Earnings Call Transcript - SBFG Q1 2022

Operator, Operator

Good morning, and welcome to the SB Financial First Quarter 2022 Conference Call and Webcast. I would like to inform you that this conference call is being recorded. 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, Management

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. Joining me today are Mark Klein, Chairman, President and CEO; Tony Cosentino, Chief Financial Officer; and Steve Walz, Chief 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 advised 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. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. I will now turn the call over to Mr. Klein.

Mark Klein, Chairman, President and CEO

Thank you, Sarah. Good morning, everyone. Welcome to our first quarter 2022 conference call and webcast. Last night, we issued our earnings for the first quarter, and we were pleased with the start of the year to what we all know may be a challenging year for many things. In the midst of these headwinds, we remain focused on expanding households for various scales, providing more services than those households, and remaining the preferred provider of additional services to our now over 36,000 households. At the same time, we were especially pleased and honored to be included in KBW's Bank on a roll of high-performing banks for the second year running, included in the select group of publicly traded banks this year. This is a strong statement to our earnings trend over the last 10 years. Highlights for this quarter include a $900,000 pretax mortgage servicing right recapture, and net income of $2.81 million, down from $4.3 million from the prior year quarter. When we adjust for non-GAAP impact in 2022, net income was $2.1 million. Earnings per share was $0.40, which is reduced to $0.30 per share when adjusting for the servicing rights recapture. Net interest income of $8.5 million is down nearly 12% from the prior year, driven by the impact of PPP forgiveness in 2021. Adjusting for the PPP impact results in net interest margin being generally flat to the prior year. Loan balances adjusted for PPP were up from the prior year quarter by just over $56 million in the linked quarter, up $28 million. Deposits continue to grow, up $25 million from the linked quarter, $18 million from the prior year. Expenses are down $50,000 due to lower mortgage commissions and higher vacancy levels. Mortgage origination volume was $97 million, down 38% from the prior year and 23% from the linked quarter. Asset quality metrics improved from both the prior year and linked quarter, with our level of nonperforming assets remaining strong at 42 basis points. We are comfortable with a zero provision during the quarter due to our strong asset quality metrics, higher reserve level, and negligible net charge-offs for the quarter. As conveyed in our annual meeting and many quarters before, we continue to reiterate that the future success of our company is driven by our five key initiatives: growing and diversifying revenue, achieving more scale with organic growth and opportunistic M&A, providing more products and services for our client base, excellence in operations and customized client communication, and of course, maintaining asset quality. Revenue diversity remains key, and Peak Title continues to provide support for residential mortgage efforts while expanding its reach into more clients outside of the State Bank. We completed the purchase of a small title agency in the Northwest Ohio region in 2021, and the integration into these markets with our lending team has been very well received. Additionally, we now have a commercial lender to complement our existing residential real estate and title insurance business in Indianapolis. We were able to do a bit of commercial title business in the quarter to supplement the decline in residential buy. To ensure our commercial traction remains strong, we have even increased our pay to our vendors to ensure they utilize our own title agency, and the results are beginning to pay off. Although mortgage originations in the quarter were below $100 million, we feel good about the level of production in all of our markets given the headwinds from rising rates and continued compressed housing inventories. Over the last 12 months, we have still delivered nearly $550 million in total mortgage origination volume. Our private client group mortgage product, developed in 2021, has enabled us to book approximately $57 million over the last 13 months, which we would not have achieved without launching this initiative some time ago. Our Wealth Management Group continues to be a key differentiator for our company, particularly as some of our competitors have adopted a more remote presence in this high-touch business line. Total assets under management ended the quarter at $561 million, and revenue generated for the quarter was $955,000. Loan growth was positive in the quarter as we increased by $28 million from the linked quarter, net of PPP, or an annualized 13.6%. We have had positive adjusted loan growth in three of our last four quarters. Compared to the prior year, net loans were up 7.1%, nearly all the way back to our high single-digit, low double-digit rate that was more of a norm for our company pre-pandemic. Pipelines are building well in our markets. We recently named a new market and lending executive in the robust Indianapolis market. This market fits our product lineup well, and we expect to mirror the success that we have had in the Columbus market over time. Our deposit base expanded to $1.14 billion, up another $18 million from the prior year. With impending rises in rates, we expect that deposit pricing will return to some normalcy during 2022. Although we still have ample liquidity, our customers have slowly begun to spend, and we will focus on hedging rising rates and continuing to grow deposits, albeit with a mild duration extension and appropriate pricing. As we review last quarter, we sold $1.6 million in audio properties this quarter, which has reduced overall nonperforming assets by nearly $1 million for both the prior year and linked quarters. However, the level of nonperforming loans has increased slightly due to the slight increase in our residential loan portfolio. As our communities have begun to allow the foreclosure process to move forward, we expect to improve our metrics in the coming quarters. As I stated earlier, record earnings in 2021 from PPP and mortgage sales allowed us to build our reserve level, which now stands at $14 million and is 1.62% of loans. Net charge-offs were only $1,000 in the quarter, and we certainly have a runway within our reserves to easily handle anticipated loan growth throughout the year. Now I’ll ask Tony to give us a few more details. Tony, please provide insight on the quarterly performance.

