator

Good morning, and welcome to the SB Financial Second Quarter 2024 Conference Call and Webcast. I would like to inform you that this conference call is being recorded and that 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 Sarah Mekus with SB Financial. Please go ahead, Sarah.

Sarah Mekus, Investor Relations

Thank you. 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; and Steve Walz, 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 are 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.

Mark Klein, Chairman, President and CEO

Thank you, Sarah, and good morning, everyone. Welcome to our second quarter 2024 conference call and webcast. Highlights for this quarter include: Net income of $3.1 million, up 1.2%. Diluted earnings per share increased to $0.47, a 6.8% increase from $0.44 that we delivered in the prior-year quarter. Net interest income totaled $9.7 million, a decrease of 1.7% from $9.8 million in the second quarter of the prior year. Total loans increased to $1.01 billion, up over $20 million or 2.1% from the prior-year quarter and higher compared to the linked quarter by nearly $14 million. Return on average assets increased to 0.93%, up 2 basis points, while return on average equity declined slightly to 10.16%, down 16 basis points. Tangible book value per share increased to $15.26, up $1.45 or 11% compared to the prior year, while adjusted tangible book value increased to $20.02. Our mortgage banking revenue increased by 18.8% to $1.8 million this quarter, demonstrating our strong operational performance compared to the same period last year. Mortgage originations for the trailing 12 months were $218 million, delivering a servicing portfolio now of $1.39 billion or an increase of approximately 2.7% from the prior year. Total interest expense amounted to $6 million, marking a slight decrease of 2% from the linked quarter. Operating expenses for the first six months were also down approximately 1% compared to the prior-year same period. And finally, asset quality metrics continued to improve. Our strategic path forward remains hinged on our five key initiatives: First, revenue diversity. Our mortgage banking net revenue increased by 18.8% to nearly $2 million from the previous year, demonstrating our initiatives to balance net interest income with fee-based revenue amidst shifting market conditions. Organic growth for scale: We achieved a 5.6% annualized growth rate in our portfolio this quarter. We have a very strong pipeline in a number of markets with the Columbus team providing the bulk of the expected growth for the second half of 2024. Deepening relationships/more scope: Our deposit base grew by $44 million to $1.12 billion. The Ohio Homebuyer Plus program that I mentioned briefly last quarter has been quite successful. To-date, we have opened nearly 400 accounts with balances in excess of $40 million at a weighted rate well below our margin and the market. We are especially encouraged that over 25% of those accounts are new relationships to our bank. Excellence in operations: We have developed a stronger bench to ensure durable operational efficiencies. As a result, we've experienced a modest 3.2% increase in noninterest expenses compared to the prior-year quarter, delivering a net noninterest expense ratio of negative 1.87% with still a strategic goal of zero. Asset quality remains robust evidenced by a low non-performing asset ratio of 0.39% of total assets. While this metric has had a minor shift, we remain confident of our diligent approach and continued commitment to prudent portfolio administration. Our classified loans balances declined over 25% compared to the prior-year period. Now looking just a bit closer at revenue diversity, our mortgage businesses originated over $75 million in volume, an increase of nearly 15% from the $65 million in the prior-year quarter. Mortgage sales reached over $55 million, representing 74% of total originations. While certainly below our capacity, we feel better about the direction of this business line. Our Indianapolis office has delivered nearly 30% of our total volume thus far this year, and we're also seeing opportunities to add mortgage originators throughout our entire footprint. We're also excited to confirm that we will be venturing into another dynamic Ohio market, Cincinnati, with a seasoned market leader that will not only produce but will also work to build out a team of local professionals as well. With his background and market presence, we are confident that the residential real estate lending levels will rival those of our other growth markets of Columbus and Indianapolis in fairly short order. Noninterest income stabilized at $4.4 million, benefiting from gains in mortgage servicing rights and customer service fees. Our title insurance business and wealth management services, despite market challenges, remain key areas for future growth. We believe the growth trajectory in both divisions will be positively influenced by our holistic approach to client care, which includes coordinated outreach and referrals across all regions and business lines. On the scale front, deposit growth has accelerated. This quarter we were up by $3.1 million compared to the linked quarter and up 4.1% from the prior year. Deposit costs have slowed as total interest expense declined from the linked quarter for the first time in over two years. We will continue to add clients and expand this portfolio well into the third and fourth quarters. Loan growth is certainly gaining traction. While not up to our historical standards of high single-digit growth on a year-over-year basis, did show growth from the linked quarter, and we are starting to see the positive impact to our pipeline of the calling efforts from the last several years. Over the last 12 months, we have had loan production of $164 million, excluding residential mortgage lending, and right in line with total production from the prior 12-month period. Given our diverse markets, capacity and commitments, growing our loan portfolio remains a top priority as we move through the second half of 2024. A strong equity foundation is certainly a prerequisite to our growth, and this quarter, we strengthened it. Our equity to asset ratio grew to 9.35%. Our tangible equity to tangible assets ratio increased to 7.2% and our common equity Tier 1 ratio for the bank remains strong at 13.89%. We continue to embrace technology to enhance client engagement. We have further integrated our corporate sales champion and new contact center with more fintech platforms, aiming to deepen our penetration and improve our level of services per household. Emphasis continues on organic expansion opportunities. Significant resources have been added to our management team in the Greater Columbus market where we anticipate accelerated balance growth in both commercial real estate and commercial and industrial arenas. We're optimistic about growth as we see a strong pipeline ahead with meaningful contributions to future revenues as we assist our small business clients with proper balance sheet structure to optimize cash flow. Despite the challenges posed by higher interest rates, our mortgage business continues to perform quite well. In addition to the gain on sale revenue of $1.3 million achieved this quarter, revenue from our servicing portfolio was a healthy $862,000. We sold over 74% of our originated volume in line with our traditional levels with gain on sale yields on par with historical averages at 2.3%. This approach of an 80-20 sale to portfolio origination level not only supports our clients' needs but also ensures the sustainability of our mortgage operations. The change in the market dynamics is evident in that over 94% of our volume thus far in 2024 has been for purchase or new construction transactions. Refinance volume is certainly a distant memory. Finally, on asset quality, clearly a focus of ours since the Great Recession. In fact, net recoveries were positive this quarter and underline our risk management strategies. Our proactive internal loan review program continues to play a crucial role in early identification and mitigation of potential client stress. The coverage of our non-performing portfolio remains comprehensive, showcasing our commitment to maintaining a healthy loan portfolio while building ample reserves as well. Now, I'd like to turn the call over to our CFO, Tony Cosentino, for some additional comments on our quarterly performance.