Tony Cosentino, Chief Financial Officer

Thanks, Mark. Good morning, everyone. For the quarter, as Mark stated, we had GAAP net income of $2.8 million or $0.40 per share. Our earnings were impacted by the $900,000 recapture of our prior mortgage servicing rights. Adjusting for this recapture item, net income would have been $2.1 million for the quarter. Our recent highlights include operating revenue down 30.5% from the prior year and down 8.9% from the linked quarter. PPP forgiveness and the impact of a slowing mortgage business impacted our results. Operating expenses were down nearly 1% from the prior year. The margin revenue was down from the prior quarter due to a $1.3 million decline in PPP forgiveness revenue. We were able to grow core margin with loan growth and reduced funding costs that helped offset the rate declines in the loan portfolio. I’m going to break down further the first quarter income statement, starting with margin. Net interest income was down 11.9% from the prior year but would be up 1.8% when we adjust for the PPP forgiveness. Our average loan yield for the quarter was 3.9%, decreased by 70 basis points from the prior year, which is reduced by 43 basis points when PPP is excluded. Loan yield comparisons are impacted by the fees for PPP programs, which are nearly all realized. We own nearly $5 billion in fees and interest for the program, primarily taken during 2021. On the funding side, we reduced the cost of our interest-bearing liabilities from the prior year. The rate on our interest-bearing liabilities for the quarter was 39 basis points, down from the prior year by 11 basis points and down from the linked quarter by 1 basis point. Net interest margin of 2.68% was down 53 to 21 basis points from the prior year and linked quarter. Excluding PPP, margin is down by 25 and 9 basis points, respectively. Excess cash on our balance sheet continues to impact our margin, but we are optimistic that extended loan growth and increased consumer spending will improve our balance sheet mix. Total noninterest income of $5.8 million was down $5.1 million or 47% from the prior year, reflecting lower mortgage volume and a $1.8 million negative swing in servicing rights. If we remove the impact of the mortgage business line from fee income in both 2022 and 2021, other noninterest income would be up 8.8%. Total residential gains on sale came in at $1.7 million, which was 2.3% on our sold volume of $72.2 million. As expected, average yield on loan sales tightened, making this quarter equally difficult due to the rapidly rising rate. Our hedge position allowed us to lower the impact of the rate, and we believe this is the bottom of the curve on yield. Our servicing portfolio is now nearly $1.4 billion with over 8,600 loans and provided revenue for the quarter of $862,000. The market value of our mortgage servicing rights improved significantly this quarter with a calculated fair value of just 105 basis points, up 20 basis points from the prior year and up 12 basis points from the linked quarter. We now have a servicing right balance of $13.1 million with remaining temporary impairment of $600,000. Rising rates should provide additional momentum for future recapture. Total operating expenses this quarter were $10.9 million, which were down $50,000 from the prior year and down $780,000 or 6.1% in the linked quarter. Our headwinds include rising labor costs and technology spending, offset by open employment positions and production base continuing into May. Loan outstanding at March 31, 2022, stood at $850 million, which was 63.7% of total assets of the company. As we have discussed in prior quarters, deposit levels are well beyond expectations, certainly impacting total asset growth. We continue to optimize our balance sheet as appropriate and are optimistic that our team of commercial lenders and treasury management staff will identify additional opportunities to rebalance our asset mix. As we look at our capital position, we finished the quarter at $132.6 million, down $11.3 million or 7.9% from the prior year, with our equity-to-asset ratio standing at 9.9%. On a per-share basis, tangible book value of $15.31 is down compared to the first quarter of 2021 due to the bond portfolio unrealized loss. If we adjust for ROCE year-over-year, tangible book value has increased by 2.6%. The buyback continued at a brisk pace this quarter with 131,000 shares repurchased at an average price of $19.60. Total non-performing assets of $5.6 million or 42 basis points were down $900,000 for both the prior year and the linked quarter. Included in our numbers are $700,000 in accruing restructured credits. These restructured loans elevate our nonperforming level by 6 basis points, and absent them, our total nonperforming asset ratio would be reduced to 36 basis points. Provision expense for the quarter was zero, and our loan loss reserve was up from the prior year by $500,000 or 3.6%. Now I’ll turn the call back over to Mark.