Tony Cosentino, Chief Financial Officer

Thanks, Mark, and good morning, everyone. For the second quarter of 2024, we recorded net income of $3.1 million, with an EPS of $0.47. When we combine that with our first quarter performance, net income for the year is $5.5 million, delivering a full year EPS of $0.82, slightly higher than the prior year first six months of $0.79. Total operating revenue experienced a slight downturn, declining by 1% year-over-year, influenced by pressures from the competitive interest rate environment and money market fluctuations. We recaptured mortgage servicing rights revenue this quarter as a slight volatility in rates improved the valuation of our servicing portfolio. At quarter-end, the servicing portfolio was valued at $1.39 billion, up by 2.7%. Our net interest margin ended the quarter at 3.11% on a tax-equivalent basis, reflecting the asset mix shift and current market conditions. This represents a 12 basis point increase from the linked quarter. With funding costs stabilizing and contractual loan repricing approximately $150 million over the next six to nine months, we anticipate further improvements in asset yields and operating revenue. Cycle to date betas continue to be a net positive with the earning asset beta at 35% and the funding beta at 32%. The efficiency of our balance sheet has been a focus with an emphasis on maintaining a healthy loan-to-deposit ratio of nearly 92% and cost-effective capital management. This strategic focus has allowed us to support anticipated loan growth while maintaining a strong liquidity profile. Our investment portfolio is calibrated to support projected loan growth and provide a base level of liquidity. We project about $25 million in amortizations annually, which should reduce the portfolio to our strategic goal of 12% sometime in late 2025. The current portfolio's yield of 2.76% ensures that each dollar amortized will potentially drive interest income higher by a minimum of 300 basis points on the redeployed funds. On expense management, which remains a strategic focus, our noninterest expenses were flat when we adjust for the commission expense related to the 15% increase in mortgage volume. Total expenses for the quarter of $10.7 million remained relatively consistent with the total expenses recorded in the past four quarters, and we remain focused on controlling our expense base. Our strategic initiatives in loan growth and deposit management have been supported by the effective management of our wholesale funding. Specifically, deposit growth and portfolio pay downs have allowed us to eliminate over $46 million in variable rate average cost FHLB borrowings of 5.5% in the last 12 months. The balance sheet reflects stable figures for FHLB advances and subordinated debt as compared to the linked quarter. Our investment portfolio strategy involves strategically realigning our investment portfolio to enhance liquidity, which is crucial for supporting anticipated loan growth. This approach is visible in the minor adjustments in our available for sale securities ensuring that we diversify asset types to bolster financial stability and prepare for future opportunities. On credit losses management, our proactive risk management strategies are underscored by our steady allowance for credit losses currently at $15.6 million, showcasing our commitment to financial prudence and risk mitigation. The strength of our capital structure remains robust, evidenced by our shareholders' equity totaling $125.5 million, up nearly 7% compared to the prior year. We further enhanced shareholder value this quarter by continuing to repurchase our shares at average prices below tangible book value. I'll now turn the call back over to Mark.