Mark Klein, Chairman, President and CEO

Thank you, Tony. A solid start to another year, albeit with a completely new conversation of higher inflation, higher rates, a steepening yield curve, and higher mortgage rates, which will drive more stable operating revenue and improved asset mix. And this is going to be great news regarding our inclusion in the KBW on their roll-out. We acknowledge the two events this quarter that have continued our pattern of returning meaningful earnings to our shareholder base. First, in February, as you know, we announced a 5% stock dividend. Just this week, we announced a common stock cash dividend of $0.12 per share, which equates to an approximate payout ratio of 30% and now a dividend yield of 2.44%. We continue to look for ways to prudently return capital to our shareholders. Now I’ll turn it back to Sarah for questions.

Sarah Mekus, Management

Thank you, and now we’re ready for our first question.

Operator, Operator

Today’s first question is from Brian Martin at Janney Montgomery.

Brian Martin, Analyst

Maybe just a couple for me. Just if you can talk about the news on the Indiana expansion and what the outlook is there. Can you share a little bit more about what the plan is there? I missed some of what you said, but I heard you’re going to Indiana, and just what capacity and how are you thinking about that over time?

Mark Klein, Chairman, President and CEO

Sure. We’ve talked about for a while. As you know, we have five mortgage producers now in Indiana, and they’re doing some good work. We had committed to expanding that region, as well as the Columbus region, and we now have an individual who has been in that market for his entire life, more than 20 years in the commercial area, with a nice portfolio of PCG lending balances. We’re happy to have him with us. He has larger bank experience and some community bank experience, and we’re looking for $67 million growth in the market in the last half of the year.

Brian Martin, Analyst

Got you. Okay. So the plan would be just to build a team around this person? Is that kind of over time what you’re thinking?

Mark Klein, Chairman, President and CEO

Yes. As you know, we started in the Columbus market on the commercial side and then expanded in residential. We’re looking at synergies between the current team we have there, which now includes a title insurance specialist, and this new individual. We’re looking forward to some great results like we have had in the last 12 to 13 years in Columbus.

Brian Martin, Analyst

Okay. And then maybe just high-level on the mortgage outlook, given what we’ve seen happen here. I know your model is more purchase-based, but you are benefiting from refinance activity. Just how are you thinking about the volume change and gain on sale margins? It sounds like they’re obviously a little lower across the board in the industry. Any context you can provide on that?

Mark Klein, Chairman, President and CEO

Yes, Brian. Our entry into the PCG world has been beneficial. It's given us some great balances. While the sales gains have not been optimal, we continue to expand in both the Indianapolis and Columbus markets. We’re built for $500 million to $600 million. Our expectation is to deliver on our numbers through additional hires and a variable cost structure.

Tony Cosentino, Chief Financial Officer

Yes, Brian. As we look at volume, the market will likely be down. Our numbers are down roughly 38% year-over-year, aligning with others reporting similar figures. I believe the first quarter was a bit of an anomaly due to the craziness with rates. I envision settling into a 25% year-over-year change in volume. We aim to take advantage of opportunities as competitors retreat. However, the yield for this quarter is likely to have hit the bottom and should trend upward, as we have a strong team capable of converting contracts. Our expectation is to return to a yield of 2.4% to 2.5% by year-end.

Brian Martin, Analyst

Got you. Just to be clear, you’re suggesting a potential 25% drop compared to 2021 levels, is that correct?

Tony Cosentino, Chief Financial Officer

Correct. We did $600 million in 2021, so that indicates a potential target range of $450 million to $475 million, depending on staffing.

Brian Martin, Analyst

You sound optimistic about the loan growth front, having had good trends recently. Are you confident that these trends are sustainable? Any insights from your clients?

Mark Klein, Chairman, President and CEO

Yes, Brian. We stick to the fundamentals by making joint and individual calls. We're finding good traction even amid lower rates and intensified competition. It’s a diverse geography, with different markets contributing at various times. Loan growth remains sustainable across all markets.

Steve Walz, Chief Lending Officer

Yes, absolutely, Mark. I’d reiterate the broad-based growth we’ve seen in our footprint, both in rural and urban markets. Our pipelines today are as strong as they were coming out of fourth quarter, and we expect continued loan growth, barring any unfavorable shifts in the interest rate environment.

Brian Martin, Analyst

Your optimism seems to suggest attainable mid- to high-single-digit growth for the year, given the current pipeline. Would you say that's accurate?

Steve Walz, Chief Lending Officer

I think it is reasonable. It's hard to predict the third and fourth quarters due to the interest rate environment, but clients indicate steady conditions, and we're optimistic about loan growth assuming supplies for borrowers improve. Our management’s expectations for growth remain high.

Brian Martin, Analyst

And regarding the margin and rate hikes, how does the balance sheet look today? Are we likely to see growth, or is it primarily about remixing?

Mark Klein, Chairman, President and CEO

Good question. As we look at Q1, we were at a favorable margin. I believe we could see an 8% increase, targeting around a 3% margin number, depending largely on loan growth. Most of our portfolio is variable, which should respond positively to rate increases.

Tony Cosentino, Chief Financial Officer

Deposit growth may have peaked, and we likely need to be opportunistic moving forward. We have over $100 million in cash which we want to put to work. If we move that toward loans, the bond portfolio will likely stay stable. It’s all about rebalancing and taking advantage of opportunities for growth.

Brian Martin, Analyst

Looking at expenses, can you provide insight into whether the current expense levels are sustainable amidst market pressures?

Mark Klein, Chairman, President and CEO

We are encountering strong headwinds regarding staffing levels and costs, but we believe we have a strong structure in place. Competition may increase with rising labor costs, but we’re optimistic about adapting our model to have more commission-based incentives, which aligns us with production.

Tony Cosentino, Chief Financial Officer

Certainly, we are facing similar challenges. This structure has allowed room for growth while navigating our expenses. It serves as a solid base going forward based on expected mortgage volume.

Brian Martin, Analyst

Lastly, regarding the buyback and capital returns, are you anticipating continued repurchases in the near-term?

Mark Klein, Chairman, President and CEO

Absolutely. We still have a good amount of runway under our existing buyback authorization. We plan to maintain these quarterly levels for the upcoming two quarters, viewing it as a way to return value to our shareholders while remaining strategically flexible.

Tony Cosentino, Chief Financial Officer

It’s around 340,000 shares left in the program. We aim to remain opportunistic depending on pricing and market conditions.

Operator, Operator

If there are no further questions, I will now turn the call back to Mark Klein.

Mark Klein, Chairman, President and CEO

Thank you everyone for joining us this morning. We look forward to speaking with you in July or Q2 of this year. Have a great day.

Operator, Operator

Thank you, everyone. Today’s presentation has now concluded, and we thank you all for attending. You may now disconnect your lines. Have a wonderful day.