Mark Klein, Chairman, President and CEO

Thank you, Tony. Overall, it was a very nice quarter for us. We made substantial progress across a number of fronts and saw meaningful contributions from each of our business lines and regions. I'm excited for the opportunities that our new team in Columbus will deliver, and I'm optimistic that the Cincinnati market through the efforts of our new leader will deliver results well in line with our experiences from having entered other growing markets like Columbus and Indianapolis. Now, we'll open the call up for questions.

Operator, Operator

Our first question comes from Brian Martin with Janney Montgomery. Please go ahead.

Brian Martin, Analyst

Hey, good morning, guys.

Tony Cosentino, Chief Financial Officer

Hey, Brian.

Mark Klein, Chairman, President and CEO

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

Brian Martin, Analyst

Yes, thanks. So, I joined a minute or two late, Mark, so I may have missed some of your comment on. But I was just wondering, just kind of on your loan growth outlook, I know I think you mentioned maybe being optimistic on that as you look at the back half of the year or just into next year, but can you just talk about what your outlook there is? Just kind of what you're hearing from your customers in terms of demand or opportunities out there?

Mark Klein, Chairman, President and CEO

Sure. It seems like our loan clients have digested higher rates a bit more easily of recent. We continue to find good traction in commercial real estate. Commercial and industrial, as we all know, is a bit more difficult to find, but we still have a focus on that. With our new leader, new commercial lender in Columbus and support staff and treasury management individual in Columbus, our expectations remain high. We would like to think we can get back to that middle to upper single-digit growth level that we've been more accustomed to. Clearly, the funding is available and we have opportunities to find additional funding below the margin, so we're excited about the growth. Steve Walz, our Chief Lending Officer, is here as well. And I would ask Steve to opine a little bit on our pipeline and the projected growth.

Steve Walz, Chief Lending Officer

No. Certainly, Mark. I would agree with your comments earlier regarding the Columbus market and our expectations going into the second half of the year there in particular with the new leadership. This may also be more of an early '25 play, but I wouldn't overlook the addition of the dedicated experienced Treasury Management professional that we've added there. As Mark noted, commercial and industrial relationships tend to take time to cultivate, so I do think that's going to be meaningful. We had a few meaningful loans not closed by 6.30% that I thought would close during the first couple of weeks of July. So, I think we've got a good start into Q3 and as Mark noted looking good for the second half of the year to meet those expectations we had at the start of the year.

Mark Klein, Chairman, President and CEO

Yeah. Final comment, Brian. The single-digit growth would be okay, but the 8% that we averaged for seven or eight years almost consistently is certainly more in my appetite. So, we have a nice pipeline and we seem to be finding some really nice projects. So we continue to be pretty optimistic on that front.

Brian Martin, Analyst

That's good news. Thanks. Regarding the mortgage segment, it appears there have been some positive developments with the entrance into Cincinnati, and there may be potential benefits from the current rates. I'm curious about your outlook for the second half of the year in relation to mortgages and the contributions Cincinnati might make.

Mark Klein, Chairman, President and CEO

Sure. From a volume perspective, we're beginning to see movement that would get us to that $300 million run rate, which we once perceived as a minimum number of $500 million. The Cincinnati initiative has a lot of potential with a market leader who is well-versed and experienced, who will produce as well as build a team. We have enjoyed the opportunities in Columbus for over a decade and in Indianapolis for a few years, and I think Cincinnati will follow that same trajectory.

Tony Cosentino, Chief Financial Officer

Yeah, Brian. Our base case is a 6.5% to maybe a 6.25% 30-year rate, which likely delivers $130 million to $140 million of volume between now and the end of the year. If we can see another slight decrease below 6%, I think that could add another $35 million to $40 million. We believe the 250 to 275 basis points range for the full year is quite achievable.

Brian Martin, Analyst

Yeah. And then '25 even maybe a bit more optimistic if those rates come down, Tony, and Cincinnati begins to really gain some momentum?

Tony Cosentino, Chief Financial Officer

Absolutely. The leadership in Cincinnati could potentially bring in $15 million to $20 million a year, and if we can assemble a team like we have in Indianapolis, that could be an additional $50 million to $60 million in that region.

Mark Klein, Chairman, President and CEO

Additionally, we see an expansion in multi-family housing, which should provide more single-family financing opportunities. The supply is somewhat equalizing demand and coupled with the expected rate changes, this will certainly add momentum.

Brian Martin, Analyst

Got you. Okay. And then I guess also feels like the outlook for margin is optimistic. Tony, you talked about the borrowings going down over the last 12 months and the benefit from the homebuyer program. So, is the outlook on margin a bit better than expected?

Tony Cosentino, Chief Financial Officer

I've generally been pessimistic on margin improvement, but today, I'm more optimistic. We're seeing loans in the 7.25% range accepted by the market and we haven't identified as much deposit competition on rate as may have been previously anticipated. We think stabilization has arrived in our deposit base and contractual repricing will positively affect margins, so we expect a consistent positive move in margins moving forward.

Mark Klein, Chairman, President and CEO

Indeed, with a 92% loan-to-deposit ratio, we can be selective. We're seeing higher-rate deals that we've been competitive on, and there’s good balance on where we see margins going. We're clearly encouraged by the slow down in interest expenses.

Brian Martin, Analyst

That was positive in the quarter. Tony, just that repricing, what was the — it's $150 million that reprices, maybe 250 basis points to 300 basis points higher, is that what you said over the next 12 months?

Tony Cosentino, Chief Financial Officer

Yes.

Brian Martin, Analyst

Okay. So, $150 million at 250 basis points to 300 basis points higher coming in there. So, okay. And then, just as far as the credit outlook, it still feels pretty healthy in terms of how you're thinking about the reserve levels. I guess, is the expectation that the reserve coverage may moderate a bit given the favorable trends you're seeing?

Mark Klein, Chairman, President and CEO

From a high level, we've seen a bit of stress in a couple of relationships, but we are well-secured and optimistic on where those will go. Tony and I have slightly different views on reserves, but we're both optimistic about credit quality and our review process. Steve, could you add some context on this?

Steve Walz, Chief Lending Officer

We had a little uptick in delinquency but nothing unforeseen. Our internal loan review processes are robust. Our credit standards have remained unchanged, and we are confident in our credit culture. The reviews of our commercial real estate portfolio show strong leases and quality principles behind them.

Mark Klein, Chairman, President and CEO

Thanks, Steve.

Tony Cosentino, Chief Financial Officer

We ended the quarter at $155 million reserve to loans, which might decline with loan growth, but we are comfortable in the $130 million range given our credit risk portfolio. We think we’ll head toward the mid-$140 million range eventually.

Brian Martin, Analyst

The expectation seems like it's just a timing issue as you get those resolved and not really any significant loss content is what it sounds like. Is that fair?

Steve Walz, Chief Lending Officer

That is a fair statement. Those are generally well-secured loans or supported by SBA guarantees. The challenge is that any issue will take time to resolve, but we don't have loss concerns.

Brian Martin, Analyst

Yeah. Okay. All right. That's all I had guys. A lot of encouraging things there, so I appreciate it.

Mark Klein, Chairman, President and CEO

Thanks, Brian.

Tony Cosentino, Chief Financial Officer

Thanks, Brian.

Operator, Operator

Seeing no further questions, I will now turn the call back to Mark Klein.

Mark Klein, Chairman, President and CEO

Thank you. Once again, thanks for joining us. I look forward to speaking with you in October for our third quarter 2024 results. Thanks for joining. Goodbye.

Operator, Operator

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